Five bottlenecks for central banks in the run-up to the RBA investigation | Satyajit Das


OIn addition to the usual fears about its predictions and decisions, the Reserve Bank of Australia is facing an investigation. The ground rules of such assessments, according to Sir Humphrey Appleby of Yes Minister, are not to investigate anything you do not need to investigate, and certainly never unless the findings are already known.

In fact, the problems surrounding central banks are obvious, if not easy to fix.

1. Opaque mandates

The RBA is to 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. Lack of detail – what does full employment mean?; are growth and well-being synonymous?; why the 2%-3% inflation target? The objectives are often incompatible, priorities are unclear and the time horizon is vague.

2. Limited Resources

Central banks set interest rates, deliver cash through open market operations and quantitative easing (primarily buying and selling sovereign debt), and provide forward guidance (“open mouth” or “jawboning”). Alan Greenspan, former chairman of the US Federal Reserve, was famous for his delphic oratory: “If I’ve made myself clear, you’ve misunderstood me.”

The RBA has limited influence over budgets (government) and financial institutions (the 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 limits; for example, the zero limit of interest rates and overall debt levels.

3. Flawed Economic Models

Nairu (non-accelerating unemployment rate inflation) or the Phillips curve states that higher unemployment lowers inflation. In practice, the relationship is unreliable. Cause and effect are often difficult to distinguish.

Critical data comes in with a delay and is random – inflation measurements 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-hours contracts and contracts. Shoppers and businesses see price pressure for central bankers.

US Fed Chairman Jerome Powell has admitted that “we understand better how little we understand about inflation”. Impenetrable jargon, arcane math and fake empiricism obscure a foundation of ignorance, but allow for brilliant ex-post justifications of actions.

4. Cultural Issues

Most central bankers are educated economists, who spend most of their working lives in the institution, government or academia. They mainly talk to others of their tribe and encourage groupthink. There is an incomplete appreciation of the needs and concerns of ordinary people. At a fateful “meet the citizens” event, William Dudley, president of the Federal Reserve Bank of New York, was disturbed with “I can’t eat iPads” when he suggested that rising food prices were offset by falling technology costs.

Central bankers must also consider their post-institutional careers with financial institutions, think tanks or as non-executive directors. They and their views should be seen as “sound” by those in the position to award these lucrative paydays.

The rise of famous central bankers, based on the self-serving cheerleading of financial markets and media, has encouraged hubris. Unfathomable restraint and invisibility have given way to dexterity and Twitter handles. Instead of good stewardship of the economy, the focus is now on stock markets, house prices and debt-driven illusory wealth, which do not always benefit all citizens equally.

5. Limited supervision

The basis of actions is rarely clarified. In 1929, the Bank of England stated that it would not explain its policy because it would be akin to a woman defending her virtue.

Governments are reluctant to intervene, fearing criticism of undermining central bank independence. Boards are dominated by insiders. Independent directors, who come from the same background, are unlikely to question the recommendations of the staff, even if they have the expertise and information.

The proposed research is likely to obscure the identified issues. Members, former central bankers and “experts,” possibly foreigners, are unlikely to be overly critical of peers or judicial controversies. Competing self-interested bureaucracies will defend the acreage, wary of relinquishing power or importance.

There will be plenty of recommendations – broadening the number of directors, more consultation with the community and business, improved communication and regular reviews. Accurate targets and radical changes will be countered because they reduce flexibility or risk unknown side effects.

The central question of whether an independent central bank is needed will be unclear. Governments could set interest rates alongside fiscal and structural strategies, allowing for better coordination of economic management.

The unrecognized reality will remain that current arrangements allow governments to hand over sometimes painful or controversial choices to central bankers. They can then assign blame or claim credit, depending on the results.

Central banks provide politicians with an institutional mechanism to avoid accountability and scorn. Governments do not investigate the truth or real improvement, but alibis and the appearance of action.

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