A board that provided "limited challenge" to the views of the Reserve Bank of Australia's executive — and with a skill set mismatched to the "complex and uncertain economic environment": That was the assessment of the review of the Reserve Bank of Australia (RBA).
That review's major recommendation — to create a specialist monetary policy board to set interest rates — reflects its criticism of the existing board structure.
"The external members of the Board have been outstanding leaders in their fields," the review diplomatically notes.
"However, collectively, they have less economic and financial market expertise, and spend less time on monetary policy, than decision-making bodies at comparable central banks."
The review has also recommended that a change be made to the Reserve Bank Act 1959, which currently outlines the RBA's objectives to use monetary policy to achieve its goals of price stability, full employment and the economic prosperity and welfare of the Australian people.
That is now facing a rewriting, with its objectives limited to the pursuit of price stability and full employment, for the "overarching purpose" of economic prosperity and welfare.
So, how did it come to the conclusion these changes were needed?
'Coddled' board didn't challenge RBA's view
The review concluded that the Reserve Bank's performance over the past three decades has generally been pretty good and contributed to a period of economic stability.
"Inflation and unemployment have been both lower and more stable than in the preceding decades," it said.
"The monetary policy framework, and the RBA’s actions, have contributed significantly to these outcomes."
However, during the review process, concerns were raised about the central bank's performance during several recent periods.
The first was the period of low inflation between 2016 and 2019, during which the RBA board largely sat on its hands.
Despite inflation consistently undershooting the bank's 2-3 per cent target band during this period, the board did not move the cash rate for 30 consecutive meetings.
All the while, the RBA continued to forecast that inflation would gradually return to the target band.
Through its examination of board papers and meeting minutes, the review found that this period was an example of the board providing "limited challenge" to the views presented to it.
"Between 2016 and 2019, the Reserve Bank Board never took a decision that went against the recommendation of the RBA executive," the review states.
"Throughout most of the period, little discussion in the board papers was dedicated to policy options or decisions. Alternative views among RBA employees and alternative policy choices — and their costs and benefits — were rarely presented.
"These written materials did not engage with whether the Reserve Bank board’s strategy was still correct, or whether alternative approaches should be considered."
Another period examined by the review was the response to the COVID-19 pandemic, beginning in March 2020.
It details how the board weighed-up some of the monetary policy tools used in the pandemic response, and concludes that it was not provided with, nor requested, enough information to "fully debate and challenge" the proposals put by the RBA executive.
"The RBA developed a set of internal papers outlining more detail on the design of the yield target and term funding facility, but these materials were not provided to the Reserve Bank board," it found.
"The RBA considered these materials to have a level of technical detail that was not required for the Reserve Bank board’s decision."
Former Reserve Bank economist Zac Gross said the review suggested that the RBA staff would "censor" what they provided to the board so as not to "overload them with too many complicated arguments or too many different options".
"What you see is the RBA staff are coddling the board to try [to] help them come to what they see as the 'right' solution," Dr Gross said.
"And, so, the board's role — which is to hold these policies up to the light and make sure that the we're picking the best option every time — isn't really being fulfilled."
Board members don't sit there meekly, Lowe says
RBA Governor Philip Lowe disagreed with the review's findings of a lack of debate and challenge emanating from board members.
"The review panel did not sit in the boardroom and the description of how the board process works, and the challenge in the boardroom that the panel has, doesn't particularly resonate with me," Mr Lowe said on Thursday.
"[Other board members are] probing, they challenge me and, sometimes, I speak last in the meeting.
"So, the idea that the board members sit there meekly, and accept the recommendation that I put to them, is very far from the reality that that I've lived as the governor."
Dr Gross thinks Mr Lowe was a-bit-too defensive on that point and that, while the review panel was not in the board room, they had access to materials from meetings, in addition to interviewing many former board members.
"Maybe that's true — although I would say that's an indictment on the RBA's process of recording its meetings if it is — but I think more realistically is that the RBA review is correct: They are very specific about the mistakes that the board made," the now-Monash University lecturer said.
