The RBA is a moribund institution – an incumbrance on the economyNov 20, 2023
For the last three decades the Reserve Bank of Australia has focused on just one economic goal – a rate of inflation between 2 and 3 per cent. It is a goal they have pursued relentlessly since 1993, regardless of how effective or fair it is. Last Tuesday they increased the cash rate yet again. The Guardian summed up the pending possibility as “A Melbourne Cup Day rate rise would not be tough on inflation, it would just be cruel”.
The RBA rate increases mainly impact the 3.5 million Australian households who have mortgages. The other 6.5 million out of our 10 million households are largely left untouched. Interest rate rises are thus a cruel and heartless targeting of those on low to middle incomes who are already struggling under other rising living costs.
But do the RBA’s policies work? They can’t seem to nail inflation and the country is constantly in a state of uncertainly about interest rates.
A real problem is that too often the RBA’s monetary actions are counter to the government’s fiscal policies.
What the RBA is meant to do and what it actually does
The primary macroeconomic goals of the Australian government are divvied up. Fiscal policy is the responsibility of the federal government, through taxation and spending. The RBA is responsible for monetary policy through interest rates and the money supply.
The RBA charter and core functions states: “It is the duty of the Reserve Bank Board … to ensure that the monetary and banking policy of the Bank is directed to the greatest advantage of the people of Australia” and to best contribute to currency stability, full employment and the economic prosperity and welfare of Australians.
But then we read these weasel words:
Policies in pursuit of these objectives have found practical expression in a flexible, medium-term inflation target, which has formed the basis of Australia’s monetary policy framework since the early 1990s. The policy objective is to keep consumer price inflation between 2 and 3 per cent, on average, over the business cycle.
Thus, they see low inflation as the only necessary goal.
However, of all objectives, the most critical macroeconomic goal should be low unemployment. They used to think that at the RBA too. This paper from their 1998 annual conference begins by explaining how unemployment has many evils, including that it is a major source of poverty, rising levels of anxiety, lack of structure of life and negative psychological well-being. Add to this that a pool of long-term unemployed can morph into a pool of unemployables.
But nowadays the RBA seems to believe that unemployment is acceptable collateral damage to achieving their obsessive inflation target. On August 30 the Australia Institute wrote: “The RBA wants to make 140,000 more people unemployed because they believe that unless this happens inflation and wage increases will not slow.” The article questions the RBA’s theories on unemployment and inflation. Consider the work that could have been performed by 140,000 people unemployed for six months.
So is inflation the most serious economic problem facing Australia? Clearly, we don’t want inflation spiralling out of control and we don’t want negative inflation either as that can make the economy implode. But does inflation have to be between 2% and 3%? This article from The Conversation postulates that inflation targets have been set too low in most OECD economies.
It is foolish to think that a target band dreamt up in 1993 is still relevant 30 years later! Will it still be relevant in 2093?
Does the RBA know what it is doing?
All this is due to trying to solve a problem largely caused by over-stimulation by both fiscal and monetary policy during Covid. That crisis was fully predictable. Yet, in his final speech as governor, Lowe said “the RBA and government provided too much economic support – but that conclusion was only possible with the benefit of hindsight”.
He was paid a fortune to be wise in foresight, not to be wise in hindsight!
The Covid stimulus resulted in a situation of there being too much money in the community chasing too few goods. And that is the problem that the RBA seems to be trying to solve now – but it is mainly only taking money from those who have mortgages. Counter effective is that at the same time the RBA effectively gives money to others through higher interest on deposits. Further, businesses pass on the rate increases via higher prices.
Other actions should be taken by the government at the same time to ensure the burdens or benefits are more equally spread. For example a 25% GST on luxury items would dampen expenditure from high income earners, even if they have mortgages.
Apart from being grossly unfairly targeted, we have to ask whether the RBA’s policies work, do they do any good at all? Since the 1990s inequality in income and wealth has ballooned.
Divided macroeconomic responsibilities do not work
Too often government fiscal policy does the opposite to the RBA at the same time, with one stimulating by adding money to the economy while the other takes it out.
To illustrate, the federal government has provided energy relief to help households with the cost-of-living crisis. But this is not much different to the Treasurer deciding to give mortgage relief to those affected by the latest interest rate rises caused by the RBA!
The RBA rigidly chooses to manage our economic woes by sticking to a questionable inflation band concocted thirty years ago. But why, instead, not have a 2% to 3% band for the cash rate, or better, 2% to 3% for unemployment!
Unhappily for our country, the federal governments of either party, find taxation and spending decisions to be too hard politically. Thus they have been willing to leave the bulk of so-called economic management to the central bank and for them to take any blame.
And there are more cruel rate rises to come!
Some economists wrongly think Melbourne Cup day will be our last rate rise. However, the stage-three tax cuts are to begin in July next year. If they go ahead, they will change Australia for the worse, forever. And inflation could skyrocket as high-income earners will have far more money than they know what to do with. Under the current macroeconomic management regime, what the federal government gives away, the RBA will have to take back with massive interest rate rises.
And the bunnies having to pay will be the 3.5 million households with mortgages!
That is all unconscionable. Fiscal policy and monetary policy need to work together. The RBA can no longer remain independent.