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. John, if you had been shorter, you would have been appointed to the RBA during Howard’s reign. He seemed to prefer economists he could see eye-to-eye.

    Three very good points. The idea of a fiscal authority with a role similar to the RBA but for fiscal policy ought to be raised again (something Nicholas Gruen has raised in the past). Or a combined authority with fiscal and monetary powers, better still. And there is great scope for looking at the micro consequences of macro policy and how the detail of policy, existing regulation and institutions, have important and subtle and not so subtle consequences as indicated in your points two and three.

  2. Nothing? Resigning?
    Converting to a body to address high youth unemployment and the deficit of fiscal policies?
    Stop looking after banks and start looking after people?
    Making sure they really are at full employment before they keep talking about the labor market tightening (for which segment does it tighten?)

    Actually looking at underemployment before they crow about the unemployment rate?

  3. Thanks for explaining that Alice – I’ve deleted a few comments, which didn’t seem to make much sense

  4. How can the RBA persist with this myth of inflation targetting when they do have a responsibility to get us to and maintain full employment.

    I dont buy the line that the natural rate of unemployment has increased and us parents with kids have to get used to it – Id like to save more for my retirement but Im too busy supporting kids over twenty – hence I must work longer and I must take their jobs – its a damn catch 22 and I still wont have eneough for my retirement despite working longer and stealing my own kids potential jobs.

    Something isnt right – what do we want? An RBA that supports us all working longer for nothing extra??? Im sure they agreed with the extension of super access age. The only people not facing longer working lives are comfortable public servants who come back and double dip big time. Youth are out of a job and so are indebting themselves at uni to so the right thing? BUT they cost their parents a fortune.

    Just looks like a worse chance to save for my retirement to me.

    The RBA seems to me to be a chronic disconnect from everyday life in this country. When they talk about GDP pusing against constraints their only justification is on MINING.

    Big woop. What about transport? What about agricultural production? What about our paltry starved maunfacturing sector/ What about retail? What about wholesale?.

    Im sick of hearing about the RBA talking about Mining when the amount of jobs it adds is paltry. Im sick of mining getting all the kudos. Im sick of mining getting all the help.

    If its the only industry doing well something is rotten in economic policy.

    I really am starting to hate the topic of mining especially when more is ripped out of Australia’s economy than is put back by miners.

    The RBA just shows its alliances and they arent people friendly. I dont think much of the RBA and if they shut down tomorrow and stopped fiddling with the cash rate I doubt anyone much would notice any difference.

  5. Sorry Prof
    That partner of mine really is out of order. He doesnt know anything about economics except selling used cars so you will have to excuse him. If you had a decent make and model or wanted a car – you would encounter a completely charming person (much to my irritation seeing as I suspected years ago he had a gift, found a car yard and suggested he rent it and go to work in it and give up his English teaching – of course he now thinks he is the brilliant one)!!
    This is typical of the male species…but maybe I should have given up my teaching at the same time.

  6. John

    I think Glenn Stevens is turning out to be an outstanding central bank governor.

    His acknowledgement that the RBA kept the cash rate too low for too long during the terms of trade boom in my opinion sets him apart from the pack.

    Especially when compared to Ben Bernanke who still won’t acknowledge that loose Fed policy was the major driver of the credit boom which led to the GFC.

  7. The credit boom, by itself, didn’t lead to the GFC. Poor regulation was the prime cause and loose monetary policy, motivated by fear of spooking the markets, simply added to the fuel, of which there was plenty anyway. There is always plenty of money available when people are apparently spinning straw into gold.

    The concern with Mr Stevens is that he will err in the other direction. Maybe after too hot and too cold governors they will choose one ‘who is just right’.

  8. @sdfc
    Neither does “I found a flaw Greenspan” who then turned straight back to pushing his market models.
    I have to be completely honest here and say I am teaching from the (WORST the VERY WORST) economics first year text I have ever taught (and I have been teaching almost two decades) and it has Bernanke’s name on it. Im constantly apologising to my students for the holes in the logic in it
    I mean even the students pick up on it. Its embarassing Lets see now NS = national savings = (Y-C-T) plus (T-G) ie private plus public svaings – so tell me what happens in this flat accounting equation when tax rises? nothing (like hell) and what happens when when run a government deficit (NS goes down – like hell it does).
    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. Why do I have to teach this garbage that doesnt even model real Y decently, let alone NS.

