Playing politics with the RBA

If the RBA really was losing its independence it would be missing its inflation targets – that's not happening and only a brief look at history reveals it was the Liberal Party-appointed RBA board that most recently did so.

Thankfully Paul Howes, national secretary of the Australian Workers Union and Garry Weaven, chair of Industry Funds Management, have zero influence on economic policy. Last week, both made some absurd points and claims regarding monetary policy, the inflation target, the Australian dollar and the operations of the RBA.

Both Howes and Weaven revealed the shallowness of their experience by showing little or no understanding of the critical importance of the inflation target. It is imperative that the inflation target remains in place because ongoing low inflation is the best thing policy makers can deliver if there is to be a boost to competitiveness, productivity and with those, employment and real wages.

There is also zero chance that the RBA charter is going to change, at least under this government, nor will the inflation target change, nor will there be any material changes to how the RBA works.

Howes’ and Weaven’s comments deserve criticism, as do others who say and write misguided, factually flawed or faulty economic analysis. The economy is too important for ill-informed commentary and misguided policy prescriptions.

Which brings us to the point made by an ignorant and sometimes politically biased few that the RBA now is somehow being politicised, losing its independence or being lent upon by the government.

That clearly is a fantasy.

If it were true, the only way it would show up would be in the RBA having inappropriate monetary policy settings and not achieving its inflation target. There is no other way to even vaguely support the claim of political interference or undue influence.

Is there any other way any such politicisation of the RBA board would show up?

Clearly not, and only poor quality, inexperienced and/or biased commentators trying to get some attention would suggest that the RBA is structurally flawed due to any government decision or appointment.

Let’s turn this around and look at some facts to see whether there ever has been any political influence on the RBA.

Before starting, let’s agree with the unanimous assessment that a series of monetary policy changes starting today will not have a material impact on inflation for a year or two. There is no debate about the long lags between interest rate changes and the impact on the economy.

Consider the only bad miss of the RBA in terms of its 2 to 3 per cent target for inflation.

That error of the RBA showed up in the period from the end of 2007 to the end of 2009 when the underlying inflation rate averaged a shocking 4.0 per cent having hit a peak of 5.0 per cent in the September quarter of 2008.

That monetary policy error had its seeds sown during 2005 and was really compounded during 2006 and early 2007 when policy was too loose for too long. It must have been – there is no other explanation for such a bad miss on inflation.

Recall that in 2005, with mortgage rates some 50 basis points lower than where they are today, the RBA delivered just one, piddling 25 basis point rate hike having left interest rates steady at very accommodative settings right through 2004. In 2006, the year started with monetary policy still accommodative and despite the massive upswing in the terms of trade and sharp falls in unemployment, the RBA dragged the chain with just 3 hikes in the year.

Only at the very end of 2006 did the mortgage rate reach neutral; that is, roughly where it is today. Clearly, the RBA delivered easy monetary policy for a very long three year period.

It is unlikely that there was any direct political interference on the RBA over that time, but curiously, it was the Liberal Party appointed board of the RBA, including Governor Ian Macfarlane, that so badly blew the inflation target. Monetary policy was kept too easy in the period from 2005 to 2007, curiously when the Liberal Party was in office and when Prime Minister Howard and Treasurer Costello used monetary policy and interest rates in its campaigning and economic rhetoric in a way the current government is still a million miles from approaching.

By the end of 2002, every member of the RBA Board with the exception of Frank Lowy, had been a Liberal Party appointment. Mr Lowy’s term ended in December 2005 meaning that during 2006 and up to the election in 2007, every RBA board member was a Liberal Party appointee.

It was only when Glenn Stevens became governor, in September 2006, that monetary policy moved towards an appropriately tight setting. While Glenn Stevens was appointed by the Coalition, there were no other contenders for the role when Ian Macfarlane retired. To appoint anyone else would have been truly shocking.

Mr Stevens quite forcefully delivered 5 interest rates hikes in his first 16 RBA board meetings as governor, including two in early 2008 when the financial crisis was rapidly unfolding. Finally, the RBA was acting to reign in inflation with a hugely hawkish approach. And to the credit of Glenn Stevens and the RBA, that policy approach worked with inflation back on target by the middle of 2010.

The underlying inflation rate has been 2.75 per cent or less since the middle of 2010 and it will be probably be close to, or at a 12 year low below 2.5 per cent, when the March quarter CPI is released on April 24.

Unemployment has also recently edged up, fiscal policy has been tight, the world economy weak, yet the 'politicised' RBA has rates at the upper end of neutral and shocked the market in the early months of 2012 by not cutting interest rates. This is despite only 3 of the 6 outside board members being appointed by the Labor Party.

And just getting back to the key point in this – if the RBA was being politicised, it would show up in monetary policy being too loose for too long and inflation building to a level above the target. The exact opposite is happening right now.

In the last 20 years, there has only been one example where monetary policy has been too easy for too long and that was in the period from 2005 to 2007 when every member of the RBA board has been appointed by the incumbent government. Look at these facts and make up your own mind about the issue of politicising the RBA and monetary policy.

Stephen Koukoulas is Managing Director of Market Economics and was former economics advisor to the Prime Minister Julia Gillard.

This article first appeared on the Market Economics blog. Republished with permission.

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