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Wednesday, June 29, 2022

The RBA is largely right, but there is still room for investigation

Treasurer Jim Chalmers is about to conduct an independent review of the Reserve Bank of Australia. It’s refreshing that his campaign promise was bipartisan — that’s what both sides of politics want.

What we don’t know yet is who will conduct the investigation and what it will look at.

12 leading Australian economists, in some sort of cultural animosity, called in an international expert to conduct this – someone like the former governor of the Bank of England.

There is much to be explored. But, in our view, this does not include the record achievement of the inflation target, which was near-perfect and better than the competition.

In 1981, Campbell conducted an investigation into the financial system, examining some aspects of the structure and operations of the Reserve Bank. But there has been no systematic review of its goals or means to achieve them since the bank’s founding in 1960 – and perhaps before, when the same goals were set out in the Commonwealth Banking Act of 1945.

Reserve Bank and Interest Rates: An Explanation – Selwyn Cornish, ANU, April 2010

Experiments, then inflation

Half a century ago, Australia abandoned its fixed exchange rate against the British pound.

What followed was a long tortuous journey in which, according to current Reserve Bank Governor Philip Low, Australia experimented with almost every type of exchange rate regime until the dollar was floated in 1983.

For a while, the bank bought and sold financial instruments to stabilize the money supply in the economy, but it turned out that money changes shape when cornered, requiring ever-changing definitions and making it an imperfect inflation control tool.

Needing something else, in the mid-1980s, the bank developed a derided “checklist” that included everything but the kitchen sink:

all monetary aggregates; interest rates; Exchange rate; external accounts; current performance and outlook for the economy, including asset price movements, inflation, inflation forecasts, and market expectations for inflation.

It turned out to be so all-encompassing that it provided neither discipline nor guidance.

When, in 1990, New Zealand became the first country in the world to formally target inflation and inflation only (initially targeting 0-2%), Australia and other countries, including Canada, took notice.

Reserve Bank of Australia governor Bernie Fraser and then head of research Ian McFarlane unsuccessfully tried to get the Hawke government to announce an inflation target in 1990.

From 1992, Frazier began to mention in his speeches his goal of keeping inflation around 2–3%, and by 1994 Keating government ministers began citing a 2–3% target.

Read more: RBA Memorandum: We must live with inflation, more than it

In 1996, Treasurer Peter Costello and Governor Ian MacFarlane signed a formal agreement recognizing the goal of keeping core inflation averaging between 2% and 3% over the economic cycle.

By adjusting the size of the loan or credit in the interbank overnight market, a bank can influence the “cash rate” that banks charge each other, and through it, the overall price of money and, hopefully, the rate of inflation.

Success in numbers

In numbers, it was a success in meeting the inflation target.

Between March 1994 and the start of the COVID pandemic in the March quarter of 2000, inflation averaged 2.48%, in the middle of the 2–3% target range.

In addition, prior to the COVID shutdown, Australia avoided recession by avoiding both the 2001 “tech crash” recession that devastated the United States and the 2008 “Great Recession” during the global financial crisis.

Under the inflation-targeting regime of the Reserve Bank, unemployment fell to its lowest level in almost fifty years.

This is a record at least as good as that of other central banks and better than most. The review is unlikely to significantly improve Australia’s economic performance.

But there is reason to review

The first governor of the RBA HC “Nugget” Coombs.
National Library of Australia

The first Governor of the Reserve Bank, H.K. Coombs wanted the financial system to be reviewed every five years, an idea that was blocked by the Treasury.

However, there are things in the bank that need to be learned. One of them is the composition of the board of the bank.

Under former treasurer Josh Frydenberg, most of the board members became women, and there are more independent members with economic experience.

Before Peter Costello became treasurer in the 1990s, the board included a union leader.

It might make sense to bring back union representation and add social service representation to balance business interests.

It may make sense to release more information about the board’s deliberations, or to separate the management of its administration from the management of monetary policy.

The Bank’s recruitment and promotion policy may be reviewed. His preference for internal assignments preserves corporate memory but risks “groupthink”.

And there will be occasion to examine the mechanics of his bond-buying program (“quantitative easing”) and its communications (“forward-looking leadership”) during the COVID crisis. The question of whether to issue a digital currency is already under consideration, and this prospect does not seem very attractive.

Read more: Open letter: RBA review should be independent of the government

Almost no one wants to return to a fixed exchange rate, but the inflation target and the method the bank used to achieve it should be open to scrutiny.

Some argue that the bank has kept interest rates too low, causing house prices to rise and inequality to rise. Others argue that the rates are too high, leading to unnecessary unemployment.

It’s hard to argue that this is done too wrong. In recent years there have been independent reviews by the US Federal Reserve, the Bank of Japan, the Bank of England and the European Central Bank.

Remarkably, they often recommended moving to Monetary policy framework used by the Reserve Bank of Australia.

World Nation News Desk
World Nation News Deskhttps://worldnationnews.com/
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