    Rubbish. Its some ort of flat accounting statement ie NS = Y-C-G and it ignores economic relationships.

    My students are not idiots.

  9. Freelander of course the credit boom was the primary driver behind the GFC. The problem wasn’t the rise in asset prices in of themselves but rather the run up in financial liablilities.

    Without ultra-low interest rates the boom and bust could not have happened. Regardless of the regulatory regime. It is basic economics that low interest rates distort decision making. Easy money has been proven time and again to drive irresponsible financial behaviour.

    Give me a central banker who errs on the tight side to one who is too loose anytime. Recessions are painful but that is nothing when compared to the damage a financial crisis causes to output and employment.

  10. @sdfc

    You’re entitled to your opinion. All the easier to have one, when unconstrained by fact or knowledge, of course.

  11. Alice

    While I haven’t agreed with everything Bernanke has done (particularly when a member of the FOMC under Greenspan) I think he has done what has been necessary to shoer up the financial system and prevent the US money supply from falling. In doing so he has played a large part in staving off deflation. I also give him full marks for telling the House Financial Services Committee that a rush to fiscal austerity would cost jobs in the short term.

    As for the accounting identity, I think it is a pretty good place to start when teaching the basics. The problem with questions on deficit spending is that the answer changes depending on what part of the cycle you are in.

    I tend to think of the economy in cash flow terms these days. A change in the fiscal balance is simply a change in the balance of payments between the public and private sectors.

    During a downturn I think it is good policy for the government to support private sector incoem by basically pumping money into the economy through deficit spending. Generally the automatic stabilisers should be enough to achieve that end however during a deep downturn, particulary one that is associated with a financial crisis more is needed.

    When the government borrows money that money is essentially created by the banking system. Just as it is when the private sector borrows. That is why deficit spending is inherently inflationary and the correct policy when you are concerned about possible deflation.

    The US and the Europeans have got themselves into so much fiscal trouble because they run deficits as a matter of course. No matter where they are in the business cycle.

    Sorry if that is a bit of a ramble.

  12. Freelander if you don’t understand that the GFC was a classic boom/bust scenario driven by easy credit then I’m afraid it is you who is not familiar with the facts.

    Deregulation may have facilitated some of the extravagances of the credit boom but it played only a supporting role I’m afraid.

  13. Freelander :
    The credit boom, by itself, didn’t lead to the GFC.

    I’m sorry, Freelander, but the credit boom did lead directly to the GFC. Not just the easy money for mortgages, but the easy money for investment banks, hedge funds, global speculators and every sort of financial charlatan. Credit, credit, credit, bang.

    Now it may be argued that regulation was lacking, but the dominant meme for the last three decades was deregulation. Deregulate the financial system, deregulate the labour market and global trade, deregulate compliance and probity checks, deregulate fiscal rectitude, deregulate your grandmas, deregulate the … lot. So one can’t then turn around and say it was a problem of regulation.

    As to John’s issue, it would seem to me that the independent Reserve bank has become the stool pigeon for government irresponsibility. In particular, if the reserve bank puts up interest rates, well, it’s not the government’s doing, and if we’re not running full employment (or the lowest participation rates and highest underemployment rates since records began), well, that’s not the government’s doing either, its in the reserve banks charer, and if the government can’t borrow to invest because that would mean they are competing for funds and driving up interest rates, well, that’s not the government’s doing either.

    So here we have a system where the government can run deliberately fiscally irresponsible policies, like the cash hand-out to upper middle income young persons to buy their first house that passes good government money directly to that most needy group in our society; older, asset rich, high net worth individuals.

    Or the even more outrageous spend of $6 billion in tax breaks to keep said class in a
    manner to which they have now become accustomed.

    So if the asset boom gets a little out of hand, they can always rely on the reserve bank to put the squeeze on, which effectively means transferring wealth from those with the least to those with the most as a means for curtailing the madness of those with the most from an orgy of self-destruction brought on by over-investment and under-regulation: ie, an asset bubble.

