By Shane Wright
The first of three steps towards the largest shake-up to the Reserve Bank of Australia were taken almost seven years ago.
The independent review panel that this week released a 300-page dissection of the bank’s actions is grounded on three key periods – the first of which occurred in 2016.
Philip Lowe, then a 34-year RBA veteran, had been made governor in September of that year. Just weeks before taking up the position, the Reserve Bank had cut the official cash rate to what was then a record low of 1.5 per cent. It would stay at that level for a record 30 consecutive months.
Throughout this period, inflation averaged 1.7 per cent – well below the RBA’s own 2-3 per cent target.
While consumers and businesses are angry about high inflation, the opposite is also a problem.
As the review found, there was an economic cost to keeping interest rates steady. It could be measured in the ranks of the unemployed.
“Higher interest rates likely contributed to below-target inflation and higher unemployment than otherwise,” it found.
The review noted that it appeared the bank’s senior staff were worried that lower interest rates – which would have allowed the economy to grow faster and brought more people into work – would make their presence felt in the housing market.
A key concern was the level of Australians’ indebtedness. According to the review, the bank used one of its objectives – to contribute to the economic prosperity and welfare of all – to justify its decision to baulk at lowering interest rates any further.
But the review noted, using interest rates to target home prices and household debt is not a universally accepted policy.
“Whether these risks around household debt could have justified a higher level of interest rates is contentious,” it found.
There’s been plenty of anger directed at Lowe for saying in late 2021 that interest rates were unlikely to rise until 2024. But in late 2018, he was saying publicly the next move in interest rates was likely to be upwards.
It was this 2016 to 2019 period that contributed to then-shadow treasurer Jim Chalmers’ decision to openly call for a review of the Reserve Bank in early 2021. It was a substantial political risk but one that would be justified by yet-to-unfold events.
The next step to the review was the COVID-19 period when the bank slashed interest rates to a record 0.1 per cent and printed hundreds of billions of dollars to protect the economy.
As Lowe noted in his press conference this week, the bank board believed it was better to take out insurance to protect the economy rather than see just how many people lost their jobs due to the pandemic.
The review backed the call.
“The Reserve Bank board acted decisively and successfully at the onset of the pandemic to protect against more severe outcomes and support the economic recovery,” it found.
But it also found problems in how the board dealt with the growing number of programs used to support the economy.
The bank went much further than just slashing official interest rates to 0.1 per cent during the pandemic. It effectively bankrolled the federal and state governments with a $200 billion bond-buying program while also extending a $180 billion line of credit to commercial banks.
The review found the bond-buying program, aimed at keeping a lid on the interest rates on government debt, delivered modest benefits at a huge cost.
Over three years, the program is estimated to have boosted GDP by $25 billion and lifted employment by 37,000 people. But the cost due to the losses now being incurred by the bank on the program is estimated at between $35 billion and $58 billion.
One of the recurring themes of the review was the inability of the board to challenge the RBA executive and its proposals. It also found the board not willing to ask tougher questions.
“The review’s assessment is that the Reserve Bank board did not receive or request sufficient material to support a robust debate about whether further monetary support was required,” it found.
The final step towards the review is the current period of surging inflation.
While home buyers and business operators may focus on Lowe’s commentary about low interest rates until 2024, the review went to a much bigger problem – that the RBA missed the start of the largest surge in inflation since the late 1980s.
“While the RBA clearly could not have anticipated wars and natural disasters, the review believes that certain choices and judgments by the RBA made it more likely to misjudge the size and persistence of the inflation shock as time progressed,” it found.
Even more critically, the review found the bank was too fixated on looking for inflation pressures due to growing wages.
It was at its September 2022 board meeting, where interest rates were lifted half a percentage point to 2.23 per cent, that the Reserve Bank noted a lift in wages. By November, the bank was worried about a “prices-wages spiral”.
The bank had forecast an acceleration in wages growth through the 2010s. It never eventuated.
Now here it was, expressing concern about a surge in wages. But the review, in some of its harshest criticism, argued the bank was focused on the wrong issue.
“The RBA did not weigh highly enough risks that were becoming evident in other countries or the possibility that firms’ pricing behaviours could change in an environment of widespread price increases,” the panel members argued.
“Indeed, papers provided to the Reserve Bank board throughout 2021 contained little discussion of the risks posed by non-wage sources of inflation.”
Together, the three key stepping stones have led to the review, released by Treasurer Chalmers, that maps out the most significant changes to the institution since it moved to inflation targeting in the early 1990s.
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