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New RBA governor: The two things that will determine her success

Michele Bullock has a very straightforward mandate as incoming RBA governor.

Composite image of incoming RBA governor Michele Bullock, and outgoing governor Philip Lowe.
Incoming RBA governor Michele Bullock will be hoping to avoid the pitfalls of her predecessor, Philip Lowe. (Source: AAP/Getty) (AAP/Getty)

When Michele Bullock assumes the role of governor of the Reserve Bank (RBA) in September, she faces a significant task, including the implementation of the wide array of reforms recommended by this year’s review of the central bank’s operations and functions.

These are important for the functioning of the RBA and perceptions of its transparency and success, but they are more the building blocks and mechanisms that lead to the true goal – returning inflation to 2-3 per cent and having the economy operating at a pace consistent with full employment.

Should Bullock get these wrong - as outgoing governor Philip Lowe did throughout his tenure - not much else matters in terms of the performance of the RBA.

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Other than at times of extreme crisis, Bullock will rely almost exclusively on interest rates to achieve the bank’s objectives. They are the main lever used to guide the economy. This means setting the official cash rate at a level that will skew current economic conditions - whatever they are - towards an inflation rate around 2.5 per cent, the midpoint of the target, while ensuring full employment, which is currently assumed by the RBA to translate to an unemployment rate around 4.5 per cent.

As is well understood, there are long and variable lags between interest rate settings and their impact on the economy.

This means that even for six to 12 months after Bullock assumes the governorship, the economic outcomes will be more of Lowe’s making than hers. Only after the new Monetary Policy Board is functioning and Bullock has been in charge for a year or so will she be truly accountable for economic outcomes.

Other issues for the new governor

There are many justified criticisms of Lowe, including his lack of agility when news emerged, a pig-headedness in believing the veracity of the bank’s economic forecasts, his judgment that financial markets were often ‘wrong’ and his inability to accept economic analysis and suggestions outside his economic beliefs.

Bullock would be wise to jettison this approach to monetary policy, which means admitting errors early, adjusting policy when it is clearly at odds with the inflation and full employment objectives, and to publicly consider why alternative points of view and analysis should be debated.

Former RBA governors Bernie Fraser, Ian Macfarlane and Glenn Stevens operated this way, and successfully so.

Lowe, conversely, had many instances of retaining inappropriate monetary policy because of his closed-minded attitude to outside ideas and an unwillingness to move when economic circumstances changed in unexpected ways.

Among those errors were:

  • Not cutting interest rates because he wanted to “lean against” rising house prices

  • Not cutting interest rates despite inflation being embedded below the target, while unemployment was high and wages growth was falling.

  • Refusing to adjust interest rates because of a perception that a rate cut would create financial instability, even though he never defined what that meant

  • Judging full employment to coincide with an unemployment rate of at least 5 per cent

  • Rubbishing markets in late 2021 for pricing in interest rate hikes as inflation lifted - as a result, the RBA was slow to hike interest rates in the current cycle

  • Failing to appoint outsiders to senior policy roles within the RBA

  • Failing to give regular speeches on economic conditions, especially when inflation was lifting in late 2021 and early 2022 - this lack of transparency was evident at other times.

It is to be hoped that Bullock will be more open, pragmatic and quick to change the view and policy settings of the RBA when circumstances change. As noted, her role as governor will be judged over many years on the outcomes for inflation and unemployment.

If the Bullock scorecard has annual inflation in a relatively narrow range around 2.5 per cent, and if the unemployment rate is consistent with annual wages growth - around 3.5 to 4 per cent - she will have done a good job.

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