What should the RBA be doing?

My son called the other day to say I’d been mentioned in the Fin as a possible candidate for the the Board of the Reserve Bank. If I were a serious contender, this would be the cue for me to adopt a pose of grave silence on all policy issues, interspersed by gnomic observations to be pored over for their inner meaning. I’m not a serious contender (even if it’s nice to be thought of as someone who might be) so this seems to be a good time for unsolicited advice to whoever gets appointed.

In the short term, I’m pretty happy with the settings of macroeconomic policy. The Rudd government and the RBA got the monetary and fiscal stimulus right in 2009, and the move back to fiscal surplus and neutral settings for monetary policy has been paced appropriately (the government’s insistence on relying on spending cuts rather than scrapping the last stage of the tax cuts promised in 2007 was a big mistake in terms of budget policy, but that’s a different issue).

My concern is rather with longer-term issues arising from the GFC. First, it no longer makes sense to separate monetary and fiscal policy as sharply as was done in the pre-2007 period, given that, in any real emergency, the two will have to work together. That doesn’t imply doing away with central bank independence (we’ve had an independent central bank since the RBA was established) but it does imply a degree of co-ordination between RBA and Treasury more like the relationship that prevailed before the 1990s.

Second, the inflation targeting approach, based on Taylor rules, failed globally in the leadup to the crisis and during the crisis. An important lesson (which Stephen Bell and I, among others, pointed out before the crisis) is that low and stable inflation rates do not imply a stable economy. In fact, they may contribute to the growth of asset price bubbles (what Minsky terms the shift from hedge to speculative finance). There’s still a lot of room for discussion about what should replace inflation targeting, but full employment needs to be given more weight than in the past.

Third, the separation between monetary policy and prudential policy needs to be re-examined. Everything went well in Australia, but the problems overseas suggest we need to take another look at this.

45 thoughts on “What should the RBA be doing?

  1. Alice

    High inflation lowers real income unless you have bargaining power in the market. The most vulnerable are those with little bargaining power. The central bank should be targeting inflation. Just without the blinkers.

    There is nothing much the RBA can do about fuel and grocery prices. That is a change in relative prices. A wage inflation is a facilitator of a general inflation.

    The RBA has handled the crisis well from what I see. Regardless of its overly loose policy 2005-07

  2. @sdfc
    I dont agree that the central bank should be targetting inflation sdfc when there isnt any about except in the things that the ACCC should be targetting or the unreasonable govermment charges committee shoud be targetting.

    I dont think any central bank handled the crisis well. They contributed to it and actually blew it up by keeping rates to low for too long (and do banks actually follow the RBA – only some of the time)and furthermore the large banks in cahoots with governments robbed us all to keep afloat an obese sector (financial services) that seriously needs rationalising and should never have been fattened on our super to start with.

    Whats effective about that. The RBA and other central banks are in part to blame because of their voodoo economics and faultily measure inflation targetting.

    You dont need to be targetting inflation when there isnt any and there hasnt been any for decades and they are supposed to get us to full employment and they couldnt give a damn about employment.

    central bank policies are just bah humbug.

  3. Central banks in Europe and the US have played a major role in staving off deflation through their actions. They may have been a major contributor to the cause of the crisis but their actions in the wake of the GFC have been extremely effective.

    The only question is, what now? The underlying problem in market. Too much debt. has not been addressed.

    Financial markets have always been unstable. Central banks were created in part to stabilise financial markets though the money supply. The GFC is the result of policy error, not central banking in of itself. You should be careful not to throw out the baby out with the bathwater.

  4. @sdfc
    How have Central banks been effective??

    Financial markets have never been as unstable as they are now sdfc.

    There has been far too much focus on the so called powers of central banks and not nearly enough on regulation and paying attention to fiscal initiatives.

    The interest rate is not the magic cure all panacea central banks imagine it is.

  5. Alice

    Financial markets were incredibly unstable during the 19th century.That’s the reason the Fed was created.

    Inappropriately low interest rates can cause immence damage to the financial system.

  6. What are you talking about Freelander?

    To me a liquidity trap is the function of uncertainty keeping money rates above the expected profit rate.

    From what I remember Keynes thought it was the result of interest rates being too low.

    You’ll have to forgive me it’s been a while since I opened the GT.

  7. @Alice
    The idea in the equation is that all income is either saved or consumed. If taxes increase but nothing else changes (in particular, G is unchanged), than this is just a transfer from private savings to public savings, and hence no change in national savings. Is this a simplification of reality? Of course. But it’s a simplification that has been made to make a point. The whole approach of teaching economics is to start with fundamental ideas, then add complexity and reality once these ideas have been set in stone. As for your comment:

    “Then of course I have students who ask, as they should :but Miss if G goes up doesnt Y go up and if T goes down doesnt C and Y go up? Of course it does.”

