A Broken Board
The RBA review shows in gory detail how badly we need reform
The cornerstone of the RBA review is the recommendation that monetary policy powers be taken from the RBA Board and instead be given to a dedicated monetary policy committee staffed mostly by external experts.
Some commentators have criticized this recommendation as a mere rearrangement of deck chairs, taking the decision of monetary policy from one bureaucratic committee and giving it to another - leaving little impact on the interest rates that Australian households end up paying.
I think this view reflects a profound misunderstanding of the RBA review's findings. In fact the review spells out in great detail why they believe the current structure has led to multiple policy errors that a panel of experts would almost surely not make.
In this (lengthy) article I am going to unpack just one part of the review - the evidence for why the Board is so badly broken.
The Broken Guidance
The decision in October 2020 to issue a prediction that interest rates would stay at 0 per cent for the next 3 years is the most universally agreed upon error by the Reserve Bank of Australia in recent times. Everybody (including the Governor himself!) now admits it was a mistake.
So, how did this policy error get made? The RBA review examines this decision in detail and find that
The Reserve Bank Board did not receive any written briefings proposing calendar-based forward guidance before it was introduced by the Governor in a speech in mid-October 2020.
So despite receiving no advice proposing the idea the Board decided to implement it anyway!?
But even worse the Board had been actively warned about the risks involved in calendar based forward guidance only one year earlier!
The lack of written briefing for the Reserve Bank Board at the outset is notable given the RBA’s advice on forward guidance to the Board in 2019 which focused on the drawbacks and risks of calendar-based guidance.
The review concludes that
…the introduction of calendar-based guidance was not treated in the same way as other policy shifts, and there was no documented discussion of the risks and implications of this shift. The lack of consultation reduced the opportunity for the Reserve Bank Board to debate, challenge and collectively own the decision.
This is a stunning indictment of the current Board.
Despite being warned about the dangers of the 3 year guidance, they implemented it anyway while failing to debate or discuss the very real risks around the policy - namely that that inflation would rise quicker than expected and they would be forced to break the guidance.
Which of course is exactly what happened. This decision was a massive unforced monetary policy error. How would this have been different under a board of expert monetary policy makers?
Well there are plenty of studies on the risks of time-based forward guidance if you know where to look. Any expert in monetary policy or macroeconomics would have known this. Moreover a committee of experts would have taken staffs’ advice placing more weight on staff recommendations and, if they disagreed with them, couched their disagreement using empirical evidence or macroeconomic research. If the Board had listened to the expert advice they had received they would never have given that guidance and would have avoided misleading the Australian people.
By contrast a monetary policy committee of experts would likely have avoided the most universally loathed mistake the RBA has made in recent years.
270,000 Jobs Destroyed
The 3 year forward guidance mistake, while high profile, ultimately harmed the RBA’s reputation more than it did the economy. A far more costly mistake was the decision to keep interest rates too high over the period 2016-2019. A mistake which destroyed 270,000 jobs.
This was an error many years in the making - not in the heat of the Covid-19 Crisis.
Surely, this additional time would have enabled the Board to debate ways to solve the inflation undershooting and to get the unemployment rate back down to the NAIRU?
The evidence gathered by the Review suggested that there was not a sufficiently deep ongoing debate around the strategy of accepting gradual progress towards the Reserve Bank Board’s targets. The Board papers contained only limited consideration of alternative strategies, whether because the executive chose not to put them forward or the Board did not ask for this material.
I guess not.
Despite killing hundreds of thousands of jobs, neither the RBA executive nor the external members of Board seriously entertained the idea of changing course.
In 2017 the review reports that the RBA hired an independent overseas expert who “equipped Reserve Bank Board members with the necessary information to genuinely explore and debate alternative viewpoints on the appropriateness of the policy strategy”. Sounds promising! The expert report even acknowledged the costs of the approach of “Leaning against the Wind” - the underlying reason why the RBA destroyed so many jobs.
So now that there were armed with a crash course in macroeconomics did the Board turn the ship around and stop the RBA from suffocating the Australian economy?
There is limited evidence in Reserve Bank Board papers or meeting Minutes that the question was re-examined in a meaningful way over the next 2 years.
Oh well.
Of course the RBA did have access to a large internal source of expertise and dissent did exist among the RBA staff at this time. But alas
Alternative views among RBA employees and alternative policy choices – and their costs and benefits – were rarely presented.
