The Reserve Bank will now have a separate board just to set interest rates. Here’s why that’s significant
- Written by John Hawkins, Senior Lecturer, Canberra School of Politics, Economics and Society, University of Canberra
On Thursday night, after a whirlwind day in Canberra, the Senate finally passed the federal government’s long-delayed amendments to the Reserve Bank Act.
The reforms will create two separate boards for the Reserve Bank of Australia (RBA) – one will be focused on monetary policy, the other on governance.
The idea of having two boards emerged from a landmark independent review of the Reserve Bank, which reported back in March last year.
But only a couple of months ago, such reforms were feared “dead” after the government had failed to strike a deal with either the Coalition or the Greens.
The government’s stunning recent turnaround – which required it to make some concessions – will have important implications for the way the Reserve Bank operates.
Whether it will ultimately translate to different kinds of monetary policy decisions is less clear.
What will the new board look like?
Under the reforms, the current functions of the Reserve Bank board will be split across two new boards.
The first will be a specialist monetary policy board, dedicated to setting the “target for the cash rate”. This is the interest rate on overnight loans between banks.
Controlling this rate is how the Reserve Bank affects the interest rates charged by banks to households and businesses, and how it exerts its influence on the economy.
Like the current board, the new monetary policy board would have nine members. These would include a governor, deputy governor, treasury secretary and six external members.
Creating this board was a key recommendation of the 2023 review. It would bring the RBA into line with some other central banks, such as the Bank of England.
There is no evidence, however, that having a separate board has led to a superior performance.
Monetary policy experts
Monetary policy board members are likely to be selected for being monetary policy experts, rather than corporate executives and other non-economists.
The six external members will not be RBA staff, public servants or bankers. But they will be expected to spend the equivalent of a day a week on monetary policy considerations.
This is a significant time commitment, meaning it may be difficult to find qualified outsiders who are willing to perform the role.
That’s led some commentators, including former Reserve Bank board member John Edwards, to suggest the board risks becoming dominated by academics.
The other board will concentrate on governance and operational issues, such as staffing decisions, premises, IT and so on. It will be more like the board of a company.
Splitting off monetary policy decisions from this board may mean governance matters get more attention.
Why create a separate board?
It’s important to understand why the government had been pursuing these reforms in the first place.
One key argument that emerged from the independent review of the Reserve Bank was the board wasn’t challenging the governor enough on interest rate decisions – that it was simply “rubber-stamping” decisions.
That would be a problem if true, because providing quality scrutiny is supposed to be one of the board’s key roles.
According to the review’s final report, the board had:
not voted against a recommendation of the RBA executive in at least the last decade.
It said the board was “not always fully involved in decisions” and there was a need to “shift the nature of the board from what is in effect an advisory body to one that proactively shapes policy decisions”.
Differing views
That assertion was soon challenged, however, by then-Governor Philip Lowe, who said in April 2023:
The idea that the board members sit there meekly and accept the recommendation that I put to them is very far from the reality that I’ve lived as the governor.
Recent board member Mark Barnaba echoed Lowe’s sentiment, reflecting:
In my experience, the way this board operates is diametrically opposed to a simple rubber-stamping.
It is difficult to be definitive on this. We have not been in the room during the board’s deliberations – but neither had the review panel members.
It is therefore hard to know just how much the proposed changes will reduce the influence of the RBA governor and staff.
Under the current system, there have not been formal votes on the RBA board. But this does not necessarily mean the governor always gets their way. They may just not bring to the table a recommendation likely to be rejected.
Would a separate board have made a difference earlier?
Australia’s target cash rate has now been held at 4.35% for over a year, its highest level since 2011. That begs the question: if we’d had a separate specialist board of experts earlier on, would we have a different cash rate?
One way of assessing how much difference a panel of monetary policy specialists might have made is to look at the record of the nine-person “RBA shadow board”.
This was established by the Centre for Applied Macroeconomic Analysis. Since 2011, it has been asked to report on what it thinks that the RBA should do. This is distinct from market economists, who concentrate on predicting what it will do.
In 105 out of 130 instances, it has made the same recommendation as that adopted by the actual board.
The average difference between the cash rate target set by the RBA and that suggested by the economists on the shadow board was less than 0.05%.
This would support the conjecture by academics Ross Garnaut and David Vines and journalist John Kehoe that had the separate boards been in place, recent policy settings would not have been very different.
Employment and inflation outcomes would likely have been similar, too.
What had to be dropped?
To get the legislation through the Senate, the government had to drop two suggestions from the review. One was a proposal to remove the ability of the treasurer to overrule the RBA.
It is important to note this veto has existed in central bank legislation since 1945. It was introduced by a Labor government and retained by the subsequent Coalition government.
But it has never been used, despite having been considered on some occasions. In each case, one side backed off or a compromise was reached between the government and the Reserve Bank.
Actually exercising it would likely come at a large political cost to the government of the day. But that doesn’t automatically mean it shouldn’t be available.
There is a democratic principle around whether a central bank should be able to exercise total “unelected power”.
Back in the 1930s, the chair (this was before the governor became the ex officio chair) of the Commonwealth Bank (the Reserve Bank’s predecessor), arguably exacerbated the Great Depression by refusing to help the Scullin Labor government fund public works.
Another abandoned recommendation was a plan to remove the Reserve Bank’s power to direct lending policies of banks.
This power has not been used for decades and is highly unlikely to be revived for monetary policy purposes.
Some other changes suggested by the review did not require legislation and have already been implemented.
Authors: John Hawkins, Senior Lecturer, Canberra School of Politics, Economics and Society, University of Canberra
