Reserve Bank Review represents significant progress although some challenges remain
The Reserve Bank Review recommends extensive constructive changes but issues around the dual mandate; communication; and the structure of the Monetary Policy Board contain challenges.
The much anticipated Review of the Reserve Bank has recommended sweeping changes to the operation and structure of the Bank.
There are some very significant improvements to the operating model for the Reserve Bank that are recommended in the Review.
These include establishing separate Boards to cover monetary policy and corporate governance; removing the ability of the Treasurer to override RBA decisions; removing the RBA’s ability to directly control bank lending decisions; ensuring the Treasury secretary sits on the Board in a non-political capacity; and calling for more clarity around the way the Council of Financial Regulators operates, particularly with respect to macroprudential policy.
Separating the Board responsibilities between governance and monetary policy highlights the importance to the nation of a well researched approach to setting interest rates.
The Review recommends a tightening of the wording around the Bank’s key policy objectives and gives equal weighting to inflation and full employment.
It has appropriately recommended that the wording around inflation – “on average over the cycle” should be tightened to set a specific objective path back to the middle of the 2–3% target range.
It must be noted that the Bank already sets out that path in its forecast tables in the quarterly Statement on Monetary Policy (SOMP).
For example, in the February SOMP the target timing is clearly set out as June 2025.
The new arrangements are likely to ensure that the Board is forced to defend that timing. Certainly the current timing seems to be a less ambitious objective than other central banks who are planning to reach their targets earlier. Defending a less ambitious target will be a welcome discipline under the new arrangements.
The Governor’s defence, and part of his justification that rates in Australia do not need to go as high as in comparable systems such as US; Canada; and New Zealand, is that he is more mindful of protecting the employment gains over the last year. That is an indirect way of noting the dual mandate around inflation and employment.
But that approach of “protecting the employment gains where possible” is likely to be tightened significantly under the recommended arrangements. Under the Review an explanation of the expected path back to full employment will be required.
That raises a number of issues – firstly, the point definition of the full employment rate and secondly the well understood challenge in policy of having only one instrument (the cash rate) and two quantitative objectives – inflation and full employment.
Inflation targeting evolved from the empirical observation that economies which attained stable inflation were able to operate closer to maximum capacity – indirectly achieving the full employment goal without having to adopt a quantitative employment target at the first stage. No doubt the Bank’s forecasts are likely to indicate that achieving the inflation target will eventually allow the achievement of full employment in the steady state but the path of the unemployment rate in the near term will be difficult to balance as the Bank pursues its specific inflation target.
It is proposed that Board meetings be cut back from eleven per year to eight and every Board meeting is followed by a press conference.
If the objective is to improve communication and the understanding of the monetary policy process this is not an unambiguous improvement. While the press conference will allow the 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. The Board Minutes have become a rich source of information allowing an understanding of the evolution of policy. Receiving those Minutes on a less frequent basis will be a disappointment. But there is certainly merit in the observation in the Review that fewer meetings will allow more time to respond to developments.
The structure of the Monetary Policy Board is proposed as nine members, including the Governor; the Deputy Governor; and the Secretary of the Treasury. Other Board members will be selected on the basis of their understanding of various aspects of the decision process including macro economics; financial markets; the labour market; wages/inflation; industry policy and fiscal policy.
It is planned that these members will be much more closely linked in with the Reserve Bank, spending, on average, around one day per week, at the Bank, while still retaining their current employment. If that one day guideline is to be a condition of membership it will probably preclude the CEO’s who have held Board positions in the past given the demands on their time. It will also exclude anyone practising in the financial system, given obvious conflicts; 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. That will have the obvious disadvantage of not being able to bring people with current relevant practical experience to the table.
The model has a huge advantage in that the impressive research resources of the Bank’s staff will have much more direct access to Board members. This is emphasised in the Review where specialist advisory committees including staff are proposed. With the Bank’s two representatives on the Board likely to find their influence being diluted relative to the current arrangements it is critical that the Australian people continue to get the best use of the Bank’s impressive research resources for the policy process.
It will be very important to get a balanced make up of the Monetary Policy Board. The record of the so called “Shadow Monetary Policy Committee” which seemed to consistently adopt a hawkish bias serves as an important warning around the risks of biasing a committee too far towards one particular group such as academics.
With the decision process in the Monetary Policy Board now being subject to a vote it is disappointing that dissenting voters do not have the responsibility to set out the reasons for their dissent. That is a time honoured practice at the FOMC and provides additional insights into the decision making process. Under the current proposal only the “unattributed” vote count will be reported. Independent Board members will have the flexibility to speak out and the responsibility to make at least one speech per year. This arrangement seems somewhat haphazard and would be better handled with dissenting reports being required.
The Review recommends a closer alignment between fiscal and monetary policy. We expect that will be welcomed at the Bank.
A recent study by respected modeller Chris Murphy at the ANU calculated that inflation, which printed 7.8% in 2022, would have been 3 ppt’s lower if fiscal and monetary policy had not been excessively expansionary over the COVID period. He attributed 2.4 ppt’s to fiscal policy and, only, 0.6 ppt’s to monetary policy. This example, while extreme, highlights the challenges faced by the Bank in achieving its targets when other policy instruments are operating in a different direction.
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