Revolutionizing the Reserve Bank: Jim Chalmers’ Plan to Modernize the RBA for the 21st Century

The review in the Reserve Bank of Australia has just been published by Treasurer Jim Chalmers, and it’s a blockbuster.

The review made 51 recommendations, including:

• taking power over interest rates away from the Reserve Bank’s board of directors (which has traditionally been dominated by non-economists, usually corporate executives) and handing it over to a panel of experts

• reduction of the number of decision-making meetings from 11 to 8 per year

• increasing the transparency of the decision-making process and holding them more accountable for those decisions.

Chalmers offered assent in principle to all of the panel’s 51 recommendations and would seek support from the opposition for any legislation necessary to implement them. The review has informed Opposition Treasury spokesman Angus Taylor of his thinking.

Chalmers put the review from three people in July 2022, the appointment of Carolyn Wilkins, a former senior deputy governor of the Bank of Canada, Renée Fry-McKibbin, of the Crawford School of Public Policy at Australian National University, and Gordon de Brouwer, a specialist in public sector reform public sector.

What was the problem?

While the apparent nature of the problem has changed over time, the root cause remains the same.

When the concept of the 2020 revision was first discussed, the economy was in a bad state with inflation well below the bank’s target of 2-3% and weak economic growth.

As a result, wage growth was too low and unemployment too high.

The most likely explanation is that the bank was too focused on stabilizing the financial system and not enough on stimulating the economy.

The bank set interest rates using its gut instead of its brain, in an almost literal sense – it didn’t do what its computer model suggested it should.

When the investigation began, the problem was reversed. Inflation was too high.

But the underlying problem—that the board was populated by monetary policy amateurs rather than experts—remained the same.

The study concluded that monetary policy is a complex area of ​​government policy and is best led by a team of experts who are well versed in the current state of the economy.

Just as we have the brightest legal minds in the country at the Supreme Court of Australia and our best health professionals set vaccine policy, it felt we should have Australia’s best macroeconomic minds directing monetary policy at the Reserve Bank of Australia .

This lack of confidence in expertise could help explain why the bank made the fateful decision to signal interest rates to remain near 0% until 2024.

During the pandemic, bank employees explicitly advised against predicting how long interest rates would remain at 0%.

But the bank board ignored this advice and instead issued a three-year projection for how long interest rates would remain low.

When the economy recovered much faster than expected and interest rates had to rise, many Australians interpreted the turnaround as a broken promise.

Read more: The RBA’s failure to cut rates faster may have cost 270,000 jobs

Culture club

The review says former and current employees have said the bank’s culture is hierarchical and risk-averse.

It’s clearly not ideal to have a major institution where diversity of thought is discouraged and employees feel unable to speak up.

Accordingly, the review recommended that the bank improve its culture by appointing a chief operating officer with a mandate to open the bank to new ideas and staff and break down silos within the bank.

What does this mean for rates?

Whatever changes as a result of the review, it is unlikely there will be any significant changes to the current approach to keeping interest rates relatively high.

Rates will remain high as long as inflation is expected to remain above the target range of 2-3%. The last official inflation rate was 7.8%. It will be updated next Wednesday.

The evaluation examined whether or not the target of 2-3% remains optimal and concluded that this is the case. It considered alternatives such as a higher inflation target or pursuing nominal gross domestic product, and found these to be lacking.

It recommends that a new monetary policy council meet eight times a year, instead of the 11 times the current council meets. It says this will give the board’s outside expert members more leeway to “do deeper and better prep work before each meeting,” helping them make better decisions.

What about RBA Governor Philip Lowe?

An evaluation showing that the bank was functioning well would have warranted reappointing the current governor, whose five-year term expires in September.

The scope of the changes recommended by the review is large – there’s an entire section dedicated to a year-long implementation process.

The government may well decide that Lowe is the right person to carry out that process and that his term should be extended rather than let his successor fall into it.

However Chalmers intends to go about it, the review he has commissioned has sparked a revolution at the bank – one that will hopefully make it stronger, smarter and better placed to serve the Australian people.