Just how independent is the Reserve Bank?

It will be interesting to see whether the RBA’s paralysis will be successful in taming inflation. It doesn’t have a great track record in recent years.

Certainly, RBA inaction in the mid to late 2010s saw inflation increasingly diverge away from the target. This was a major reason why the RBA Review was commissioned.

In addition, the RBA was late and slow to the party on raising rates — arguably causing inflation to be higher, and last longer, than necessary.

Perhaps the biggest problem facing the RBA is that it is stuck between a rock and a hard place on inflation. Or perhaps more accurately it is stuck between economics and politics.

The August 2024 Statement on Monetary Policy lays out a very compelling economic case. Unfortunately, the action it best supports is not the one the RBA took: the Statement clearly points to a need to increase interest rates. As the Statement notes “inflation is proving persistent and the quarterly underlying inflation rate has fallen very little over the past year”.

It has yet again pushed back the time it expects inflation to return to its target of 2.5% — now not expected until after 2026.  Even then, the Bank’s discussion of risks suggests this forecast has an element of wishful thinking.

It goes on to note that demand remains high, housing and labour markets remain tight and growth is stronger than expected. The Statement points to the stimulus effects of government spending (while noting that the government’s accounting tricks with its cost of living payments may impact the headline figure in the short term).

In other words, all the economic conditions exist for the RBA to raise interest rates. In fact, the Governor was clear that it sees no likelihood of interest rate cuts any time soon, while increases remain on the cards.

This was deeply unwelcome news in a number of corners, at least from a political perspective.

First, the government has made it clear that it sees no case to raise interest rates and that it will do nothing of substance to address the inflation issue.

Indeed, the Treasurer continues to dispute the RBA’s interpretation that the government spending program is inflationary.

It is hard to see how the government can continue to do so with a straight face. On the one hand they are saying they aren’t contributing to inflation while on the other they are underwriting massive pay increases sector by sector.

The latest announcement of a $3.6 billion package to increase childcare workers’ wages will not be the last. The government’s blatant interference in the operation of centres to try to restrain rising fees seem like an increasingly desperate attempt to avoid the plain economic consequences of its policies.

Of course, underlying all of this is fear within the government that after two years the public will blame them for continuing inflation and high mortgage rates, rather than the previous government.

No doubt the government would like to be able to go to the next election campaign with a backdrop of falling interest rates. But absent an external shock, or deliberate political interference, this looks increasingly less likely.

While pressure from the government is unlikely to result in the RBA cutting rates when they should be raising them, it is harder to avoid a potential conclusion that the RBA is not raising rates at least in part because of an aversion to potential criticism from government.

Another strong force likely to hold back the RBA is the very palpable anger of mortgage holders if interest rates were to increase again.

The fact is, as some have repeatedly pointed out, the fight against inflation has largely been about which groups in society wore the most pain from the necessary correction. Mortgage holders have borne the brunt — and they are not happy.

There is a growing belief, no doubt at least in part encouraged by government, that the RBA will start cutting rates soon and deliver relief to those who are now paying thousands, or even tens of thousands of dollars, more on their mortgages.

While it is hard to see an economic justification for this belief, it nevertheless persists.

Last — and likely least — is the volatility in the stock market in recent weeks. The best that could be said is that the movement in stock markets to some extent reflects genuinely-held sentiments about global growth prospects.

These prospects, rather than the price movements, would be relevant information for the RBA to consider. In practice, there are far better local indicators pointing in the other direction.

In some respects, the dilemma the RBA faces is more acute because of its structure. Monetary policy authorities around the world tend to have policy committees dominated by monetary policy experts.

The RBA board, on the other hand, has a number of members with more broadly-based (a polite term for less) expertise that is tuned into the sentiments of the narrow industries from which they come. Although previous Governors liked having their decisions rubber-stamped, in this instance it could easily be a weakness.

On top of that, RBA Governor Bullock would not be human if she did not observe the way her predecessor Philip Lowe was treated when he jammed rates up at an unprecedented pace.

Of course, it is always possible dumb luck will win out — as it did in 2009 when the GFC cured accelerating inflation, or in 2021 when the rebound from the pandemic offset errors in the other direction. But the RBA’s reliance on overseas surprises to put it back on track will eventually come a cropper.

It is more likely questions will be put to the RBA that will demonstrate whether they are really as independent as they claim — or if they too will bend before the whims of public and political pressure.

Simon Cowan is Research Director at the Centre for Independent Studies.