Along with the US Federal Reserve, the RBA is somewhat unusual amongst central banks insofar as it has a ‘multiple objective’ mandate. Rather than exclusively targeting ‘price stability’ (ie, low inflation) the Reserve Bank Act of 1959 gave it three exceedingly broad—and sometimes conflicting—aims:
* the stability of the currency (prices) of Australia;
* the maintenance of full employment in Australia; and
* the economic prosperity and welfare of the people of Australia.
These aspirations are so wide-ranging that the RBA could arguably embark on any number of radical endeavours in the name of seeking to, say, ‘maximise the welfare of the Australian people’, whatever that means.
One example of this was the misguided attempt (inspired in part by Paul Keating) in the late 1980s to use high interest rates to crush a burgeoning current account deficit. Yet by 1990 households faced 17% mortgage rates and the ensuing recession we had to have.
While ‘price stability’ and the 2-3% inflation target are the dominant objectives today, this was not always the case. It is an interesting piece of largely forgotten history that there was a vigorous debate within and outside of the RBA regarding the integrity of the second abovementioned objective: that is, full employment.
Given the historical trade-off between inflation and unemployment, the conflicting full employment ambition was seen by RBA insiders to undermine the Bank’s inflation-fighting bona-fides at a time (in the early 1990s) when the RBA was just finding its feet.
The former Secretary of the Treasury and Keating-appointed Governor of the RBA, Bernie Fraser, has revealed that he advocated a different perspective. Fraser thought that the full employment ambition provided an important constraint on those inflation zealots who might seek to raise rates in an unreasonably aggressive fashion in pursuit of cutting the CPI:
“The multiple objectives of the Reserve Bank Act help make the trade-offs [between inflation and unemployment] explicit in Australia, which is one reason why I have always championed our approach over the more fashionable, inflation only objective of many other central banks…I see the Bank’s multiple objectives as a counter to the (understandable) preoccupation of central banks with low inflation…
“I felt a bit lonely on many occasions – and I argued with them about what they [Bank insiders] themselves focused most on – on low inflation. Unless the Bank can carry the broader community, and that means having regard for employment…you’re going to lose support for low inflation with people…And I don’t think it is too far away before you see some more intensive questioning of inflation only in the European Central Bank.”
Bernie could have made exactly the same arguments about asset price targeting. Nonetheless, the RBA’s inflation hawks ultimately prevailed. Today the RBA makes it very clear that full employment is a secondary objective vis-à-vis the dominant aim of price stability:
“Since 1993, these [three] objectives have found practical expression in a target for consumer price inflation, of 2–3 per cent per annum…Controlling inflation preserves the value of money. In the long run, this is the principal way in which monetary policy can help to form a sound basis for long-term growth in the economy.”
As I noted in my recent summary of the RBA’s evolution (critiquing the AFR’s claim that it was just 50 years old), the first formal endorsement of the RBA’s inflation target and its independence came in 1996 when the Governor and the newly elected Howard Government executed the Statement on the Conduct of Monetary Policy. According to the RBA’s historian, Stephen Bell:
“The Statement, while reiterating the broad objectives of the Bank’s charter – including the dual goals [of price stability and full employment] added: ‘Price stability is a crucial precondition for sustained growth in economic activity and employment.’ This gave the inflation goal ‘top billing’, making other goals conditional on it. Interestingly, reference to the Bank’s statutory goals – including full employment – was removed from the front matter of the Bank’s Annual Reports from that point on.”
Bell relays that while Bernie Fraser was publicly supportive of the Statement, he had private reservations. To quote Fraser:
“I wasn’t a fan of the Statement. It wasn’t something that I would have pursued, for two main reasons. One, it gave more prominence to inflation than I thought the Charter justified and was appropriate – that issue of balance [between employment and inflation] had been an ongoing theme in my term at the Bank. And the second thing was that the Statement was essentially an accord between the new Governor and the Treasurer; the Board wasn’t involved at all. I thought the Board was a significant part of the Bank’s policy process.”
Fraser’s concerns could easily be extended to the contemporary debate around whether the RBA should be allowed to lean against, or target, asset prices (eg, sharemarket values or house prices). There is little doubt that the RBA could unilaterally rationalise ‘managing’ asset prices in exceptional circumstances based on the nebulous nature of the original objectives bequeathed to it by the Reserve Bank Act. Indeed, the RBA already does this in the FX market, where it buys and sells the Australian dollar when it believes that its value has moved far out of line with fundamentals (actions that it quite explicitly justifies on the basis of ‘inefficient markets’).
