RBA review: Westpac’s Bill Evans says challenges remain on interest rate policy settings

The near-term unemployment rate will be difficult to balance as the bank pursues its specific inflation target, Westpac’s Bill Evans says.

RBA Governor Philip Lowe with Westpac chief economist Bill Evans at the National Press Club in April. Picture: NCA NewsWire / Gary Ramage.

A looming power shift from the Reserve Bank to external members of a new monetary policy board adds uncertainty to the interest rate outlook after a long-awaited independent review.

While backing most of the 51 recommendations – all of which were immediately endorsed by the Government – some of the nation’s leading economists have concerns on how the structure and operation of the monetary policy board will work in practice.

Westpac chief economist Bill Evans, says a proposal to cut the number of board meetings from 11 to eight a year, and follow every meeting with a press conference, is “not an unambiguous improvement” for communication and the understanding of the monetary policy process.

“While press conferences will allow direct questions along the lines of what we observe at the FOMC press conferences — which is an advantage — the trade-off will be that we will only receive eight board Minutes per year,” Mr Evans said.

The minutes of RBA board meetings are a “rich source of information” on the evolution of monetary policy, and getting these on a less frequent basis will be a “disappointment”.

On the composition of the policy board, Evans noted that its six external members will be “much more closely linked” to the RBA, spending on average around one day per week, at the central bank, while still retaining their current employment.

“If that one day guideline is to be a condition of membership it will probably preclude the chief executives who have held board positions in the past given the demands on their time,” Mr Evans said.

He noted that it would also exclude anyone working in the financial markets — due to the obvious conflicts involved — and “may lean heavily on those people such as academics and retirees who are not conflicted and can find the necessary time to spend at the bank.”

Mr Evans said that would carry the “obvious disadvantage” of not being able to bring people into the monetary policy board with current relevant practical experience to the table.

According to Westpac’s Mr Evans – who once ran the entire research department of the RBA – it will also be “very important to get a balanced make-up of the Monetary Policy Board”.

The track record of the so-called “Shadow Monetary Policy Committee” — run by the Australian National University – appeared consistently hawkish, and is therefore “an important warning around the risks of biasing a committee too far towards one particular group such as academics.”

With post-meeting decisions of the monetary policy board to be subject to an official vote, Mr Evans is disappointed that dissenting voters won’t have to give the reasons for their dissent, something that the Federal Reserve does, which provides additional insights into the decision making process.

Under the current proposal only the “unattributed” vote count will be reported. External members will have the flexibility to speak out and the responsibility to make at least one speech per year.

Mr Evans sees this as “haphazard” and something better handled by requiring dissenting reports.

While he sees the proposed tightening of the wording of the RBA’s inflation goal to the midpoint of its current 2-3 per cent range as a “welcome discipline” on the RBA, he says its current approach of “protecting the employment gains where possible” is likely to be “tightened significantly” and an explanation of the expected path back to full employment will be required.

That raises a number of issues, including the definition of the full employment rate and the challenge of using the cash rate to simultaneously achieve full employment and target inflation.

“No doubt the RBA’s forecasts are likely to show that achieving the inflation target will eventually allow the achievement of full employment … but the path of the unemployment rate in the near term will be difficult to balance as the bank pursues its specific inflation target,” Mr Evans said.

Still, he noted significant improvements including separate boards for policy and governance; removing the ability of the Treasurer to override decisions; removing the RBA’s ability to control bank lending; ensuring the Treasury Secretary sits on the board in a non-political capacity; and more clarity around the way the Council of Financial Regulators operates macroprudential policy.

Lowy Institute senior fellow and Adjunct Professor at the John Curtin Institute of Public Policy, John Edwards, said one issue is that the conclusions of the RBA review aren’t based on evidence.

“That is not to say the recommendations are wrong, but that they are speculative,” said Mr Edwards, a former RBA board member. “They deserve debate and reflection, not uncritical applause and adoption. There is no claim in the report that the model used in the UK or Canada has produced better outcomes, because as a matter of fact it has not.”

Deutsche Bank chief economist Phil O’Donaghoe said the greater voting power of external members of the yet-to-be-formed monetary policy board will be a key difference to overseas peers.

Only the Bank of Japan now has a similar balance of power in its monetary policy board, where external members have more voting power than internal members.

An external majority of the board is nothing new for the RBA, but votes on monetary policy decisions don’t take place, at least not formally. Vote-based decisions will, however, be a central feature of the new model, and the review states that a reason for moving to the new board model is that the board “as currently set up can provide only limited challenge to the view of the RBA executive”.

“With an external-majority, vote-based model, it is not at all impossible to have a scenario where the group of six external members uniformly disagree with the ‘internal’ members on a policy decision,” said Deutsche Bank’s Mr O’Donaghoe. “If that happens, the external view would be carried.”

“The extent to which this matters in practice, will depend on who the external policy board members are and how they vote, but it’s a notable distinction nonetheless compared to peers.”

Goldman Sachs Australia chief economist Andrew Boak said that if inflation stays above target and the labour market remains well above “full employment” as he expects, the clearer prioritization of the RBA’s inflation and employment targets dictated by the Review should have “ incrementally hawkish implications” for monetary policy.

“However, it is unclear at this stage whether this shift in the RBA’s reaction function occurs in the very near term or is delayed to the realisation of changes to RBA board structure over the next 12 months.”