Future Fund’s Peter Costello blasts Reserve Bank’s ‘failure’ to rein in inflation

The chairman of the Future Fund says the Reserve Bank ‘completely missed’ the surge in inflation, calling it the RBA’s worst monetary policy failure in 30 years.

Former Treasurer and chairman of the Future Fund Peter Costello. Picture: AAP

Former treasurer Peter Costello says the Reserve Bank “completely missed” the surge in inflation, heightening the risk of a recession with its worst monetary policy failure in three decades.

The Future Fund chairman’s intervention comes as Jim Chalmers finalises the structure and terms of reference for an independent review of the RBA, the first since the 1980s.

The review is expected to concentrate mainly on the future, avoiding investigating past controversies such as poor inflation forecasting and the abandonment of an RBA policy last October to hold medium-term bonds at an ultra-low interest rate.

While the leader of the review is yet to be finalised, the Treasurer is considered likely to appoint an outsider to ensure the review’s independence. One potential candidate understood to have been discussed is Paul Tucker, a former deputy governor of the Bank of England. An appointment of Sir Paul’s calibre could address concerns that the review could be dominated by the RBA and Treasury, which is represented on the board by departmental secretary Steven Kennedy.

But RBA director Ian Harper, who stressed he was speaking in a personal capacity and not as an RBA representative, defended the central bank’s policy record, saying it was aligned with the responses of peer institutions.

“Those people who say we should have been faster on the way down (with the cash rate) are the same people who now want us to be faster on the way up,” Mr Harper said. “These things are a matter of judgment, remembering that the pandemic was going to cause the biggest downturn since the Great Depression.

“The markets clearly have a view, market economists have a view and the RBA has a view – people should observe that these views are not always the same.”

Mr Costello said he had believed as far back as the March quarter that inflation was an emerging problem, unlike a lot of the “Johnny-come-latelies” who only recently became RBA critics.

“The RBA completely missed the takeoff point in the March quarter and now it’s behind the curve,” he told The Weekend Australian in an interview.

“Its primary duty is to manage the (2-3 per cent) inflation target and it failed in that duty.

“It’s the worst failure in monetary policy since the 1990s, and the consequences are that the RBA now has to raise interest rates faster and further than would otherwise be the case.”

The risk of a recession, he said, was therefore higher.

While monetary policy was ultimately the preserve of the RBA, Mr Costello said that, as Treasurer, he would have tried to persuade the central bank that its inflation outlook was wrong.

But ultimately the policy decision was for the RBA.

Global central banks in recent months have been desperately pulling the rates lever to try and put the inflation genie back in the bottle. Just this week, the US Federal Reserve increased rates by 75 basis points to a target range of 1.5 per cent to 1.75 per cent – the biggest increase since 1994.

Fed Reserve chairman Jerome Powell said the next moves were expected to be 75 basis points or 50 basis points, with the former less common.

Overnight on Thursday, the Bank of England hiked by 25 basis points to 1.25 per cent – the highest level since 2009, with the BoE forecasting that inflation would surge to 11 per cent.

The RBA surprised the market last week by lifting the cash rate 50 basis points to 0.85 per cent.

It was the first such increase since February 2000, as RBA governor Phil Lowe upgraded the inflation forecast to seven per cent by the end of the year. “That’s a very high number, and we need to be able to chart a course back to 2-3 per cent inflation,” Dr Lowe told the ABC on Monday. “I’m confident that we can do that but it’s going to take time.”

On the cash rate’s likely peak, Dr Lowe said it was reasonable to think that the rate would get to 2.5 per cent “at some point”, because the midpoint of the RBA’s inflation target was 2.5 per cent.

This would equate to a real interest rate of zero, which was very low in historical terms.

Former RBA director Warwick McKibbin was more specific, saying the cash rate was likely to top out at about 4.5 per cent.

“It’s not a precise science, because it depends on what’s happening with productivity growth and actual inflation,” Professor McKibbin said. “But that’s what you’d be thinking about as a midpoint, and it’s what I’d be using in terms of a plan for next year. So 2.5 per cent could be after you’ve gone through 3.5 per cent or 4 per cent – (Dr Lowe) didn’t say that but he didn’t not say it either.”

In contrast to Mr Costello, former RBA governor Bernie Fraser’s assessment was that the RBA “is on the job”.

The 75 basis-point increase in the cash rate in two months demonstrated that the central bank was “starting to reinforce its credibility as an inflation-fighter”.

Mr Fraser said the more aggressive approach of the Fed was tailored for the US environment, where inflation was a bigger problem. “The precise timing of changes in policy rates will vary according to circumstances, so one central bank going a month or two earlier than another is not such a big issue,” he said.

The ex-governor was critical, however, of Dr Lowe’s now-discarded forecast that the cash rate would not be lifted until 2024. “Noone can forecast that far ahead – it was an unnecessary risk to take and potentially damaging because it could have encouraged people to borrow more,” he said.

Mr Costello argued strongly that the RBA’s performance in combating inflation had to be at the forefront of any review, particularly its preoccupation with wages growth when its mandate was to control inflation.

“So why did it go wrong and what should we do to ensure it won’t happen again?” the former treasurer said on Friday.