Home Banking The Reserve Bank of Australia Review: A Welcome Dose of Accountability?

The Reserve Bank of Australia Review: A Welcome Dose of Accountability?

by internationalbanker

By Nicholas Larsen, International Banker


On July 19, Australia’s treasurer, Jim (James Edward) Chalmers, announced the first review of the Reserve Bank of Australia (RBA) since the central bank began conducting independent monetary policy in the 1990s. In doing so, it marks the first attempt of its kind globally to seek accountability for what has purportedly been a sluggish response to surging inflation, both in Australia and across much of the world. Such an endeavour will thus keep other central bankers on edge and, given their own failings, may prompt them to conduct similar post-mortems.

The review has come in the wake of questionable monetary policy pursued by the RBA—specifically, the decision to hold off on hiking interest rates until May—despite inflation in Australia having accelerated to 5.1 percent by that time. Since then, it has scrambled to make up for this lacklustre response by raising its benchmark cash rate repeatedly—by 25 basis points in May to 0.35 percent and then by 50 basis points in each of June, July and August—such that it stands at 1.85 percent today. But with inflation continuing to climb to 6.1 percent in the second quarter, many believe the central bank’s monetary tightening was far too late in coming.

Indeed, the RBA was roundly criticized for delaying its rate hikes, especially given that neighbouring New Zealand began its own tightening seven months before the RBA’s first rate increase in May. Even the bank’s governor, Philip Lowe, acknowledged that mistakes were made and described its forecasting—which pledged to keep rates as low as possible until 2024—as “embarrassing”. As a result, such guidance only further swelled an already dangerous and systemically impactful housing boom as Australians became further indebted amid a worsening macroeconomic environment. “We should forecast this better. We didn’t,” Lowe added.

With harsh criticism coming from the top, then, a review of the RBA is now underway. “This is an important opportunity to ensure that our monetary policy framework is the best it can be, to make the right calls in the interests of the Australian people and their economy,” Chalmers stated. “The Review will consider the RBA’s objectives, mandate, the interaction between monetary, fiscal and macroprudential policy, its governance, culture, operations, and more.” It is being carried out by Carolyn Wilkins, the former Bank of Canada deputy governor and external member of the Financial Policy Committee (FPC) at the Bank of England (BoE); Professor Renée Fry-McKibbin, the interim director at the Crawford School of Public Policy at the Australian National University; and Gordon de Brouwer, a senior civil servant and the secretary for public sector reform.

Truth be told, even prior to recent inflationary woes, calls for a review of how the RBA goes about its business have been a long time coming, with various parties expressing misgivings. “Depending on evolving economic conditions, the sequence of policy normalization should likely entail further tapering and ending asset purchases before raising the policy rate, and eventually unwinding asset holdings,” the International Monetary Fund (IMF) stated in December 2021. “In light of the changing global environment and an expansion of central bank toolkits, a review of the monetary policy framework, as conducted in many peer central banks, would be good practice to ensure that the RBA’s framework remains up to date.”

In September 2021, meanwhile, the Organisation for Economic Co-operation and Development (OECD) recommended a similar course of action for the central bank. “Now would seem like an appropriate time for a review of Australia’s monetary policy framework, given the institutional and structural changes that have occurred in the economy as a result of the pandemic and the unconventional policy instruments the RBA has begun to employ,” the OECD’s “Economic Surveys: Australia” suggested. “Such a review should be broad in scope, potentially including a review of the central bank mandate, policy tools, methods of public communication, hiring processes and internal structures. It could also consider the alternative paths for rebuilding monetary policy space from the current position of policy rates at the zero lower bound.”

And even in academia, there has been considerable debate over whether the RBA’s strategy needs reform. “At any time, the public should be able to evaluate whether the Reserve Bank of Australia’s interest rate decisions are consistent with achieving statutory mandates. The current policy and communication strategy makes this difficult,” a January 2020 paper from the University of Melbourne’s Centre for Applied Macroeconomic Analysis (CAMA) stated. “The mandates, as interpreted by the RBA, fail to provide a clearly identifiable performance benchmark. And the supporting communication strategy falls short of a commitment to explain the economic basis of why and how interest-rate decisions achieve mandated objectives. Examples of both concerns are given from various public documents. Basic reforms would improve the accountability and effectiveness of monetary policy.”