    I haven’t looked at the book, but I’m sure this is an unfair criticism. The answer comes purely from an accounting identity. It probably hasn’t been mentioned because it’s immediate and inserting Y(C,I,G,X) is too messy. Anyway, my point is, it may be better to understand and emphasize the point of these questions rather than muddle it with unnecessary details (even if these details are correct).

  8. @sdfc
    sadfc you say”Central banks in Europe and the US have played a major role in staving off deflation through their actions”

    We have entire nations grossly indebted now due to the actions of central banks in the recent crisis. We have people across the world unemployed. We have needy citizens suffering welfare cuts and deep cuts to government spending precisely because central banks saw fit to keep a bubble afloat in global banks who desperately need to have less money at their fingertips and less power. The central banks “staved of a crisis” until when because it is the financial sector that needs rationalisation for us to get back on the path to stability, not the ordinary man on the street. Those who can afford to save with the investment banks should pay for the crisis, not those who cannot.

    The “staving of of the crisis” by central banks involved one of the greatest wealth transfers from the poor to the rich we have ever seen in our lifetimes. The crisis has not been averted at all.

  9. sdfc,
    I think there are a number of reasons for the GFC.
    I believe the major reason was institutions trying to get a greater return than they could given the lower inflation rate.

    That was a regulatory failure not low interest rates.

  10. @Jeepers Creepers
    It wasnt regulatory failure Jeepers. It was the absence of regulation that caused the crisis and it was the absence of regulatory intervention to raise interest rates by the central banks that contributed. Call it what you will but if we have to have centrak banks they should be working for the greater good and full employment, not keeping the financial sector happy ( way too happy).
    As Madoff says – the entire government is a Ponzi scheme and he asks “why is there not one Goldman executive jailed”.
    When the master of ponzi schemes asks maybe we should listen. Madoof may be in jail for 150 years but there are a lot more who should be in jail but instead they were “bailed out”.

    If you want to call that a regulatory failure – thats fine. It was… but it wasnt too much regulation over banks and the financial sector that caused the crisis, it was too damn little regulation little that did it. We have had your free market deregulation experiments and anyone who persists with the line that “regulation done it” is just too denialist to argue with.

    To add to my depression we see another Chernobyl happening in Japan – there is no point in debying it now despite all the “feel good messages in the media” (dont watch what the media says watch what governments and business does – foreign governments have banned a huge array of food products from the region – foreign businesses have repatriated theie employees – foreign shipping lines have banned their ships from the region – Tokyo is affected by these supply cuts

    That disaster, like the financial crisis – is the fault of too little regulation. So dont come the raw prawn with any of us here. You are arguing the ridiculous.

    The only regulatory failure was not increasing, imposing or policing regulation.

  11. sorry but too little regulation is regulation failure in my books. So I agree.

    Central Bankers were arguing for yonks that risk wasn’t priced properly but they did little about it.

    It seems ironic that low inflation caused people to seek higher returns without realising the risk involved.
    It is one of the first things people learn in finance

  12. Amusing how those who argue for little or no regulation morph into their usual ‘government’s fault’ claim when regulators take their ‘light handed’ advice. Yes, in a way, it is the government’s fault for listening to, or being taken over by, free market worshiping loonies. There is no great magic in the market, or anywhere else for that matter.

  13. Jeepers

    Inappropriately low interest rates encourage risk taking financed by debt. The reason credit spreads were too low was because of the search for yield after asset prices had been driven sky high because of the abundance of money.


    Most of those countries were in a fiscal mess coming into the crisis. Ireland was the exception. Their problem was the guarantee of Irish bank debt. It’s a suicide pill if you don’t have your own currency.

    At best they needed to negotiate a restructuring on behalf of the banks. If no restructuring was on offer then insolvent Irish banks should have been liquidated and their functions nationalised for duration of the crisis.

  14. Sorry to disagree but the search for higher yields was driven by lower inflation and investors stuck on nominal returns not real returns.

    I am by no means saying easy credit did not have some input but to my mind it wasn’t the major issue.

  15. @sdfc
    says “then insolvent Irish banks should have been liquidated and their functions nationalised for duration of the crisis.”

    I dont see a single thing wrong with nationalised banks after how the sector has been conducting itself. Frankly I would prefer it.

  16. Banking is not a complex function. It has been made unnecessarily complex mainly to harvest larger commissions, greater fees, higher remuneration and ‘performance’ bonuses. The core functions of banks can be done just fine by a nationalised or government owned entity. The more speculative activities could be left for the private sector. Having a government owned bank competing in the sector could provide several benefits, including introducing the element of competition that has been missing.

  17. I see that John Edwards has got the academic economist’s spot on the Board. This is a safe but dull appointment. I don’t think he’ll be doing too much boat rocking.

  18. It is actually a good appointment.

    He worked in financial markets so he gives the RBA fresh insight on them.

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