Phil Lowe’s most dangerous idea
His accidental legacy to Australian monetary policy
Amid the flurry of commentary on RBA Governor Lowe’s replacement by Deputy Governor Michele Bullock, few seemed able to sensibly evaluate Lowe’s term in office. One of the main arguments for inflation targeting is that it provides a clear benchmark against which to evaluate the performance of monetary policy. Amid the many takes on Lowe’s departure, few bothered to reference this obvious and easily quantifiable benchmark. As Lowe himself conceded in an address to accountants in Wagga on 16 December 2021:
‘My main KPI is to deliver you an average rate of inflation of 2.5 per cent, and I'm falling short on that.’
The RBA actually benchmarks its inflation performance based on time spent in the target range more so than the average inflation rate. On that measure, Governor Lowe scores a lowly 11/100 (three quarters out of 28).
But the inflation target misses were symptomatic of a much deeper problem. Lowe had insufficient conviction in the effectiveness of monetary policy. This exchange from the House Economics Committee on 7 February 2020 nicely illustrates the problem:
Conditioning monetary policy on a Phillips curve relationship is a mistake, but even on its own terms, a flat Phillips curve is an argument for doing more with monetary policy, not less. Lowe’s argument failed either way you look at it. For reference, the US CPI inflation rate has fallen from 9% to 3% over the last 12 months while the US unemployment rate remains near cycle lows not seen since the late 1960s. Flat indeed. But that does not mean that monetary policy had no work to do. Just ask Jay Powell.
Governor Lowe blamed below-target inflation on a laundry-list of real factors, everything from globalisation to technology, while often deflecting to fiscal and structural policy. During the RBA’s February 2019 appearance before the House Economics Committee, the words ‘hope,’ ‘hopeful’ or ‘hopefully’ were used 12 times, mostly in relation to the outlook for inflation or wages. For Lowe, hope really was a strategy.
As the following chart from Pinpoint Macro shows, the RBA’s main policy instrument displayed an unprecedented level of inertia during Lowe’s term in office, at least until the pandemic struck:
While we should be wary of inferring the stance of monetary policy from the level of interest rates, Friedman’s insight that low rates are often symptomatic of relatively tight rather than easy monetary policy is also in evidence.
Lowe gave the G20 a lecture on lifting productivity this week, which is unexceptional in itself, although he would have a stronger platform if he had delivered on his own mandate. The pre-pandemic failures of monetary policy decision-making had negative spillovers for Australian public policy more generally. With inflation persistently below target, many in the policymaking community mistakenly concluded that monetary policy no longer worked instead of reaching the more obvious conclusion that the RBA was not really trying. As I noted in this piece, there were demands for more activist fiscal policy and even a return to centralised wage fixing. The persistent undershooting of the inflation target threatened to up-end the entire institutional division of labour for post-reform era economic policy.
It is hard to escape the conclusion that Lowe simply did not fully appreciate the power or economic significance of the policy instruments at his disposal, over which he enjoyed almost unlimited statutory authority. He is hardly the first central bank governor to make that mistake. As the Romers famously argued, the idea that monetary policy doesn’t matter is also ‘the most dangerous idea in Federal Reserve history:’
An unduly pessimistic view of what monetary policy can accomplish has been a more important source of policy errors and poor outcomes over the history of the Federal Reserve.
We know very little about Michele’s macroeconomic thinking, other than what she has articulated in recent speeches, which is probably more an institutional rather than personal perspective. Fortunately, the RBA Review’s recommendations will help ensure that monetary policy decision-making is much better informed on her watch than it was under Lowe’s. The government’s legislative reforms to the RBA could be in place by Christmas. Perhaps that is Phil’s accidental legacy to Australian monetary policy.
ICYMI
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Peter Tulip discusses the change in RBA leadership:
The way mainstream economics treats money surely has something to do with this. That, in a monetised economy, money is half of all transactions and that, when there is no information from the future, expectations are crucial, does not seem to properly sink in. Indeed, that monetisation directly affects the scale of economic activity does not seem to sink in. We are dealing with choosing agents, not economic “particles” in some mechanistic social Physics.