But is such a review even necessary for an institution with exemplary performance up until recently, one might ask? After all, it is worth remembering that the RBA presided over three decades of positive growth in the gross domestic product (GDP) before the COVID-19 pandemic sent not only Australia but the entire global economy into recession. And even upon the impact of the pandemic’s seismic economic shock, the general global perception was that the RBA was among the most proactive central banks in its response. It swiftly lowered interest rates such that by March 19, 2020, the official cash rate had been brought down to 0.25 percent. It also introduced a target for the 3-year Australian Government Bond (AGB) yield to be achieved through secondary-market bond purchases and 3-year fixed-rate funding facilities for authorised deposit-taking institutions. And it began a 5-to-10-year government-bond-purchasing programme in November 2020 (along with a further cash-rate reduction to just 0.1 percent),  extended three months later.

And while one might reasonably conclude that the RBA was late to the party in terms of rate-tightening, it was hardly the only one. Listless central bank responses were also witnessed in the United States, where the Federal Reserve (the Fed) openly admitted that its assessment last year of inflation being “transitory” was a grave error; in the eurozone, where the European Central Bank (ECB) began raising interest rates only in July for the first time in 11 years; and in the United Kingdom, where inflation has now skyrocketed to double digits.

What’s more, the RBA had already acknowledged key shortcomings in its yield-targeting strategy before the review, stating that its exit was disorderly and inflicted much damage to the bank’s reputation. “The target was met for the bulk of the period, but the exit in late 2021 was disorderly and associated with bond market volatility and some dislocation in the market,” the central bank admitted in June. “This experience caused some reputational damage to the Bank.” It also confirmed that it would be unlikely to use any yield targets in the future and would rather purchase bonds in set amounts across different maturities.

Indeed, it is almost certain that forward guidance is now out the window, following widespread criticism both in Australia and elsewhere of a practice first introduced by the Fed under former Chair Alan Greenspan to help manage future economic expectations. And with Lowe recommending as late as last year’s final quarter for rates not to be lifted until 2024 and then describing the eventual 25-basis-points rise in May as “business as usual”, forward guidance has not been effective in achieving its aims. “The Board expects to take further steps in the process of normalising monetary conditions over the months ahead, but it is not on a preset path,” the RBA stated in early August.

This decision also follows similar actions by the Fed and the ECB. “It’s time to just go to a meeting-by-meeting basis and to not provide the kind of clear guidance that we had provided,” Fed Chair Jerome Powell said in July, while his eurozone counterpart, Christine Lagarde, also abandoned its forward-guidance policy. “We are much more flexible; in that we are not offering forward guidance of any kind,” said the ECB’s president, Christine Lagarde. “From now on, we will make our monetary policy decisions on a data-dependent basis, will operate month by month and step by step.”

Ultimately, central bankers hold much power to massively impact their entire populations’ financial lives; indeed, they do so every time they announce their latest monetary-policy decisions to the world. It is also worth remembering that those populations don’t vote in such bankers; instead, they are chosen by incumbent governments, which means that direct accountability to the public is far from forthcoming. As we are seeing now across much of the world, directing anger at politicians for this ongoing spike in living costs has become a virtually redundant exercise given that the likes of the RBA, the Fed and the ECB have arguably done more—ironically, by not doing enough—to land people in this mess.

Thankfully, it seems that the RBA’s review is already inspiring others to follow suit. Just one week after the Australian central bank’s review was announced, New Zealand authored its research note into how central bank mistakes after 2019 led to inflation. As concluded by the report’s co-author and a former governor of the Reserve Bank of New Zealand (RBNZ), Graeme Wheeler: “To begin restoring their damaged credibility, central banks must assess and acknowledge why their models and judgements were so inaccurate and inform the public on what steps they are taking to rebuild public confidence.”

Indeed, it is that “public confidence” in a nation’s preeminent financial institution that matters above all else, as far as its remit is concerned. And for those inclined to seek greater transparency from authorities by wondering, “Who watches the watchers?”, one might not only cheer on more of such comprehensive root-and-branch reviews of central banks going forward but also more real-time monitoring of their activities and ensuring they are more directly answerable to the public. When central banks are supposed to be the lynchpin financial institutions within democratic governance systems, such demands seem only reasonable.


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