RBA review in uncertain times

The Albanese government’s three-person review of the Reserve Bank of Australia coincides with a period of extreme pressure for central banks around the world. All face a dilemma similar to that of Australia. After an extended period of ultra-low official interest rates due to rolling economic crises and a pandemic, inflation has roared back to life. In many places, fiscal policy (government spending) is fighting against monetary policy (interest rate setting), making the challenge more acute. Unsurprisingly, governments are slow to own their part in the dilemma; witness US President Joe Biden’s high-spending and misnamed Inflation Reduction Act that will pump more billions into the economy.

Back home, Jim Chalmers has an opportunity in the upcoming budget to demonstrate he has learned the lessons of inflation battles past and resist giveaways to take the sting out of the RBA’s aggressive hike in rates to tame inflation. While Australia’s big-spending pandemic response has been widely praised, RBA governor Philip Lowe has been left to shoulder the hangover. Calls have been made for Dr Lowe to lose his job for telling borrowers as recently as November last year that interest rates would remain low into 2024. Like many central bankers around the world, he was wrong.

The view popular among policymakers that inflation was transitory because of supply-side problems linked to the pandemic has proved to be wildly off the mark, as some had correctly forecast. Global inflationary pressures have been compounded by a bounce back in activity after pandemic restrictions while supply lines remain strained and a war in Ukraine has produced an energy price shock.

The US Federal Reserve is battling a four-decade high in inflation that is proving difficult to tame. Higher rates are only now starting to work their way into the real economy as stockmarkets wake up to the fact tighter monetary policy is here to stay. Financial markets have been unsteady since Federal Reserve chairman Jerome Powell issued the warning a week ago that rates would go higher and stay there longer. Wall Street closed overnight Tuesday with the S&P 500 index down 4.3 per cent and the Dow Jones Industrial Average index 3.9 per cent lower after it was announced that US inflation remained at 40-year highs last month, more than four times the Federal Reserve’s target despite a 10.6 per cent fall in the price of petrol. Inflation was fuelled by higher prices for rent, food and electricity. The Australian sharemarket followed Wall Street down.

Having delivered 2.25 percentage points of official rates hikes in five months, the RBA board has been considering whether it can slow the pace of tightening. Although our inflation problems are not on the scale of those in the US, there is no easy answer. Aggressive rate hikes overseas will have an impact on the value of the Australian dollar, lifting the price of imported goods.

All things considered, it is a volatile time in which to launch an investigation into the RBA’s processes and performance. A discussion paper released on Thursday gives an outline of what issues the inquiry will focus on. The first will be on Australia’s current monetary policy framework and include the ability of Australia’s flexible inflation-targeting regime to respond to various economic challenges, alternative monetary policy arrangements and the interaction of monetary policy with other macro-economic policy levers. The second focus will be on the RBA’s implementation, including the choice of tools and approach to communication. This is likely to review Dr Lowe’s statements about the likelihood of sustained low rates. The review also will look at the RBA’s governance arrangements including the appointments process, composition, professional experience, qualifications and tenure of the Reserve Bank board.

The review will assess the culture within the RBA and consider how the RBA’s staff profile, and recruitment and staffing processes contribute to its ability to deliver on its objectives. The review is being conducted by Bank of Canada former deputy governor Carolyn A. Wilkins, financial academic Renee Fry-McKibbin and Gordon de Brouwer, who has been appointed by the Prime Minister to lead and implement public sector reform.

There is plenty of scope for recommendations that would represent a radical overhaul of the relationship between the RBA, government, business and the trade union movement. But it should not be a witch-hunt or an excuse to experiment with radical new ideas. The important thing is that the RBA is able to focus on its day job, safeguarding as best it can the jobs and economic wellbeing of all Australians.