Light-touch RBA review gets inflation call right

Australia’s central bank should meet less often and have a specialised board to make interest rate decisions, a review panel commissioned by the federal government recommended today.

But more radical changes were avoided in the long-awaited, 294-page report.

The principal example was the Reserve Bank of Australia’s inflation target, which the panel said should remain between 2 per cent and 3 per cent.

The target had worked largely effectively since its introduction in 1996, the review said, and contributed to “superior economic outcomes compared to earlier decades”.

The advice to keep the target follows calls from the likes of the Australian Council of Social Services, which argued it should move to between 3 per cent and 4 per cent.

What will change will be the creation of a dedicated Monetary Policy Board, with access to more in-depth research and a less frequent meeting schedule, moving from 11 times a year to just eight.

The RBA will need to better communicate thinking, too.

Internally, the shake-up will include a new chief operating officer, which will enable the bank’s governor to focus more on policy decisions.

While he said the changes were positive, governor Philip Lowe was also clear that the impact would be minor.

When asked by journalists whether making changes to the central bank’s governance earlier would have helped avoid the ongoing inflation breakout, Dr Lowe said it would only “make a difference at the margin”.

“It’s not correct to say a different decision-making structure would fundamentally make a difference.” Dr Lowe said.

“We’re not suddenly going to be delivered 2.5 per cent inflation every year.”

The review also knocked back calls for the RBA to have a “specific climate transition objective”.

The RBA’s tools were not relevant to climate change, and pursuing climate goals could compromise inflation and employment outcomes, the review said.

Instead, the report said the RBA should keep working to understand climate change’s implications.

Reviewing what?

Pressure began to build on the RBA from some commentators even before the pandemic.

That’s because inflation was running slightly below the target range, despite unemployment continuing below 6 per cent for an extended period.

Some commentators suggested interest rates, already at then-record lows, should have been even lower to support higher job growth.

What a difference a few years can make.

Now, the low pre-pandemic inflation rate is a distant memory, with price rises of almost 8 per cent nationally in 2022.

The failure of slightly-below-target inflation seems almost inconsequential when compared against the havoc now being wreaked on the economy by rocketing prices.

Australia was not the only country hit by the sudden acceleration of inflation, although the central bank was slower than others to respond, the review found.

“While the Reserve Bank board was initially slower to respond to signs of inflation than some of its peer central banks, it acted decisively once underway,” the review said.

Notably, despite the delayed response, the RBA has increased rates less than the United States' Federal Reserve, Reserve Bank of New Zealand, and the Bank of England, among others.

The RBA has adopted that stance as it seeks to achieve a "soft landing" from inflation, without damaging the economy.

The review was also clear that excessive stimulus played a big role in inflation overshooting the target range.

As much as 3 percentage points of excess inflation in 2022 were caused by RBA and federal government stimulus, the report said.

Dr Lowe said the bank had a strong insurance mindset during the pandemic.

“Our approach during the pandemic was to do every single thing to help Australia,” he said.

He accepted criticism that the bank perhaps did too much.

“We rebounded from the pandemic quicker than anyone expected, and we had to wind back,” Dr Lowe said.

Then there’s the issue of full employment.

Part of the argument for lower interest rates pre-pandemic, and continued stimulus in 2020, rested on the case that unemployment could be driven down, permanently.

Unemployment hit its lowest level in 48 years in 2022, and was just 3.5 per cent nationally in March.

But one key number highlighted today suggests that won’t last.

When asked for guidance on what jobless rate would represent full employment, Dr Lowe said a rate of 4.5 per cent.

That means unemployment is expected to return to that level over time, regardless of any temporary actions by the RBA on interest rates.