Get ready for higher inflation
Yesterday the government released the independent review of the Reserve Bank of Australia (RBA), along with confirmation that it would accept all of its recommendations.
I’m not going to go over all 51 of them here but will say that on balance it appears to be little more than tinkering on the margin, an outcome that was always likely given the authors: a former Canadian central banker, a former Treasury bureaucrat and an academic.
Speaking of the Canadian central banker, Carolyn Wilkins, she was surely an influence behind the recommendation to split the RBA’s board in two, given that’s the model used by Canada (and the United Kingdom). Only a few countries performed worse than Australia in terms of their post-pandemic rates of inflation and, you guessed it, Canada and the UK were two of them:
Consumer prices in Australia have been rising at a similar clip to Canada and the UK.
But perhaps that’s by design? Another recommendation in the review will put the RBA’s full employment mandate on equal footing with inflation:
“The federal government should legislate that the RBA has dual monetary policy objectives of price stability and full employment, with an overarching purpose of providing economic prosperity and welfare for Australians.”
The RBA’s mandate should have been simplified to only include inflation. If inflation targeting was easy, we wouldn’t have had a review. Why complicate it by putting more emphasis on full employment, especially if it will allow the RBA to avoid accountability (‘it’s OK Treasurer, inflation may be at 8% but we’re also at full employment so all good!'). Monetary policy is a powerful tool, but juicing the economy to improve labour market outcomes is generally not advisable, given that in the long run the employment gains will be temporary but the higher inflation will persist. If you want to get more people into work, reform your labour market policies and improve productivity instead.
Now there might be some people out there who think that inflation has been too low (pre-pandemic, of course) and that Australia would benefit from a RBA that focuses a bit more on employment than price stability. I’m not one of those people, and I worry that this recommendation will lead to higher average rates of inflation and the unintended consequences that come with that.
The final recommendation that irked me was that the RBA board should meet less frequently; just eight times a year, down from the current eleven. Supposedly this will “allow for more time to make better monetary policy decisions”. Right.
What it will do is allow the RBA to avoid accountability for longer. It will also, on average, increase how large each interest rate movement will need to be – if the RBA is about to have a couple months off and inflation looks to be accelerating we might now get a 50 basis point hike instead of 25 points. It will also reduce responsiveness – what happens if there’s a sudden event that requires a monetary response, such as Russia invading a neighbour, a pandemic, or a banking crisis? Will the RBA convene an emergency meeting, or will it sit back and take “more time” while the economy tanks?
I would have preferred that the RBA convene every month, even if it’s just to explain why rates are not changing. Yes, even in January – sorry board members, you’ll have to shorten that family ski trip to the French Alps. But alas, eight times a year it is.
All said and done, the review’s recommendations are unlikely to materially change inflation or employment outcomes in Australia, but I expect average inflation to be higher with these reforms than it would have been under ‘business as usual’. There’s also the added tail risk that we eventually get a Treasurer who decides to stack the board’s six external members with partisan hacks, effectively giving the government control over monetary policy. Under such a scenario our inflation rate will have more in common with Argentina and Turkey than Canada and the UK, but hopefully our democratic institutions are strong enough to avoid that disaster. 🤞