The RBA has forgotten its job

Dr Philip Lowe’s 2021 assertion that the official cash rate will remain at historic lows until “at least 2024” will go down in history as possibly the worst guidance ever offered by an RBA governor.

Back then, the cash rate was at an historic low of 0.10%. The concern then, as the RBA saw it, was trying to prevent the inflation rate falling below the 2-3% target range.

“Our judgment is that we are unlikely to see wages growth consistent with the inflation target before 2024," he said at the time. 

"This is the basis for our assessment that the cash rate is very likely to remain at its current level until at least 2024.”

Today’s reality is just the opposite, with central banks around the world hiking rates to quell demand and rein in inflation.

In this week’s episode of The Rules of Investing, I sat down with business journalist Alan Kohler.

Kohler has been an outspoken critic of the RBA’s past and present monetary policy. Policy, he argues, that’s ground in a warped interpretation of its own mandate.

Assume the brace position

The podcast was recorded hours before the RBAs decision to lift the cash rate hiked by 25 basis points to 3.60%. But the increase was widely expected and surprised nobody.

It’s a hike too far, says Kohler.

“Whether the landing is soft or hard is entirely in the hands of the Reserve Bank.”

“There should be a soft landing. I think the Reserve Bank should pause because I think things are different this time, given the amount of debt – more than any time in the past."

Currently, the futures market is pricing that rates will get to 4.06% in September. That’s good news for depositors, bad news for the economy.

“If the futures market is right, it's a hard landing.”

All roads lead to inflation

It’s clear the RBA is focused on one thing – inflation.

“They're specifically worried about inflation expectations, and they want to make sure that inflation expectations are not embedded and elevated,” says Kohler.

“But the inflation is clearly temporary. The spike in inflation was caused by the pandemic supply chain problems, then the Ukraine war, and to some extent by the spike in demand from fiscal stimulus during the pandemic. All of those things are temporary.”

Even if they weren’t, elevated inflation may not be all that bad on balance.

“I think that there's a case for saying that the, we can live with higher, slightly higher inflation for a while - whether it's 3%, 4% or 5%, it’s not that big of a deal.”

While the inflation we’re battling today is new, the RBA’s obsession with it is not.

“[The RBA] have three parts to their mandate."

“One is the stability of the currency, which does mean inflation, the second is full employment, and the third one is the welfare and prosperity of the people of Australia. But since they started the inflation targeting regime in the early nineties, all of those objectives have come to mean restraining inflation.”

“How about 33% each of the three mandates.”

Where did this inflation targeting regime come from?

The obsession with inflation is in many ways also an obsession with employment and the wage-price spiral concept.

In the late 70s, Federal Reserve chairman Paul Volcker used rates to increase unemployment and end the rampant inflation of that time.

Buoyed by Volcker’s success, central banks redefined inflation in the context of the labour market. So whereas full employment previously meant 0% unemployment, full employment was recast as the lowest level unemployment could be without triggering inflation.

In Australia, that standard became the “non-accelerating inflation rate of unemployment” (NAIRU). No one knows for sure what level the RBA views NAIRU to be, but it’s almost certainly not zero.

What is guidance for, anyway?

Lowe’s claim of no rate hikes until 2024 probably haunts him in his sleep. And he’s become the public’s antihero because of it.

But guidance was then, as it is now, not really guidance at all. Rather, it’s a mechanism used to manipulate aggregate demand at any given time.

In 2021, the RBA wanted to increase demand and get inflation to target. Now, arguably, the guidance is for more rate hikes.

“He could be trying to avoid putting up interest rates more by saying he's going to,” says Kohler.

“If everyone acts like there's going to be two more rate hikes, then maybe he won't have to do it.”

The problem is that most people take forward guidance at face value. Even among experts who should know better.

“When he said in February that they expect more rate hikes, all the economists went, ‘oh, crikey, there's going to be two more rate hikes.’ And people who believed and had been saying that the February hike would be the last of them suddenly put two more rate hikes into their forecasts because of what Dr. Lowe said.”

“I don't think it should be taken as a prediction at all.”

Overhaul the RBA

As discussed above, the inflation targets need more flexibility. That’s the first thing.

More fundamentally, though, Kohler believes the bank needs greater expertise and more transparency.

“The RBA has a slightly unusual operating method. They've got the staff led by the governor - at the moment, Philip Lowe - and they've got a board of outsiders. Whoever the treasury secretary at the time is sits on the board, and they generally have one or two economists and then business people.”

“It looks like a normal company board… [and] because the board primarily consists of non-experts, the experts within the Reserve Bank tend to dominate.”

Kohler proposes a monetary committee of experts – in the same vein as the Federal Open Market Committee (FOMC) at the US Federal Reserve. 17 experts sit on the FOMC.”

“The FOMC publishes the interest rate forecast of each of its members. They tend to also publish anyone who dissents from a decision. So they're very transparent.”

Finally – outside appointments to Governor would help.

With a few notable exceptions, “every other governor has previously been deputy governor. There's a case now for an outside appointment to bring some fresh fresh ideas to the bank.”

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