The follies of RBA’s overpaid executives hurt us all

All the Reserve Bank really does is adjust the cash rate, yet it can’t even get that right.

There are not many issues on which former treasurer Wayne Swan and I agree. But he was absolutely right to query the decision of the Reserve Bank board, made in 2011, to award a 25 per cent pay rise to the bank’s governor.

Glenn Stevens held that position at the time and it took his total remuneration to more than $1 million. Note that officers of the RBA have been entitled to some of the most generous superannuation entitlements around. Does anyone really think the RBA’s governor should earn considerably more than the prime minister? Does anyone think that the RBA’s governor should earn more than the head of the Department of Prime Minister and Cabinet?

The board members at the time considered that the high salaries being paid by the private sector banks were reason to significantly lift the governor’s salary and, with it, the salaries paid to all other executives at the bank.

But let’s get real. Those salaries were egregious and still are. Moreover, the RBA is an effective closed internal labour market. Governors are not lured from the private sector, nor do senior executives often leave the bank to join the private sector. And think about this — the RBA governor earns more than three times the salary of the chairman of the US Federal Reserve and twice as much as the president of the European Central Bank. The scope and influence of those jobs make the role of our governor look like minding the corner store.

Now I guess if we thought the RBA had done a really good job, then we shouldn’t mind too much about the top dollars the senior staff earn. But the truth is the bank has done a lousy job for some time.

The governor, Philip Lowe, who was previously deputy governor — no surprises there — is like the boy in the orchard accused of stealing an apple. Holding the fruit behind his back, he declares “Not me”, particularly when it comes to property prices. Rising house prices — nothing to do with me. Falling house prices — nothing to do with me. It’s win-win for Phil.

Am I being too harsh? It is generally accepted that the RBA acted in an appropriate fashion during the global financial crisis. With the cash rate starting at a relatively high level, the bank was able to ratchet it down substantially and quickly. From 7.25 per cent in August 2008, the rate was moved to 3 per cent in April 2009.

In combination with the depreciation of the dollar, a flexible labour market at the time and the stimulus implemented by the Chinese government, the rapid easing of monetary policy enabled the Australian economy largely to escape the economic carnage that occurred elsewhere.

Mind you, it was probably at that point that the hubris of the RBA set in, which is never the route to good decision-making.

Whereas other central bankers were wont to ponder the reasons for their failures — all of them, including our RBA, had failed to predict the GFC or the extent of the fallout — the merry gang down at Martin Place (the expensive real estate that the RBA occupies) carried on without the benefit of serious reflection.

For a while, everything seemed to be smooth sailing. The cash rate was lifted in October 2009 because the immediate post-GFC emergency rate of 3 per cent was no longer warranted. It reached 4.75 per cent in November 2010.

Notwithstanding the fact that the economy was travelling relatively well and unemployment was higher than desirable but not at a disastrous rate, the bank began to ratchet down the cash rate from the end of 2011, reaching 1.5 per cent in August 2015, the rate at which it has stayed ever since.

Whereas 3 per cent had been deemed to be an emergency level, 1.5 per cent has become the new normal.

The factors that spooked the bank were overseas developments (very low interest rates have prevailed for many years), the value of the dollar and the need to stimulate domestic investment.

The trouble is the sensitivity of the dollar to relative interest rates is not a constant. Moreover, investment spending has proved to be stub­bornly impervious to interest rates. But this is where the story gets complicated.

While the impact of monetary policy on the real economy was clearly weakening, the same could not be said for asset prices. The main effect of having such low interest rates, in combination with available credit, foreign investment and a rapidly growing population, was to drive up house prices dramatically, particularly in Sydney and Melbourne.

The flip side of this development has been the explosion of household indebtedness. We have one of the highest rates in the world, with household debt as a percentage of household disposable income currently around 200 per cent and 120 per cent of GDP.

To be sure, low interest rates make servicing debt a more manageable task for households, but there is a very serious risk for some households were interest rates to rise significantly. Falling house prices has also made this scenario even scarier.

This is one reason why the RBA has been reluctant to move the cash rate for over two years and its related obsession with wage growth. If households could enjoy stronger wage growth, there would be more scope to raise the cash rate.

But while other central banks have been openly questioning whether the Phillips curve (the relationship between wage growth and unemployment) still exists, our RBA governor has carried on with some very tired lines. He even came close to endorsing an increase in wages by fiat as an appropriate policy response before backing off: being economically oblivious is never a good look for a central bank governor.

The bottom line is this: by lowering the cash rate to 1.5 per cent and keeping it there, asset prices have been driven up and household indebtedness has exploded. Moreover, the scope for monetary policy to achieve anything in the future is substantially diminished.

The Reserve Bank has lost serious credibility over the past decade. It has more staff members than the Treasury, which is quite extraordinary given that it really only does one thing: adjust the cash rate.

Moreover, the reputation of the bank is not helped by the deputy governor giving highly speculative speeches about climate change and the economy. Having failed to forecast the GFC, you would think that the bank’s senior staff might be a bit more circumspect.