Jonathan Kearns — now chief economist at Challenger but formerly the head of several RBA departments — backs the establishment of an expert monetary policy board.
"That's something that's become really standard in other countries. Australia has been lagging in that regard," he said.
The review recommends the external monetary policy board members should have direct access to RBA staff for support on technical matters and additional analysis when requested.
However, Dr Kearns would have liked it to go even further. He recommend board members be engaged on a part-time basis and be given their own staff.
"The current Reserve Bank board members are all really busy individuals and they come along to the Reserve Bank for a half-day meeting, they've read the papers before, but that's not enough time or nor did they have the right background to really be forming independent views."
'Confusion' about what the RBA was trying to achieve
Another of the review's recommendations involves a change to the central bank's objectives.
Currently, the Reserve Bank Act 1959 outlines that the RBA should conduct monetary policy to achieve three goals:
- Price stability (the stability of the currency)
- Full employment
- The economic prosperity and welfare of the Australian people.
The review recommends "clarifying" the objectives as a dual mandate of price stability and full employment.
"The economic prosperity and welfare of Australians, now and in the future, should be legislated to be the overarching purpose for the RBA in the exercise of all its powers," it recommends.
"It is not suited to be an additional objective for monetary policy, because this provides too much discretion to the RBA."
For example, the review found that, between 2016 and 2019 — when the board did not lower the cash rate for an extended period, despite inflation being below target — communications around its policy decisions were unclear.
"Differences in views about the correct interpretation of 'economic prosperity and welfare' likely added to confusion about what the RBA was trying to achieve," the review found.
It points to members of the RBA executive, including the governor, raising concerns about risks in the housing market and the high level of household indebtedness as key considerations.
"The governor further argued that the Reserve Bank board’s objective to contribute to ‘economic prosperity and welfare’ gave it a broader mandate than many other central banks," the review noted.
"This allowed the Reserve Bank board to keep interest rates higher than otherwise to limit the build-up of vulnerabilities …
"Whether these risks around household debt could have justified a higher level of interest rates is contentious, as reflected in some submissions to the review.
"At the same time, higher interest rates likely contributed to below-target inflation and higher unemployment than otherwise."
Peter Tulip — who formerly worked in research at the Reserve Bank and is now chief economist at libertarian think tank the Centre for Independent Studies — described the removal of economic prosperity from the objectives as a "great decision".
"That was was a licence for the Reserve Bank to do anything it wanted," Dr Tulip said.
"The RBA would invent new objectives for it to pursue — house prices or household indebtedness — which most macro-economists would think are not legitimate objectives of monetary policy.
"But it could do that because it had this third mandate that said: 'Do whatever you want.'
"We're giving the RBA a lot of independence and a lot of power and, so, there needs to be limits on that power. So, taking that third mandate away is very appropriate."
The cost of getting it wrong
It is difficult to quantify what impact the review's recommendations will have, if implemented, but Dr Kearns says the costs of mistakes by central banks are high.
"If we have a higher unemployment rate than we need to have, that could be tens of thousands of people who are out of employment and affecting those people's wellbeing," Dr Kearns said.
The review cited modelling by Dr Gross and Andrew Leigh — the current federal assistant minister for competition, charities and Treasury — which showed that a lower cash rate between 2016 and 2019 could have achieved a lower unemployment rate.
"Gross and Leigh estimated that foregone employment was equivalent to approximately 270,000 people out of work for a year," it noted.
Dr Gross says mistakes made by the RBA over the past five or six years have led to the economy running both too slow and too hot, and implementing the recommendations could assist with avoiding either of those outcomes.
"I'm hopeful that this big package of reforms will mean those mistakes happen less often in the future — so we'll see [fewer] recessions, we'll see [fewer] outbreaks of inflation.
"While the average Australian household might not notice the fact that we haven't had a recession in 10, 20 years, I think they'll absolutely be better off for it."
