Making a Statement

What should the new Statement on the Conduct of Monetary Policy include?

The Reserve Bank of Australia and the Treasury are currently in the process of writing up a new Statement on the Conduct of Parliamentary Policy, to be put in place along side Michele Bullock as Governor.

It is obviously going to involve a significant rewrite from the current Statement as many of the recommendations of the Review suggest a range of changes be made to Australia's monetary policy framework. But not all of them. Obviously some of the more low level reforms (such as running more staff surveys) don’t need to be include in this strategic document.

So which changes should be included in the Statement itself?

What does the Statement actual do?

Before you ask about what changes to the Statement need to be made, it's worth thinking about the role the Statement on the Conduct of Monetary Policy plays in Australian monetary policy.

Today the Statement’s most important contribution is that it defines how control and decision-making powers are divided between the government in Canberra and central bankers of Martin Place.

Imagine a radical proposal for the Statement that consists solely of the sentence:

The Reserve Bank of Australia shall maximise the prosperity of Australia within the limits of the Reserve Bank Act.

This would be a Statement that provides maximal discretion to the central bankers at Martin Place. They would be able to do pretty much any action or policy decision as long as it was legal under the Act. However, would this radical change in the Statement lead to a big shake-up in how monetary policy works in Australia?

No.

Almost surely the inflation target would remain between 2% and 3%. The RBA would continue to target some combination of trimmed mean inflation and the unemployment gap. They would continue to produce forecasts published in the Statement on Monetary Policy, and continue their diligent work on financial stability as a member of the Council of Financial Regulators.

What it would mean, however, is that if Australia wanted to change the nature of its inflation target or its monetary policy framework, for example, lifting the inflation target up or down or shifting to a price level target, that decision would be made at the sole discretion of the Reserve Bank of Australia, with no input from the democratically elected government.

I think most people would agree that a momentous policy decision such as changing the inflation target should have input from the government and the Treasury, and that this would represent too much discretion to be given to the unelected central bankers.

By contrast, you can imagine a Statement on the Conduct of Monetary Policy that goes in the exact opposite direction. For example outlining every detail of the string of meetings that form the RBA's regular policy process that are spelled out in this speech by Michele Bullock. Changing the statement to dictate the timing of the economic group policy meeting, the Policy Discussion Group, and the board papers would not change the status quo policy process. However it would mean that any time the RBA wants to shake up its meeting schedule or hold an emergency board meeting, it would need to get permission from the Treasurer which would be an absurd level of micromanaging from Canberra.

What you're really considering with the Statement is not just what changes are made to the monetary policy framework today but who has the right to change them in the years to come. Anything left out of the statement is de facto delegated to the RBA Governor, anything left must be approved, at least tacitly, by the Treasurer.

That is why the core tenets of the monetary policy framework such as the inflation target, the inclusion of full employment and the exclusion of financial stability, should all be included in the Statement. There are core pillars of the new monetary policy framework and they should be signed off by the elected government.

I also think it makes sense to detail a lot of the new transparency measures in relatively high detail within the Statement. Nobody likes being transparent. Whether it is from from freedom of information requests, more press conferences with pesky journalists, or the publication of board minutes the costs born by transparency measures can be high and are borne by those who run the RBA - while the benefits and much more diffuse.

That's why the RBA has always reluctant to increase their transparency measures and have only done so under the direct recommendation of the Review. The details of these transparency measures should be written into the Statement explicitly, so that the Treasurer and the Government can ensure they are implemented and have scope to add to them in future years.

Give me the midpoint, but not yet

As I've discussed previously, there is one recommendation in the Review that could prompt a fairly aggressive tightening of monetary policy, should the RBA switch to an explicit focus on the midpoint of the target band immediately and start shooting for 2.5% rather than 3% inflation by 2025 .

I think an explicit focus on the midpoint is unambiguously a good idea. It would have almost definitely saved Australian jobs in the inflation-undershooting phase from 2016 to 2019, and would act as an additional level of transparency to a central bank that either deviates from its policy goal or starts to make persistent forecasting errors.

That being said, I think there is an argument that changing tact midstream by narrowing the monetary policy target midpoint during a period of high inflation would generate an unnecessary level of volatility in the Australian economy. The RBA should switch to explicitly aiming for the midpoint in the medium term, but I think there is scope for it to state that this change will not change its current approach to monetary policy, aiming for a slow return the upper band of 3% over the next few years. Instead the change should be made when we are back within the target band such that it doesn’t lead to a sudden change in the path for interest rates.

It's a bit of a messy compromise, but I think it is better than radically tightening monetary policy overnight in a way that few Australian households or businesses would expect.