But I would submit that pursuing this non-consultative option would be cute, non-democratic and possibly quite destructive to the Bank’s longer-term durability.
Everyone knows that asset price targeting (or the euphemistically phrased ‘leaning against the wind’) has not previously been part of the RBA’s publicly understood policy mandate. This is not to say that it should not be incorporated, as I recently conceded.
But raising rates significantly to deal with a coincident asset price and credit boom in a benign inflationary environment has no precedent that I am aware of (setting aside the well-known problems of (a) accurately identifying bubbles in the first place and (b) the likely questionable impact the blunt interest rate instrument would have on any incipient boom while wreaking havoc on the rest of the economy).
The fact that the Governor himself has repeatedly described the debate surrounding whether monetary policy should be extended to cover asset prices as controversial, complex and unresolved reveals just how much a departure from the past this action would represent.
The additional fact that Dr David Gruen and Dr Guy Debelle have publicly expressed dissenting lines on this subject illustrates that there is no unifying consensus within Treasury or the RBA as to its policy logic.
The question as to what the Bank now does can be thought through as follows:
1) Let’s accept the reality that the Bank occupies an inherently awkward position in society, as Bernie Fraser understood (ie, wherein unelected officials that are notionally independent of the government of the day wield enormous discretionary influence over economic activity). Let’s also remember that this only recently-secured independence could easily be subject to change in future states of nature;
2) Let’s acknowledge that the RBA policymaking success is only a contemporary innovation; informed observers know that it sought to ex post facto rationalise the severity of the 1991 downturn as part and parcel of ‘breaking the back’ of inflation when in fact senior insiders are on the record as stating that this was a grave policy error—ie, both the interest rate levels preceding the 1991 recession, and the slow response during it;
3) We would, of course, all like to see an omnipotent and enduring central bank that can permanently institutionalise its present position within the policymaking ether. As I have argued before, the RBA is arguably our most capable public institution, and equipped with some of the best brains in the business (but that has not prevented many other great institutions from failing—cough, splutter, think HBOS, Bear Sterns, Lehman, Enron);
4) As I documented here, let’s accept that the governance structures surrounding the Bank are believed to be inadequate by many former insiders, politicians and Board members. At the very least, there is clearly an ‘issue’ here; ie, some room for evolution and improvement;
5) Now let’s situate ourselves in the (bad) left-hand side of the probability distribution and think of all the future policymaking errors the Bank could make. Let’s assume that the probability of making mistakes is materially amplified by expanding the monetary policy mandate to more explicitly account for asset prices (rather than just inflation). Let’s suppose we find ourselves in a world like, say, the 1980s where human error—due in part to uncertainty around policy objectives (ie, inflation or asset prices) and changes to the ‘transmission mechanism’ (ie, the way the cash rate influences the real economy), undermines the perceive integrity of monetary policy;
6) Now with the above in mind, surely the Bank should take some very transparent, thoughtful and accountable steps when attempting to recalibrate its mandate to enable it to ‘lean against the wind’ (as opposed to simply assuming that it can do say freely due to the ambiguity underlying the Reserve Bank Act). Surely the smart thing to do is to enfranchise all of its stakeholders in a Bernie Fraseresque fashion—the politicians, the electorate, markets and the bureaucracy—when making these changes as opposed to the stealthy alternative preferred by ‘elites’. Perhaps the Bank could dedicate a public conference to reexamining its approach monetary policy in light of the learnings of the GFC with a commitment to binding itself to actionable conclusions. Perhaps it could surprise us all and call for more part-time or full-time economic professionals to be appointed to the Board to help it think through these new and increasingly complex decisions (and more widely apportion blame in the event that things really do go awry);
7) What I don’t think the Bank wants to do is unilaterally decide that it can take these actions because they are exercisable under a reinterpretation of its existing mandate. I think that this would expose the Bank to risk of considerable future criticism, create significant confusion as to the operation of monetary policy, undermine the successful inflation target, and detract from the Bank’s fragile political goodwill. Think about the firestorm a mercurial Barnaby Joyce might cause if the Bank began hiking rates to burst an ostensibly far removed (from the real economy) sharemarket boom.
In short, my advice to the RBA is that it should work hard to take out some ‘governance insurance’ against adverse future contingencies. And I really say this with the Bank’s best interests in mind.
