Economy · August 4, 2022

Nervous central bankers are watching Australia closely

The writer is the founding editor of Central Bank Intel

There must be some nervous central bankers watching the sweeping review that has been launched in the Reserve Bank of Australia.

Around the world, central banks have been surprised by the surge in global inflation, leaving interest rates too low for too long. But the RBA has been more blunt than most in admitting its mistakes, with its own governor claiming its predictions were “embarrassing”.

“We should predict it better. We didn’t, “said Philip Lowe, governor of the RBA, in May. However, the RBA was certainly not alone in its misjudgments with central banks from Washington to Frankfurt in believing that inflation increases would be states more transient than they have been.

This is what makes the RBA review an interesting test of liability. Did the central bank just make the wrong choice or is there something more systemic that went wrong?

Two elements of the RBA survey are noteworthy. One, it will be done by an independent external panel appointed by the Treasury: two Australian economists plus a former Deputy Governor of the Bank of Canada who is a current external member of the Financial Policy Committee of the Bank of England.

Central banks love their independence and are used to being in control. So it may not be comfortable for the RBA to see their future influenced by the recommendations of strangers.

Two, it is unusually broad with the feeling of “scrutiny” or “evaluation” about it. In recent years, major central bank reviews have focused more narrowly on a particular aspect of monetary policy strategy, central bank act or governance related to special instruments or functions.

This will look at pretty much everything at the RBA: the continuing adequacy of its inflation targeting framework, the interaction of monetary policy with fiscal and macroprudential policy, and governance arrangements. It will also examine the choice of tools, policy implementation, communication and “how the trade-offs between the different objectives were managed”. Its culture, management and recruitment processes will also be evaluated.

Evidence of how edgy other central banks has been made is in the reaction of the RBA’s New Zealand counterpart. Less than a week after the RBA’s review was announced, a co-authored research paper by former RBNZ Governor Graeme Wheeler blamed central bank policy errors for high inflation.

Soon after, current Governor Adrian Orr released a statement admitting that the monetary policy of the RBMZ contributed to the high inflation. He went further and announced a review of the RBNZ’s monetary policy trend, including the use of additional policy tools. This review comes in addition to the recently initiated five-year review of its monetary policy mandate.

The RBA probably leads the central bank group in admitting their mistakes. But central banks around the world are facing criticism for keeping monetary policy accommodative longer, misjudging not only the onset of inflation but also its persistence, and also issuing over-explicit forward-looking indications about monetary policy and hence they did not pay attention to it.

Under its forward guidance, the RBA had indicated that it would keep rates as low as possible until 2024. That low rate environment not only failed to cope with rising inflation, it also helped exacerbate the Australia’s real estate boom, a not insignificant systemic risk.

Forward driving is already being abandoned all over the world. Last month, Fed Chairman Jay Powell abandoned the policy of providing detailed comments on what his central bank would do next on interest rates. “It’s time to go to one meeting by meeting and not provide the kind of clear guidance we provided,” Powell said at a post-Fed press conference.

Similarly, the European Central Bank also abandoned its forward policy guidance last month. “We are much more flexible; as we are not offering forward-looking indications of any kind, “said ECB President Christine Lagarde.” From now on we will make our monetary policy decisions based on the data, [we] it will operate month after month and step by step “.

Earlier this week, the RBA joined the trend by signaling that it will no longer provide explicit forward guidance: “The Council plans to take further steps in the process of normalizing monetary conditions in the coming months, but it is not on a predetermined path.” .

If inflation does not go down and interest rates are raised substantially, it is not just forward guidance policies that will be reviewed. More central banks around the world will face official scrutiny. The Australia review will likely not be the last.