On top of the usual angst about its forecasts and decisions, the Reserve Bank of Australia is facing an inquiry. The basic rules of such reviews, according to Yes Minister’s Sir Humphrey Appleby, are not to look into anything you don’t have to and certainly never unless the findings are already known.
In fact, the issues surrounding central banks are clear if not easily remediable.
1. Opaque mandates
The RBA must contribute to the economic prosperity and welfare of Australians, which, in practice, means jobs, price stability and the integrity of the financial system and currency. It lacks specifics – what constitutes full employment?; are growth and welfare synonymous?; why the 2%-3% inflation target? The objectives are frequently incompatible, priorities are unclear and the time horizon is vague.
2. Limited tools
Central banks set interest rates, supply cash through open market operations and quantitative easing (primarily buying and selling government debt) and provide forward guidance (“open mouth operations” or “jawboning”). Alan Greenspan, former chairman of the US Federal Reserve, was famous for his delphic oratory: “If I have made myself clear then you have misunderstood me.”
The RBA has limited influence over budgets (government) and financial institutions (the Australian Prudential Regulation Authority) which may reduce the effectiveness of its policies. The Australian dollar’s value, foreign investment flows as well as geopolitics (sanctions, trade restrictions) are largely outside its control. There are also boundaries; for example, the zero-bound of interest rates and overall debt levels.
3. Flawed economic models
Nairu (non-accelerating inflation rate of unemployment) or the Phillips Curve posit that higher unemployment lowers inflation. In practice, the relationship is unreliable. Cause and effect are frequently difficult to differentiate.
Essential data arrives with a lag and is arbitrary – inflation measures are based on a selected basket of items; growth ignores unpaid work, resource scarcity or sustainability; employment is poorly defined in a world of zero-hour agreements and contracting. Shoppers and businesses see price pressures before central bankers.
The US Fed chairman, Jerome Powell, has confessed that “we understand better how little we understand about inflation”. Impenetrable jargon, arcane mathematics and faux empiricism cloak a bedrock of ignorance but allow brilliant ex post justifications of actions.
4. Cultural issues
Most central bankers are trained economists, who spend most of their working life around the institution, government or academe. They converse mainly with others of their tribe, encouraging groupthink. There is incomplete appreciation of the needs and concerns of ordinary people. At an ill-fated “meet the citizens” event, the New York Federal Reserve Bank president, William Dudley, was heckled with cries of “I can’t eat iPads” when suggesting that rising food prices were offset by falling technology costs.
Central bankers must also consider their post-institutional careers in financial institutions, thinktanks or as non-executive directors. They and their views must be seen as “sound” by those in a position to award these lucrative paydays.
The rise of celebrity central bankers, based on the self-serving cheerleading of financial markets and media, has encouraged hubris. Inscrutable reticence and invisibility have given way to volubility and Twitter handles. Rather than sound stewardship of the economy, the focus is now share markets, house prices and debt-driven illusory wealth, which do not always uniformly benefit all citizens.
5. Limited oversight
The basis of actions is rarely clarified. In 1929, the Bank of England stated that it did not explain its policies as it would be akin to a woman defending her virtue.
Governments are reluctant to interfere, fearing criticism of undermining central bank independence. Boards are dominated by insiders. Independent directors, drawn from the same milieu, are unlikely to second guess staff recommendations even if they have the expertise and information.
The proposed inquiry is likely to obfuscate on the identified issues. Members, former central bankers and “experts”, possibly foreign, are unlikely to be overly critical of peers or court controversy. Competing self-interested bureaucracies will defend acreage, wary of ceding power or importance.
There will be copious recommendations – widening the range of directors, greater community and business consultation, improved communication and regular reviews. Precise objectives and radical changes will be resisted as reducing flexibility or risking unknown side-effects.
The central question whether an independent central bank is needed will be muddied. Governments could set interest rates alongside fiscal and structural strategies allowing better coordination of economic management.
The unacknowledged reality will remain that current arrangements allow governments to transfer sometimes painful or controversial choices to central bankers. They can then allocate blame or claim credit depending on the outcomes.
Central banks offer politicians an institutional mechanism for avoiding responsibility and deflecting opprobrium. Governments instigate inquiries not for the truth or genuine improvement but alibis and the appearance of action.
Satyajit Das is author of the recently released Fortune’s Fool: Australia’s Choices (March 2022) and A Banquet of Consequences – Reloaded (March 2021)