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Nervous central bankers are watching Australia closely

The writer is the founding editor of Central Bank Intel

There must be a few nervous central bankers watching the wide-ranging review that has been launched into the Reserve Bank of Australia.

Around the world, central banks have been caught out by the surge in global inflation, leaving interest rates too low for too long. But the RBA has been blunter than most in admitting its mistakes, with its own governor saying its forecasting was “embarrassing”.

“We should forecast this better. We didn’t,” said Philip Lowe, RBA governor, in May. However, the RBA was hardly alone in its errors of judgment with central banks from Washington to Frankfurt believing rises in inflation would be more transitory than they have been.

That is what makes the RBA review an interesting test case of accountability. Did the central bank just make the wrong call or was there something more systemic that went awry?

Two elements of the RBA inquiry are notable. One, it will be carried out by an independent, external panel appointed by the Treasury — two Australian economists plus an ex-deputy governor of the Bank of Canada who is a current external member to the Financial Policy Committee of the Bank of England.

Central banks love their independence and are used to being in control. So it cannot be comfortable for the RBA to have its future influenced by the recommendations of outsiders.

Two, it is unusually broad-ranging with the feel of “scrutiny” or “appraisal” about it. Reviews in recent years of big central banks have been more narrowly focused on a particular aspect of monetary policy strategy, the central bank act, or governance related to special tools or functions.

This one will examine just about everything at the RBA — the continued appropriateness of its inflation targeting framework, the interaction of monetary policy with fiscal and macroprudential policy, and governance arrangements. It will also look at the choice of tools, policy implementation, communication, and “how trade‑offs between different objectives have been managed”. Even its culture, management and recruitment processes will be assessed.

Evidence of how edgy this has made other central banks is in the reaction of the RBA’s New Zealand counterpart. Less than a week following the RBA review announcement, a research paper co-authored by ex-RBNZ Governor Graeme Wheeler blamed central bank policy mistakes for high inflation.

Soon after, current governor Adrian Orr issued a statement admitting that the RBMZ’s monetary policy contributed to high inflation. He went further and announced a review of the RBNZ’s monetary policy performance, including the use of additional policy tools. This review is in addition to the recently commenced five-yearly review of its monetary policy remit.

The RBA probably leads the central bank pack in its admitting its mistakes. But central banks globally are facing criticism for keeping monetary policy accommodative for longer, misjudging not just the onset of inflation but also its persistence, and also issuing too explicit forward guidance on monetary policy and then failing to stick to it.

Under its forward guidance, the RBA had indicated that it would keep rates as low as possible until 2024. That low rate environment not only failed to tackle rising inflation but also helped exacerbate Australia’s housing boom — a not insignificant systemic risk.

Already, forward guidance is being dropped around the world. Last month, Fed chair Jay Powell dropped a policy of providing detailed commentary on what his central bank would do next on interest rates. “It’s time to just go to a meeting-by-meeting basis and to not provide the kind of clear guidance that we had provided,” Powell said at a press conference after the Fed.

Likewise the European Central Bank also ditched its forward guidance on policy last month. “We are much more flexible; in that we are not offering forward guidance of any kind,” said ECB president Christine Lagarde. “From now on we will make our monetary policy decisions on a data-dependent basis, [we] will operate month by month and step by step.”

Earlier this week, the RBA joined the trend in signalling it will no longer give explicit forward guidance: “The Board expects to take further steps in the process of normalising monetary conditions over the months ahead, but it is not on a preset path.”

If inflation does not subside and interest rates are raised substantially higher, it will not just be forward guidance policies that comes under review. More central banks around the world will face official scrutiny. Australia’s review is not likely to be the last.

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