The author has been described by News Ltd as an "iconoclast", "Svengali", a pollie's "economist muse", and "pungently accurate". Fairfax says he is a "Renaissance man" and "one of Australia’s most respected analysts." Stephen Koukoulas concludes that he is "85% right", and "would make a great Opposition leader." Terry McCrann claims the author thinks "‘nuance’ is a trendy village in the south of France", but can be "scintillating" when he thinks "clearly". The ACTU reckons he’s "an enigma wrapped in a Bloomberg terminal, wrapped in some apparently well-honed abs."

Tuesday, October 26, 2010

Hockey on the RBA's history

Joe Hockey’s speech on financial services reform contained some interesting RBA history. For RBA watchers, here are the choice quotes and associated footnotes:

“A publicly-owned “central bank” was first established in Australia in 1924[2] via the Commonwealth Bank Act to supply private banks with liquidity during times of crisis, and to avoid systemic bank collapses like those that occurred in the early 1890s when more than half the note issuing banks suspended payment, and a third of them were to never reopen again.[3]

We now know this institution as the Reserve Bank of Australia. Most people tend to focus on the RBA in the context of its responsibility for monetary policy. But an equally important part of its remit, which came to the fore during the recent crisis, is vouchsafing so-called “financial system stability”. It does this by offering banks access to a range of short-term lending and liquidity facilities…

In 2009 I backed a call for a so-called “Son of Wallis”—a new financial system inquiry.[4] Wallis was completed in 1997 and was predicated on the “efficient markets hypothesis”, which has proven to be an imperfect regulatory assumption. Even Professor Harper, who I have a high regard for, one of the main authors of the original Wallis Inquiry report, has supported calls for a Son of Wallis and highlighted the frailties in the existing system.[5]

The crisis taught us that financial markets can fail and liquidity can disappear. Entire banking systems can collapse. It would be a mistake to attribute Australia’s good fortune in skirting the worst of the crisis purely to policymaking skill. A lot of providence came into play as well—our terms of trade boom, record population growth, strong domestic demand particularly for residential real estate, a pristine government balance-sheet, antipodal position, and historical accumulation of fiscal surpluses were all important parts of the story.

One of the principal recommendations of Wallis was that we should never guarantee any part of the financial system under any circumstances for fear of inducing “moral hazard” – the risk that you encourage (the) dysfunctional term, “heads bankers win, tails taxpayers lose”. That’s the sort of behaviour we have seen in the United States… [6]

As Guy Debelle of the RBA recently remarked,[10] ultimately the public has to serve as a ‘backstop’ to financial intermediaries, because we simply cannot afford for the financial system to fail. And the risk of collapse is much greater in the 21st century – with its highly interconnected world. Shocks in one country can be quickly propagated to distant isles, creating global contagions…

We have, thankfully, come a long way from the original debate on public versus privateownership and, for the benefit of some commentators, the capping of interest rates by the Parliament. The Coalition does not believe that taxpayers should run commercial banks, nor do we believe that politicians should set lending rates. It was, after all, Robert Menzies who enacted the 1959 Reserve Bank Act that formally created the RBA, and, crucially, forced the central bank to get out of the commercial banking game…[11]

To borrow Glenn Stevens words: “The finance industry, certainly at the level of the very large internationally active institutions, needs to seek to be less exciting, less ambitious for growth, less complex, more conscious of risk and more responsible about where those risks end up, than we saw for the past decade or two. And, of course, it does have to be better capitalised…[12]

The sort of financial system we should want is what was once described as ‘the hand-maid of industry’: reliably facilitating transactions, fostering trade, bringing savers and investors together, pooling risk and so on. We don’t actually want too many of the financiers to be ‘masters of the universe’. There will always be a risky fringe, but it should stay at the fringe, not be at the core”[13]

I would remind the commentariat that it was the Coalition Government that signed the first “statement” with the RBA formally enshrining its independence in 1996. That was when the Labor Party wanted to take Peter Costello to the High Court to stop the agreement.

That’s because as late as mid 1994 Paul Keating was directly interfering in RBA monetary policy decisions and forcing our central bank to reduce interest rate increases that it would have otherwise made.[14]

This independence has allowed the RBA to effectively target inflation, with Australia now firmly in the group of low inflation countries. Goldman Sachs recently remarked that the RBA is arguably the best central bank in the world.[15] I might add that it is not perfect – and I am sure they would say that as well.


[2] According to the RBA’s self-penned history, “the [Commonwealth Bank]…gradually evolved its central banking activities, initially in response to the pressures of the Depression in the early 1930s and later by formal, albeit temporary, expansion of its powers under wartime regulations. These included exchange control and a wide range of controls over the banking system (including authority to determine advance policy and interest rates, and to require private banks to lodge funds with it in special accounts)…The new Commonwealth Bank Act and the Banking Act, both of 1945, formalised the Bank's powers in relation to the administration of monetary and banking policy, and exchange control.” Available from:

[5] Professor Harper (quoted): “Our framework was essentially the efficient markets theory…We thought we had found the ultimate fixed point in the universe, namely the market price, and so we built on top of that the regulatory framework. But then there was no market price…The evolution we expected has stopped, reversed and gone the other way.”

[6] “The intensity of prudential regulation should be proportional to the degree of market failure which it addresses, but it should not involve a government guarantee of any part of the financial system…It is the Inquiry’s view that any regulatory assurance should be tightly circumscribed…Ultimately, it is the responsibility of the management and board of a financial institution to ensure that its businesses deliver on the promises made, and it is not appropriate for government to underwrite them. Prudential regulation adds an extra layer of oversight beyond regulation of disclosure and conduct, but this should not constitute a guarantee.” Quoted in Financial System Inquiry (Wallis Inquiry), 1997.

[10] “Financial services are a key intermediary input into the production process. A severe curtailment of those services has a material impact on the capital accumulation process, unemployment and the long-run growth prospects of the economy. It is in the interests of society to ensure that the public sector provides a backstop in such circumstances to mitigate the externality caused by the individually rational risk-aversion of financial sector participants.” Debelle, D, 2010, On Risk and Uncertainty, Address to Risk Australia Conference, Sydney, August 31, 2010. Available at:

[14] “Prime Minister Keating summoned the Governor of the Bank and the Treasury Secretary to his official residence. As Kelly tells it: "Fraser's recommendation [notably to the PM] was for a full 1 percentage point increase. The meeting was on Keating's turf. 'The Prime Minister had concerns,' [Treasury Secretary] Ted Evans said in a masterly understatement...The Prime Minister wanted a concession. He argued that the increase was too much, too sharp. In the end, they knocked 0.25 per cent off Fraser's proposal...[Ian] Macfarlane said: 'I was told they brokered it down to three-quarters of the point'...Keating got a concession."”