The biggest issues facing the Reserve Bank of Australia

Hip pocket issues have always been a key part of any election campaign. In that respect, this election is no different.

Until recently, prices have been generally fairly stable. This meant parties competed on how much support they offered to key interest groups like small business and pensioners, or how they would address the sectors of the economy where prices were rising, notably housing and childcare.

But the re-emergence of high inflation around the world threatens to make this election different.

Of course, for decades inflation was an issue that defined and destroyed governments. Fraser’s government never really got a handle on it. A huge focus of Hawke’s first terms in office was breaking the wage-price spiral that had emerged in the early 80s.

In the UK, Thatcher’s government remains among the most hated and admired in part because of its aggressive policies to combat inflation.

Ultimately, it was the emergence of independent central banks and the adoption of inflation targeting that both broke the back of high inflation and decentralised inflation as a political issue.

Governments too often allowed political interests to overrule sound policy. Independence for the central bank with clearly defined mandates solved that problem, but it created another one: an absence of accountability.

So, while it is right that inflation is an election issue, responsibility must remain primarily with the central bank. The correct response is to implement a process of accountability — starting with an external review of the RBA.

Of course, there is a risk that this review will be an excuse for politicians to assert political control over RBA decisions, to grandstand on unrelated issues, or to impose additional mandates beyond monetary policy such as social policy concerns.

The review must instead focus on the biggest issues facing the RBA: accountability and transparency.

The first, and most important, element of this regime would be a thorough assessment of how and why things go wrong.

Over the past decade, the RBA has shown itself unwilling or unable to achieve its inflation target. Underlying inflation has been below the bottom of the RBA’s two to three percent band for more than five years. It would still be there if not for the massive pandemic stimulus and the impact of supply chain disruptions on global prices.

Where is the RBA’s explanation for why it persistently missed its inflation target? Why was this failure not corrected?

How much of the miss was intended and how much was accidental?  Without knowing that, it is difficult to discuss remedies.

In the light of hindsight, why were the forecasts of future inflation persistently too optimistic?

Dwelling on errors is often uncomfortable and embarrassing, but learning from mistakes is in the public interest. Persistent failure in one direction suggests systematic failures of governance.

One possible correction for these failures is for independent bodies making important policy decisions to conduct their deliberations as transparently as possible.

Judicial decisions are accompanied by detailed reasoning, as are many administrative decisions. They must be explained in a way that facilitates review and appeal, and engenders public trust in those institutions. At a minimum, similar standards should apply for monetary policy.

A transparent and accountable central bank would set out its relevant policy options and fully explain its choice for one over the other, but that does not happen currently. Minutes and statements following board decisions rarely discuss the pros and cons of alternative choices. They do not explain why alternative paths for interest rates are not chosen.

For transparency to be meaningful, decisions need to be challenged and defended. This has begun to happen at recent press conferences; an innovation that should be extended.

But it is not just external processes that fail to identify mistakes or question the decisions of the Governor. Another key area in need of reform is the RBA Board.

Most RBA Board members have experience and skills in the real economy but lack formal training in macroeconomics and are unfamiliar with monetary policy. While they can ask good questions, they are unable to effectively challenge the Governor.

As monetary policy has become more technical, other central banks have seen the need for greater representation of experts, but the RBA has been left behind.

It is unrealistic to expect subordinates within the RBA, whose promotion prospects depend on the goodwill of the bank’s leadership, to provide a strong contrasting voice.

This critique should be the role of the RBA board, and they should be expected to do so publicly. RBA board members should write publicly about their views on policy, explaining where they agree and disagree with the official position, and vote on the record.

This would combat groupthink, insularity and status quo bias — common complaints about the RBA.

Moreover it would give the public a greater sense of the policy landscape, facilitating a wider range of contributions and enabling the Governor to be held to a higher standard.

In specialist areas like monetary policy, or say public health during the pandemic, it has become increasingly common for government to devolve policy making power to experts. At the same time, expectations of Ministerial accountability for these decisions have declined.

Unfortunately, while government is held accountable for their performance at the ballot box, many of these policy experts have had far less public scrutiny. This must change.

The RBA is a respected institution that has maintained a high level of public trust. However, the key to keeping its privileged position is not merely to meet its mandate but to embrace accountability and transparency. It should embrace a thorough review wholeheartedly.