    The failure of the US government to match tax revenues to social investment, and to then allow what social investment they do attempt do to be hijacked by vested interests is going to bring down their empire. The richest, shortest lived, most short sighted and ultimately incapable civilisation of all. If it wasn’t so sad it would be funny.

    And then, to cap it off, we’re going to run out of cheap fuel and cook the planet. Fix that, reserve bank.

  14. Looks like Milton Friedman is being channelled from the other side… Channelled, in stereo.
    Clear where ever he is, hot or cold, it is certainly not a room with a view. Same old baloney.

  15. Freelander

    It would be more accurate to say I’m channelling Keynes, Minsky and Wicksell.

    The Austrians too for that matter but only up to a point. Their remedy for a financial bust is well wide of the mark.

  16. Chris Warren offered a bet on the RBA stuff – Well closing this blog.

    Looks like the betting market has changed.

    Did anyone take him/her up……?

  17. “low and stable inflation rates do not imply a stable economy ….”

    The really fundamental divide in macroeconomics is between those who believe that capitalism is a self-correcting system that damps real shocks and therefore just needs to be managed to minimise those shocks (ie “keep inflation stable & the rest looks after itself”) and those who believe it inherently unstable, prone to propagating and magnifying shocks of all sorts, and that therefore needs constant fiscal, monetary and other intervention to get it back on track. Whether you believe GDP has a unit root really does matter to your opinion of macroeconomic management.

    While it is logically possible to to be either a fully fledged socialist and yet a hard money monetarist or RatExp person, or the reverse – small government but one ever ready to adjust its fiscal and monetary balance to nudge demand back where it “belongs” – in fact small government types usually extend their phobia about government action (and consequent philia for private actions) to macro policy as well.

  18. Freelander, what’s with bagging the arguments of others without putting up your own? It’s not enough just to say that you diagree and that you have all the facts. What are your so-called facts and what’s your account of the causes of teh GFC?

    Do you really think that the GFC still would have happened if credit wasn’t so readily available?

  19. By far the biggest medium-term risk Australia faces is the end of the Chinese building boom. When it ends — and it will end badly — the mirage of the Great Australian Resources Boom will be laid bare … and there will be very little left.

    Manufacturing? Gone.
    Education? Dead.
    Tourism? Vanished.

    We are totally unprepared for this eventuality. The RBA, Treasury and ABARE can see nothing in their crystal balls but decades of resources boom ahead.

  20. I think the economy is self correcting over time. Unfortunately it is overlaid with a financial system, which is destabilising. Particularly following a long period of easy money.

    Glenn Stevens appears to now understand that a blinkered approach to inflation targeting is suboptimal.

  21. @sdfc
    says “Glenn Stevens appears to now understand that a blinkered approach to inflation targeting is suboptimal.”

    I hope so – because I still keep hearing the same old rubbish. Did you know that because of the need to reconstruct QLD damage, this might actually cause tradesmen’s wages to rise (doh) and this might lead to inflation?

    I dont think so when over 10% of the labour force is underutilised in almost every age group (and some age groups are worse than 10%).

    There is a lot of slack in there to imagine that a kick in tradesmens wages is going to do it.

    If you blink twice it could cause inflation in wages but petrol and groceries can go through the roof but somehow that doesnt cause inflation (mainly because they have slectively removed the most inflation causing everyday things out of te basket).
    No matter what the real economic effects are on families incomes you can bet it will all be rosy with the RBA.

    I live with inflation. Ive been living with it for years – infaltion in groceries, inflation in rates, inflation in parking and petrol and bank fees, inflation in this, inflation in that, inflation in tolls and fines

    Oh but according to the RBA there is none and where then is some its not for the reasons that households are losing their purcahsing power.

    I personally think the RBA is next to useless but thats my opinion.

  22. You know there is a horrible lot of government service inflation in imposts and charges out there?? – are they in the basket or is it only imports of computers?
    I wish KK could stick her traffic offenses you know where – its such a blatant revenue raise. Blatant.

  23. 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

  24. @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.

  25. 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.

  26. @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.

  27. 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.

  28. 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.

  29. @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).

  30. @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.

  31. 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.

  32. @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.

  33. 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

  34. 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.

  35. 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.

  36. 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.

  37. @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.

  38. 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.

  39. 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.

  40. It is actually a good appointment.

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

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