RBA review could look at ways to avert the next crisis


As Australia plots its economic recovery from the pandemic, public attention is understandably focused on politicians but this week the Herald has felt it equally important to put the spotlight on the policies of the Reserve Bank of Australia.

As we reported on Tuesday, shadow treasurer Jim Chalmers has joined a growing group of influential economists who have called for a review into the bank’s operations in the light of its failure to meet its primary function of keeping inflation between 2 per cent and 3 per cent a year.

The target range is written into an agreement between the RBA and the federal Treasurer but the current governor, Philip Lowe, has not delivered on this KPI.

Consumer price inflation fell below 2 per cent in 2014 and has only climbed back into the target range on a couple of occasions since.

While low inflation has some advantages for those living on savings, when inflation is too close to zero workers cannot ask for pay rises and the economy cannot grow. Critics say the RBA should have cut interest rates much sooner to boost growth. If it had done so, unemployment would have been lower heading into the pandemic.

The RBA basically admits it kept rates high too long and has tried to explain where it went wrong. It was too worried about the risk that low interest rates would start a house price bubble and it failed to spot changes in the labour market and the global economy, which reduced workers’ ability to push for inflationary wage rises.

Some have even called on the RBA board to quit over this bungle but that would be an overreaction. First, the RBA is in the same boat as most other central banks of the Western world which have struggled to raise inflation for similar reasons. Second, despite the miscalculation, the Australian economy continued to grow, albeit slowly.

Whatever the criticism of the RBA’s actions before the pandemic, the central bank has changed its policies dramatically since then. It is now determined to blast inflation into the target range and beyond.

It is committed to keeping interest rates close to zero until 2024, pushing unemployment well below 4 per cent and annual wage rises of 3 per cent.

It will ignore the risk of a housing bubble, leaving it up to the Australian Prudential Regulation Authority to dampen the market using other levers such as setting minimum deposits and curbing loans to investors.


To its credit, the RBA has spoken publicly about these problems and addressed criticisms of the inflation-targeting regime.

But it would help to have these issues aired in a formal setting such as a review. Many central banks have undertaken similar reviews in the past two years.

The underlying issue is that the inflation-targeting systems that were developed in the 1980s and 1990s when inflation was often more than 5 per cent a year look ill-suited to a time when inflation and rates are stuck close to zero.

The US Federal Reserve, for example, warned in its review that in the new environment the big concern is that when interest rates are already near zero if a crisis occurs central banks cannot use rate cuts to stimulate the economy.

If a review is to face these issues, it must tap into wide international and local expertise and if possible avoid undue politicisation. Moreover, rather than focusing on past mistakes, any review should look at what is needed to avert the next crisis.

Note from the Editor

The Herald editor Lisa Davies writes a weekly newsletter exclusively for subscribers. To have it delivered to your inbox, please sign up here.

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