Former prime minister Paul Keating has warned the Reserve Bank of Australia (RBA) must not be allowed to become completely independent of government.
In exclusive correspondence with the ABC, Mr Keating said the recommendation to strip the federal government of its power to overrule an RBA decision, from last week's Reserve Bank review, goes against democratic norms.
He said when he was treasurer in the late 1980s, he once had to threaten to use that overrule power himself to push the Reserve Bank to lift interest rates quickly to crimp an "inflationary burst of credit" from Australia's major banks, in the early days of financial deregulation.
He said Australia's government must retain the power to ultimately direct the country's economic policy, at the behest of the Australian community, and it needed a institutional mechanism at its disposal to overrule the RBA in exceptional circumstances.
"The RBA has always suffered from institutional inertia," Mr Keating told the ABC.
"It was always too slow in lifting rates to manage bursts of activity, as it has been in getting rates down as activity moderated.
"Political power, its management and employment in office, must, in a working democracy, take precedence over any subordinate bureaucratic structure," he said.
The frenzy of bank lending in the 1980s contributed to the conditions that caused the early 1990s recession, which pushed hundreds of thousands of Australians into unemployment.
Mr Keating was federal treasurer from 1983 to 1991 and prime minister from 1991 to 1996.
What does central bank 'independence' mean in a democracy?
The report from the RBA Review was released last week.
It made 51 recommendations to improve the Reserve Bank's performance, and Treasurer Jim Chalmers says he supports all of them in principle.
But the review's very first recommendation regarded the question of central bank "independence."
It recommended stripping Australia's government of its power to "overrule" a decision by the Reserve Bank.
See 1.1 below:
This is the reason the RBA reviewers provided for their recommendation:
"To further enhance the RBA's monetary policy independence, the review recommends the repeal of s11 (2)-(7) of the RBA Act, which sets out a procedure for the government to override decisions of the Reserve Bank Board.
"While no Australian government has used these override powers, there is the possibility that established conventions cease to be observed.
"The current legislation creates the risk that the government wields, or threatens to wield, power in a way that undermines the independent operation of monetary policy.
They acknowledged that no Australian government had used the override power in the past, and they provided no evidence of a growing risk of future abuse of the power.
But they expressed concern that a future government may "threaten" to use the power.
That was strange, because the policymakers who put the override power into the original post-war legislation were comfortable with governments threatening to use it.
In fact, they expected that the threat of its use would provide an incentive for the government and central bank, behind the scenes, to resolve any policy differences by constructive debate rather than resorting to legislative provisions.
And they wanted the override power in the legislation as a democratic fail-safe.
They said Australia's central bank should be independent of government, as far as possible, but at the end of the day it still had to answer to executive government and parliament, and ultimately the voting public.
Keating says RBA not infallible
Mr Keating told the ABC that that override power should not be waved through parliament. It must remain in the Act.
He said the RBA was fallible, like any institution, and there had to be some democratic check on its power.
"The RBA has always suffered from institutional inertia. It was always too slow in lifting rates to manage bursts of activity, as it has been in getting rates down as activity moderated," Mr Keating said.
"I enjoyed a very happy and conducive relationship with the bank but I was at serious odds with it in mid-1988 when it was unacceptably tardy in lifting rates to check an inflationary burst of credit and with it, spending, by the four major banks in their adolescent phase of deregulation — in also trying to pull market share from one another.
"The only time I threatened to use the government's legislative power under the Reserve Bank Act was in pressing it to push rates up quickly in 1988.
"In the face of needless policy intransigence, I told John Phillips, the then-manager of monetary policy within the bank, that if he didn't move to put rates up within two weeks, I would put them up myself.
"It was an unusual stance that a treasurer should need to have taken — normally, treasurers are credited generally with seeking to push rates down but as the credit explosion was threatening gains on inflation and the wages system, the bank had to be shoved, not simply spoken to."
Mr Keating said Australians had to retain control of their major economic institutions.
"This power, reserved to the treasurer under the Reserve Bank Act, provides due regard to the parliament and the executive government in its anchored position of primacy in economic policy and management," he said.
"Political power, its management and employment in office, must, in a working democracy, take precedence over any subordinate bureaucratic structure. As the political power is itself subordinated to the community at large.
"That the reserve power under the Act has, in practice, never been used, does not diminish the validity of its presence in the structure of authority which the current Reserve Bank Act mandates.
"The exchange rate is the most important price in the economy. And attending it are official interest rates. These rates should never be set by a bureaucracy, however expert, remote from the vicissitudes of society and the real economy."
Has the RBA complained about its lack of independence?
Mr Keating said the government's overrule power had not prevented the RBA from increasingly asserting its independence over time either.
In fact, he said he had encouraged the RBA to embrace its independence when the Australian dollar was floated in 1983.
"The Reserve Bank effectively became independent the moment the government in 1983 opted for a quantitative basis for setting the exchange rate, rejecting the old administratively-set pricing arrangement," he said.
"This was especially true as I removed all exchange controls on the same day in December 1983. And both Bob Johnston, the then-governor, and I believed Australia should execute a clean float with the bank intervening in the market not to make a rate – rather to smooth and test the rate in any particular day.
"The bank had no experience in managing such a system and institutionally lacked confidence.
"But it had the support of the government and as treasurer, I went out of my way to encourage the bank adopting an independence of mind (vis a vis, from its former role as a bond selling agent of the treasury) in superintending an open market system with a view to establishing, then maintaining, the country's competitiveness," Mr Keating said.
Treasurer Jim Chalmers has agreed in principle with all of the RBA review's 51 recommendations and said he will try to make the necessary legislative changes by July 2024.