What a monumental policy error, driven by a completely broken policy process.
Would external experts have helped? Of course they would have. We knows this because
The internal experts had diagnosed the problem, but were being muzzled.
External experts were calling out the RBA in the press at the time.
The only politician who held the RBA to account Andrew Leigh, was also the only former academic economist in parliament.
This is a clear example of a time when the RBA made a serious and persistent policy error, and we have evidence of who was the canary in the coal mine. It was academic macroeconomic experts who were the first to call out the RBA for making what was a profound policy error.
Ignoring the Problem
Perhaps the greatest evidence that the Board is useless appendage is how the RBA executive ignored it during the collapse of Yield Curve Control.
In October 2021 the RBA decided to effectively abandon the yield peg as it come under sustained pressure from financial markets. But amazingly the Governor did not even check with the Board before pulling the plug on the program and stopping all interventions! The Review states that
This raises governance concerns regarding … the ability of the Governor to stop implementing a decision of the Reserve Bank Board without first consulting them.
The RBA was even aware of risks building up in their policy months earlier, but didn’t convey them to the Board.
The Reserve Bank Board was not made aware of the views of some senior staff members shared with the Governor that the RBA should exit the yield target in mid-2021.
Another example of internal experts being ignored, so that the Board could blunder into another policy error in their ignorance.
The List Goes on
I am more forgiving of errors made in March 2020. It was a hectic time for everyone - central bankers included. But it would be remiss to not mention that the people who had access to all the internal documents still consider the policy process to be deeply flawed during this period.
There was little discussion of the risk involved in implementing yield curve control
However, the Reserve Bank Board written materials gave little attention to how unusual a yield target was internationally or the fact that there was no international precedent for exiting from a yield target. The written materials also did not consider the plausible risk that the yield target might make it more difficult to change course if economic circumstances changed quickly.
Meanwhile the risk seemed readily apparent to even a humble academic such as myself per my blog post from November 2020.
Or when it came to the design of the Term Funding Facility
The Reserve Bank Board was not provided with, and on the available evidence did not demand, enough information in advance to fully debate and challenge the key design choices for the tools proposed by the RBA executive. For example, the term funding facility option presented to the Reserve Bank Board proposed to offer banks funding at a fixed interest rate. It was acknowledged in written materials that this approach carried some interest rate risk. But the risk was said to be small and warranted and was not quantified. The paper did not explore the option of offering an attractive floating interest rate, such as in the Bank of England’s otherwise similar program.
Did this limited discussion matter? I am not sure. But I am sure that academics would be far more familiar with the policy design used by other central banks compared to business executives whose experience is largely confined to the Australian economy.
Of course that expertise to consider these policy programs, and the risks involved, did exist
The RBA developed a set of internal papers outlining more detail on the design of the yield target and term funding facility, but these materials were not provided to the Reserve Bank Board.
But it was considered too hard for the Board to grok.
The RBA considered these materials to have a level of technical detail that was not required for the Reserve Bank Board’s decision.
And it wouldn’t be an Australian institution if we didn’t have a case policy cultural cringe, this time in response to creating a quantitative easing program of our own
The RBA highlighted in Reserve Bank Board papers that Australia stood out among its peers in not having an asset purchase program across the yield curve. The Review heard in consultations that part of the motivation for implementing the bond purchase program was to match its peers.
You might think that we need to follow our peers to prevent the currency being depreciated, and you’d be right that was motivating factoR
The RBA in part motivated decisions about [QE] in the context of the impact on the exchange rate.
But did the Board see any modelling on the bond purchases impact on the exchange rate?
However, no supporting analysis was provided to the Reserve Bank Board.
Ok, I think we’ve seen enough.
The Status Quo Must Go
If you care at all about good economic policy, or even just good policy process more generally, then the Review makes for eye-opening, depressing reading.
Time and time and time again the RBA staff members warn about impending dangers, but the RBA executive decides to keep their Board in the dark. In turn the Board consistently fails to ask for further information or more detail about the risks involved until inevitably something goes wrong and another unforced policy error occurs.
For a group that are supposed to be good at thinking about uncertainty, they seem to be repeatedly thrown off course whenever things don’t pan out exactly as they had planned.
Fortunately, we now know the truth and have a government that seems willing to fix the problem. The status quo is broken, change cannot come soon enough.