"Had you done your job, hundreds of thousands of Australians would have been spared the nightmare of unemployment."
This is the brutal criticism being levelled against the Reserve Bank of Australia, or RBA, by former prime ministers, eminent economists, politicians and academics. The clamour puts this politically independent institution in a tough spot. Is it time to change course?
The criticisms are not surprising. This year marks the seventh straight year the RBA has failed to achieve its inflation target of 2 or 3 per cent, on average, over time. Philip Lowe will now almost certainly end his term as governor without having once achieved his core objective.
For most of the past seven years, the RBA has asked for patience. It has argued that a big increase in inflation and wage growth is just around the corner. But alas, while the graphs showing its forecasts for inflation looked like hockey sticks, year after year the reality looked more like a pool cue. Now the RBA isn't even being optimistic. Its current forecasts have inflation below target until beyond 2023. When asked how likely it is that the target will be reached before the end of his term, Lowe's answer was "unfortunately, it's not high".
In the eyes of some, this is inexcusable. Had the RBA done more to stimulate demand in the economy, it would have met its inflation target, we'd be closer to full employment, and hundreds of thousands of people would have been spared the indignity of unemployment. This is the argument of one of Australia's leading economists, Ross Garnaut, who puts much of the blame for Australia's weak economy since the global financial crisis - the stagnant wages, investment and living standards - at the RBA's feet.
There are questions about whether Australia's macroeconomic framework - created when too much inflation was the biggest risk - is up to managing post-COVID challenges ...
For its part, the RBA is quick to point out that it has done more than ever before to stimulate the Australian economy. Since Lowe took office it has slashed the cash rate from 1.5 per cent to just 0.1 per cent. It has undertaken the largest bond-purchasing program in Australian history to push down longer-term interest rates, it has created a term-funding facility to support bank lending, and it has kept a lid on three-year bond yields to support the post-COVID-19 recovery.
But there are two problems with these unprecedented actions. The first is that much of the impact of monetary policy, particularly when interest rates are very low, comes through its effect in lowering the exchange rate. The result is that what happens in the rest of the world is just as important as what happens at home. It doesn't matter how unprecedented the RBA's actions are if the rest of the world is doing even more.
This makes the RBA's argument that its actions are the biggest in Australian history somewhat irrelevant. The fact is, many central banks around the world are doing much more to stimulate their economies than the RBA is doing in Australia, including much larger bond-purchasing programs, negative interest rates, purchases of equities and other assets, and greater co-ordination of fiscal and monetary policy.
So it isn't surprising that the Australian dollar has risen by more than a third since March 2020, hurting exports, reducing growth, weakening wages and driving up unemployment. While Australia's relatively strong performance during COVID-19 is partly to blame, many in the RBA are hoping that Joe Biden's $US1.9 trillion stimulus package makes it through Congress, taking at least some of the pressure off the Aussie dollar.
The second problem with the RBA's unprecedented actions is that, even though it is doing more than ever, it still isn't doing everything that it could. It has ruled out a larger quantitative easing program for the time being. It has ruled out negative interest rates. It has ruled out purchasing equities and other assets. It has ruled out directly financing government expenditure or issuing "helicopter money". It has ruled out allowing future inflation to overshoot its target to make up for lost time.
The RBA argues that its inaction is justified. Inflation is being held down by low wages, it says, and wages are being held down by a lack of job creation. Job creation is being driven by structural factors, and reforming structural factors is Josh Frydenberg's job rather than the RBA's. In short, the RBA's solution to weak inflation is for the government to remove distortions in the economy and create more jobs through tax reform, welfare reform, competition reform, trade reform, and changes to the financial system and capital markets. More jobs mean more demand for workers, and that means higher wages, higher incomes and then higher inflation.
This is a reasonable argument. The government has certainly squandered the opportunity to undertake reform during the pandemic. But does inaction from the government excuse inaction from the RBA, particularly given the range of tools it could use?
Thomas Sowell, an American economist, once said there are no solutions in economics, only trade-offs. In a nutshell, this is the RBA's argument when it comes to these alternative policy tools: that the marginal benefits of additional action - such as more quantitative easing, negative interest rates, purchasing equities and other assets, helicopter money, longer-term forward guidance, and allowing above-target inflation in the future - are unclear, while the trade-offs from these policies - such as runaway inflation, damaging the bond market, a loss of central bank independence, and encouraging fiscal irresponsibility from the government - are real.
To be sure, this reasoning is contested among economists, and the degree of contestation varies widely from one policy proposal to the next. But two things are missing: a detailed explanation from the RBA of why it is refusing to use these tools, especially given that many of its own models would suggest they should; and a lack of accountability when the RBA keeps missing its inflation targets.
The RBA is a politically independent institution, and that shouldn't change. But its mandate, structure and processes should be subject to a review. The RBA's reasoning and evidence base are often not articulated or publicly scrutinised. There are questions about the extent to which the board's views are challenged by staff. There are questions about whether the board is able to do its job given that, unlike in other central banks, very few board members have monetary policy expertise or experience in the modelling that helps inform decision-making. There are questions about whether the RBA's staff include the right people given that many senior staff have spent their working lives at the RBA with little experience elsewhere. There are questions about whether Australia's macroeconomic framework - created when too much inflation was the biggest risk - is up to managing post-COVID challenges by providing more coherence between fiscal, monetary, structural and climate policies.
With hundreds of thousands of unemployed Australians stuck between a government refusing to reform and an RBA refusing to do more, something has to give.
- Adam Triggs is director of research at the ANU's Asian Bureau of Economic Research, a non-resident fellow at the Brookings Institution, and a regular contributor to Inside Story.