RBA ‘indolence’ and reform

Last week Paul Keating blasted the Reserve Bank of Australia for its ‘indolence’ and ‘timidity’.  He complained the RBA was too slow to raise interest rates in the late 1980s, then too slow to bring them down in the early 1990s.  And now — again — the Bank is dithering. 

This is a recurring problem. We also saw it in the RBA’s tardy response to the mining boom, which saw the CPI rise by 5% in 2008 (to be saved by the GFC).

In recent years, inflation has consistently been below the target of 2-3% while unemployment has substantially exceeded sustainable levels.  Instead of doing the job parliament assigned it, the RBA fretted about financial stability — a problem that interest rates do not solve. 

Not surprisingly, formal research finds a pattern of excessive inertia.

As Keating agues, there is something structurally wrong at the RBA.  These errors are too systematic to be attributed to a few mistakes by select individuals. 

One explanation is the composition of the RBA Board.  Most Board members are business leaders with little training in economics and no background in monetary policy.  People without relevant expertise lack confidence in their decisions and move timidly; even after the need for action has become obvious. 

The result is confusion-driven paralysis.

The lack of expertise on the Board is a problem for other reasons.  Most Board members are not equipped to seriously challenge — let alone disagree with — the Governor.  When the Governor makes a mistake, the Board is unable to identify it; much less correct it.

These issues place recent debates on monetary policy in perspective.  Several academics have argued for a change in the RBA’s targets; for example to nominal GDP or a price level. 

However, if the RBA is unwilling to meet its objectives, tweaking those objectives is missing the point. 

It’s like a cricket coach telling a bowler which stump to aim at when the bowler can’t even land the ball on the pitch.

We need to fix the RBA’s structure and incentives before we start fine-tuning its objectives.