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Revamped RBA is about people more than the targets

The recent failures of the RBA have not due to a broken system.

Composite image of the external of the RBA, and blurred pedestrians crossing a busy street.
The proposed RBA reforms are good news but the system has not necessarily broken. (Source: Getty)

On balance, the recommendations for reform of the Reserve Bank of Australia (RBA) suggest no practical change in the course for monetary policy, interest rates, the medium- to long-term inflation rate or the fundamental strength of the labour market.

Over the next decade or two, interest rates will go both up and down on an unforecastable timeline, but inflation will hover around 2.5 per cent and the labour market outcomes for unemployment and wages growth will be determined by the business cycle, immigration and a range of longer-run structural issues outside the control of the RBA.

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This is much as it has been for the past 30 years, with the success at meeting those goals determined by the judgment of the personalities pulling the policy triggers on the ups and downs for interest rates.

In recent times, those personalities have failed. It has not been a failure of the system.

If the current forecasts of the RBA are correct, in the decade to 2025, annual inflation will have been within the 2-3 per cent target for just two quarters – a miserable record.

The other recommended changes for the RBA - relating to openness, transparency in the decision-making process and having a body of policy experts to implement monetary policy settings - are all worthy changes in process, but they are not the end game.

Overall, the reforms are necessary and long overdue. When fully implemented, they will likely lead to the RBA making better decisions on monetary policy, it is likely to hit its inflation target more often and there will be less variability in inflation outcomes.

The population will be better informed about the state of the economy, which is a good thing.

After all, monetary policy will still be adjusted with the express aim of hitting the 2-3 per cent inflation target.

That said, the new RBA monetary policy board will still only be as good as the people selected for it.

If the so-called experts on the board have the wrong expertise, show poor judgment and come to the job with pre-determined views on economic policy settings - which is a major risk - the reforms will have been for nought.

There is another issue in the review which, on reflection, could be troubling.

The elevation of the labour market – the unemployment rate in particular – to the monetary policy deliberations of the RBA could create a problem.

Importantly, it is well-established that monetary policy cannot target unemployment in any long-run structural way. Sure, it impacts the cyclical ups and downs in the unemployment rate but interest rates can never be set to achieve full employment.

If the new board thinks this - and policy is set to ‘easy’ to stop the unemployment rate from rising at a time when the inflation rate is too high - it will unleash inflation problems that will be much more damaging for cost-of-living issues for all Australians and, in time, lead to yet higher unemployment.

At the moment, the recent interest rate increases are expressly designed to slow economic growth, add to the unemployment rate to take upside pressure off wages growth and, in the end, lower inflation back to the target.

As it should when inflation hit 7.8 per cent.

As things stand, the forecast from the RBA and market economists is for higher unemployment over the medium term. It would be a policy error for the RBA to cut interest rates now on the basis of those forecasts given that inflation is, for now, still too high.

A misguided board emphasising the unemployment objective of the RBA might make that mistake.

One excellent decision from the review is to retain the treasury secretary on the board. It has not been formalised what their specific role will be given the review is also wanting to further engage the links between fiscal and monetary policy in controlling inflation and maintaining full employment. That said, the treasury secretary could provide a detailed update each meeting on the path of government demand in the economy and frame the outlook for public demand over the forecast time frame.

For example, if government finances were showing a slowing weakness in spending, this would feed into the discussions on the economic outlook and, with that, the need, if any, for a monetary policy change. It is useful information given the role of government spending and taxing decisions in the economic cycle.

Overall, the recommended reforms of the RBA are good news and will make the central bank more accountable for its decisions. As a result, it is more likely to get those decisions right.

But its success will be critically dependent on the personalities of those appointed to the board, which will be considered by interested observers as the reforms are implemented.

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