Gillard's RBA blunder

In her leaked speech criticising the Reserve Bank, Julia Gillard seems to confuse the board's priorities of promoting economic growth and keeping inflation under control.

Property Observer

In a not surprising (for readers of this column) attempt to politically pressure Australia's central bank, a major media outlet reports today that the prime minister has broken with historical convention – for an incumbent government – and called on the Reserve Bank to lower interest rates given the government's mooted fiscal promises.

This is after the current Labor government controversially took away the Reserve Bank board's pay-setting powers because they were too generous with the governor's salary package, replaced one independent (and hawkish) director with a manufacturing industry lobbyist who describes herself as a "growth girl" and an inflation "dove", and broke with long-term convention by replacing the board's standing independent academic expert (another hawk, Professor Warwick McKibbin, who had offered himself up for re-election) with a former advisor to a Labor prime minister, Paul Keating.

Some have also observed that while the current RBA governor contentiously hiked rates in the final month of the 2007 election campaign as the global financial crisis was brewing – an election that the Liberal Party lost that month – he did not touch rates during the subsequent 2010 campaign despite possessing a hawkish bias, waiting until November to raise them pointedly after Labor had scraped home with a hung parliament.

In a panel interview with Bloomberg yesterday, former RBA board member Professor McKibbin described the government’s recent elections to the RBA board as "disconcerting".

Professor McKibbin advocated a board structure comprising of three RBA staffers (currently there are only two), three independent economics experts (currently there is one), and three "community representatives" with no politically-appointed treasury secretary.

The Australian Financial Review reports that today:

Prime Minister Julia Gillard will aggressively link her budget surplus goal directly to lower interest rates, saying that the Reserve Bank of Australia has "plenty of room” to cut its 4.25 per cent cash rate... Her speech to business leaders in Perth will also make the case for a reweighting of monetary policy which could help push down the Australian dollar and provide relief to manufacturers, exporters and the tourist industry. In effect putting the political success of next month’s budget into the hands of the Reserve Bank board, Gillard will say that the large interest rate differential between Australia and offshore markets gives the RBA "plenty of room to move further if need be”.

The prime minister is quoted apparently calling on Australia's central bank to re-focus on its antediluvian 1959 mandate, which requires it to give equal weight to employment, growth, and price stability.

Since that time, however, the treasurer of the day and the governor of the RBA have signed a total five "Statements on the Conduct of Monetary Policy" that explicitly subordinate the employment and growth goals in the 1959 Act to allow the RBA to focus mainly on one medium-term objective: price stability. Specifically, the latest statement signed by Wayne Swan and Glenn Stevens says (emphasis added):

"Since the early 1990s, inflation targeting has formed the basis of Australia's monetary policy framework. Since 1996, this framework has been formalised in a Statement on the Conduct of Monetary Policy. The inflation targeting framework has served Australia well and is reaffirmed in the current statement...

"[The three objectives outlined by the 1959 Act] allow the Reserve Bank board to focus on price (currency) stability while taking account of the implications of monetary policy for activity and, therefore, employment in the short term. Price stability is a crucial precondition for sustained growth in economic activity and employment.

"Both the Reserve Bank and the government agree on the importance of low inflation and low inflation expectations...[and] on the objective of keeping consumer price inflation between 2 and 3 per cent, on average, over the cycle."

In today's leaked speech the prime minister seems to confuse these priorities. Without having the benefit of the first quarter inflation results, which are expected to be benign, or revisions to the 2011 inflation numbers, the prime minister advocates the employment and growth benefits of lower rates with inflation-targeting added as an afterthought:

"In the current economic environment, should the bank consider it appropriate to change the cash rate, this could deliver widespread benefits for households and business – noting that a number of sectors of the economy most under strain are arguably more sensitive to interest rates...This is fully consistent with the Reserve Bank’s charter obligations to best contribute to economic prosperity and full employment, as well as containing inflation.”

One problem for the Reserve Bank is, as Professor McKibbin explained yesterday, that the current government's forecasts and commitments to fiscal contraction are already accounted for in the central bank's analysis (since Treasury have always projected a steep fiscal consolidation following a fiscal stimulus that McKibbin believes was twice as large as it needed to be), and are, in any event, merely political promises.

At the invitation-only Bloomberg conference, McKibbin argued that the Reserve Bank would be far more focused on what policies the government actually delivers, given its history of missing commitments. He also suggested that it was unreasonable to ask the bank to make decisions today on the basis of assumed budget outcomes before it had the benefit of both seeing what is promised on May 8, and what the government ultimately delivers.

Christopher Joye is a leading financial economist and a director of Yellow Brick Road Funds Management and Rismark. The above article is not investment advice.

This article first appeared on Property Observer on April 17.

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