OIn addition to the usual angst over its forecasts and decisions, the Reserve Bank of Australia is facing an investigation. The ground rules for these exams, according to Minister Yes’ Sir Humphrey Appleby, are not to examine anything you don’t have to do and certainly never unless the results are already known.
In fact, the problems surrounding central banks are clear, if not easily remediable.
1. Opaque Mandates
The RBA must contribute to the economic prosperity and well-being of Australians, which in practice means jobs, price stability and the integrity of the financial system and currency. It lacks detail – what constitutes full employment?; are growth and well-being synonymous? ; why the inflation target of 2 to 3%? Goals are often incompatible, priorities are unclear, and the time horizon is vague.
2. Limited Tools
Central banks set interest rates, provide liquidity through open market operations and quantitative easing (mainly the buying and selling of government debt) and provide forward guidance (“mouth trading”). open” or “jawboning”). Alan Greenspan, former chairman of the US Federal Reserve, was famous for his Delphic eloquence: “If I made myself understood, you misunderstood me.
The RBA has limited influence over budgets (government) and financial institutions (Australian Prudential Regulation Authority), which can reduce the effectiveness of its policies. The value of the Australian dollar, foreign investment flows and geopolitics (sanctions, trade restrictions) are largely beyond its control. There are also limitations; for example, the zero bound of interest rates and overall debt levels.
3. Faulty business models
The Nairu (unemployment rate without accelerating inflation) or the Phillips curve postulates that higher unemployment lowers inflation. In practice, the relationship is unreliable. Cause and effect are often difficult to differentiate.
Critical data arrives with a lag and is arbitrary – inflation measures are based on a selected basket of items; growth ignores unpaid work, resource scarcity or sustainability; employment is ill-defined in a world of zero-hour agreements and contracts. Buyers and businesses see price pressures before central bankers.
US Fed Chairman Jerome Powell admitted that “we have a better understanding of how little we understand about inflation.” Impenetrable jargon, obscure mathematics and false empiricism mask a base of ignorance but allow brilliant ex post justifications of actions.
4. Cultural issues
Most central bankers are economists by training, who spend most of their working life in the institution, government or academia. They primarily converse with other members of their tribe, encouraging groupthink. There is an incomplete appreciation of the needs and concerns of ordinary people. At an unfortunate “meet the citizens” event, New York Federal Reserve Chairman William Dudley was met with cries of “I can’t eat iPads” when he suggested the rise food prices was offset by falling technology costs.
Central bankers should also consider their post-institutional careers in financial institutions, think tanks or as non-executive directors. They and their views must be seen as “sane” by those in a position to bestow these lucrative rewards.
The rise of celebrity central bankers, based on selfish encouragement from financial markets and the media, has encouraged hubris. Impenetrable reticence and invisibility have given way to volubility and Twitter handles. Rather than sound management of the economy, the focus is now on equity markets, house prices and debt-induced illusory wealth, which do not always benefit all citizens equally.
5. Limited Supervision
The basis of the actions is rarely clarified. In 1929 the Bank of England said it did not explain its policy because it would be like a woman defending her virtue.
Governments are reluctant to intervene, fearing critics will undermine central bank independence. Boards are dominated by insiders. Independent directors, from the same background, are unlikely to second guess staff recommendations, even if they have the expertise and information.
The proposed survey is likely to obscure the issues identified. The members, former central bankers and “experts”, possibly foreigners, are unlikely to be too critical of their peers or of legal controversies. Self-interested competing bureaucracies will defend acreage, fearful of ceding power or importance.
There will be many recommendations – broadening the range of administrators, greater community and business consultation, improved communication, and regular reviews. Specific goals and drastic changes will be rejected because they reduce flexibility or risk having unknown side effects.
The central question of whether an independent central bank is necessary will be confusing. Governments could set interest rates alongside fiscal and structural strategies that allow better coordination of economic management.
The unacknowledged reality will remain that current arrangements allow governments to transfer sometimes painful or contentious choices to central bankers. They can then assign blame or claim credit based on the results.
Central banks provide politicians with an institutional mechanism to avoid accountability and deflect stigma. Governments launch investigations not for the truth or real improvement, but for alibis and the appearance of action.