January 27, 2023

The writer is the founding editor of Central Bank Intel

There must be some nervous central bankers looking at the comprehensive review launched in the Reserve Bank of Australia.

Central banks around the world have been gripped by the sharp rise in global inflation, which has kept interest rates too low for too long. But the RBA has been blunt than most in admitting its mistakes, with its own governor saying the forecasts were “shameful.”

“We should predict this better. We didn’t,” said Philip Lowe, governor of the RBA, in May. However, the RBA was hardly alone in its errors of judgment, with central banks from Washington to Frankfurt believing that inflation increases would be more transient than they were.

That’s what the RBA Rating an interesting test case of accountability. Did the central bank simply make the wrong decision or did something more systemically go wrong?

Two elements of the RBA study are noteworthy. First, it will be conducted by an independent, external panel appointed by the Treasury – two Australian economists plus an ex-Deputy Governor of the Bank of Canada who is currently an external member of the Bank of England’s Financial Policy Committee.

Central banks love their independence and are used to being in control. So it may not be comfortable for the RBA to let its future be influenced by outsiders’ recommendations.

Second, it is unusually broad with the sense of “control” or “review”. In recent years, major central bank assessments have focused more closely on some aspect of monetary policy strategy, central bank law, or governance related to special instruments or functions.

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It will examine just about everything at the RBA: the continued adequacy of its inflation targeting framework, the interaction of monetary policy with fiscal and macroprudential policies and governance arrangements. It will also look at choice of tools, policy implementation, communication and “how interactions between different objectives have been managed”. Even the culture, management and recruitment processes will be assessed.

Proof of how sharp this has made other central banks come is the reaction of the New Zealand counterpart to the RBA. Less than a week after the announcement of the RBA review, a research paper authored by ex-RBNZ Governor Graeme Wheeler accused central bank policy mistakes for high inflation.

Shortly afterwards, current governor Adrian Orr issued a statement admitting that the RBMZ’s monetary policy contributed to the high inflation. He went ahead and announced a review of the RBNZ’s monetary policy performance, including the use of additional policy tools. This review complements the recently launched five-year review of the monetary policy remit.

The RBA is likely leading the central bank in admitting its mistakes. But central banks worldwide are criticized for keeping monetary policy more accommodative for longer, misjudging not only the onset of inflation but its persistence, and also giving too explicit forward guidance on monetary policy and then failing to adhere to it.

Under its forward guidance, the RBA had indicated that it would keep rates as low as possible until 2024. That low interest rate environment not only failed to address rising inflation, but also helped to exacerbate Australia’s housing boom – a significant systemic risk.

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Forward guidance is already being scrapped around the world. Last month, Fed Chairman Jay Powell dropped a policy to comment in detail on what his central bank would do next regarding interest rates. “It’s time to just go by meeting and not give the kind of clear guidance we had given,” Powell said at a post-Fed news conference.

Similarly, the European Central Bank also scrapped its forward guidance on the policy last month. “We are much more flexible; in the sense that we are not providing any kind of forward guidance,” said ECB President Christine Lagarde. “From now on, we will make our monetary policy decisions based on data, [we] will work month after month and step by step.”

Earlier this week, the RBA joined the trend by signaling that it will no longer provide explicit forward guidance: “The Governing Council expects to take further steps in the process of normalizing monetary conditions in the coming months, but it is not on a predetermined path.”

If inflation does not decrease and interest rates rise significantly, it is not only the forward guidance policy that will be revised. More central banks around the world will be officially audited. Australia’s review probably won’t be the last.