The end of RBA exceptionalism: how Australian political science misunderstood the Reserve Bank

Plus, John Edwards’ defence of the status quo

Paul Kelly summarised the RBA review’s final report in the following terms:

‘This is a substantial change in process and structure. It is a vote of no confidence in the Reserve Bank’s culture; it is savage on the flawed performance of the board; it judges the bank made too many mistakes; and it surely constitutes a signal that incumbent governor Philip Lowe cannot be reappointed.’

The global revolution in central banking institutions and governance, starting with New Zealand in the late 1980s, and spreading to many of the world’s leading central banks during the 1990s, partly bypassed the Reserve Bank of Australia. The RBA followed the rest of the world in adopting inflation targeting and gained greater independence from government in 1996. But its statutory framework and governance were left largely unchanged on arrangements the dated back to the 1930s and 1950s.

Australia’s failure to fully participate in this revolution in central bank governance was partly the result of the politicisation of monetary policy in the late 1980s and early 1990s. The conduct of monetary policy was a factor in the early 1990s recession and the then federal opposition put RBA reform on the agenda as part of its Fightback package of supply-side reforms ahead of the 1993 election, including greater independence and an inflation target. Then Governor Bernie Fraser’s response to those proposals in 1991 was to say ‘It's not that easy to change the charter of the Reserve Bank. I won't go just to appease some dickhead minister who wants to put Attila the Hun in charge of monetary policy.’

The Coalition’s subsequent electoral defeat was a setback for this reform agenda, yet 1993 is also the year in which Governor Fraser began to articulate an inflation target as the objective for Australian monetary policy. The RBA was moving in step with international practice through the adoption of interest rate targeting as its operating instrument and inflation targeting as the goal of policy. The RBA was even ahead of the Fed in making formal announcements of interest rate decisions from 1990.

But these changes in monetary policy practice were not accompanied by reforms to the governance, accountability and transparency framework for the Bank. By the time the Coalition came to office in 1996, it was thought sufficient to merely codify existing practice through an exchange of letters between the Treasurer and Reserve Bank Governor. In his 2004 book on the RBA, Money Mandarins, political scientist Stephen Bell quotes then Governor Macfarlane as saying that this was ‘the minimum fuss way of doing it’ (p. 161).

Bell’s book exemplifies a political science/political economy literature on the Reserve Bank that saw its internationally anomalous governance arrangements as serving to discredit the rational choice literature that inspired the revolution in central banking institutions in the rest of the world. The RBA Act, with its origins in post-war Keynesianism, was seen as a hold-out against ‘neo-liberal’ orthodoxy. The RBA’s apparent success in macroeconomic management based on a relatively loose approach to inflation targeting and dual mandate was seen as a reproach to other central banks, not least the RBNZ, and even a model to be emulated internationally. Bell concluded his book with the claim that ‘the system does not need much fixing’ (p. 165).

The RBA review report has now concluded otherwise. The claims made for the RBA’s institutional exceptionalism did not stand-up to scrutiny. The rational choice theorists were right all along. Ironically, the political economy literature on the RBA served a largely conservative agenda.

RBA reform has not been a neoliberal project. Prior to the 2007 election, the Australian Labor Party argued in favour of writing the Statement on the Conduct of Monetary Policy into the Reserve Bank Act, requiring the RBA to make detailed statements at every policy announcement and for removing the Treasury Secretary from the RBA Board. When the ALP was elected in 2007, the RBA quickly served up a suite of transparency measures to get out in front of the new government and reform on its own terms. While there was a bipartisan commitment to a review of the RBA ahead of the 2022 federal election, the Labor Party will now preside over the most significant changes to the RBA Act since 1959.

Australia’s long run of economic outperformance was seen by many as vindicating the existing institutional arrangements. Matt Yglesias once absurdly suggested that other countries should replace their central bankers with Australians, apparently believing that RBA policymakers must have some secret sauce they were not sharing with the rest of the world, somewhat overlooking the fact that most of Australia’s senior central bankers were trained in North American universities!

Long-run economic growth is a function of real not nominal factors. Monetary policy shows up in the data only when it is done poorly. The RBA often let the business cycle come to it rather than bringing policy to bear on the cycle. In my Mercatus working paper, I showed that Australian monetary policy closely approximated a nominal income stabilisation benchmark for most of the period since 1996. But that does not mean that policy could not have been improved at the margin, especially in the period since 2016.

This brings me to John Edwards’ defence of the status quo in his response to the RBA review. John is a former RBA Board member and adviser to former Treasurer Keating.