The Reserve Bank should not use interest rates to target the housing market or address fears about the high debts held by Australians, panel members who reviewed the institution have said, arguing it could cause broader damage to the economy.
The panel members, whose report into the Reserve Bank has paved the way for the largest overhaul of the bank in a generation, said any changes to the way the RBA used interest rates to rein in inflation could be reviewed by a future investigation.
Treasurer Jim Chalmers has committed to the review’s 51 recommendations, released last week, that include the creation of a separate monetary policy committee that will set interest rates, fewer RBA board meetings and the use of press conferences by the bank’s governor to explain decisions.
The review panel, made up of international monetary policy expert Carolyn Wilkins, who sits on the Bank of England’s financial policy committee, the interim director of the Crawford School at the Australian National University, Renee Fry-McKibbin, and the secretary for public sector reform Gordon de Brouwer, examined the Reserve’s decision-making during recent economic events.
Between 2016 and 2019, the bank held official interest rates steady despite unemployment remaining above 5 per cent and inflation staying below its 2 to 3 per cent target band. The RBA expressed concern at the time that a cut in interest rates could destabilise the financial system, largely because of Australian households’ high level of debt caused by large mortgages.
Fry-McKibbin, appearing with her fellow panel members at an event organised by the Committee for the Economic Development of Australia, said on Monday the worry about financial stability had confused monetary policy settings in that period.
“The jump in household indebtedness was one of the things about monetary policy in the 2016-19 period – [the bank] was concerned about financial stability coming from household indebtedness, and there was a lot of confusion around that,” she said.
“So our recommendations [are] basically saying that if the RBA is concerned about financial stability for that reason, then they need to tell APRA [the Australian Prudential Regulation Authority] and the Council of Financial Regulators need formal advice so that they can work together on how to best address those issues.”
Wilkins said monetary policy was unlikely to be the best way to deal with high levels of indebtedness.
“The first line of defence is going to be micro- and macro-prudential regulation, not monetary policy, which a lot of evidence shows that’s less effective than these others and in fact can be very costly in terms of jobs and growth,” she said.
According to de Brouwer, there were risks of unintended consequences afflicting the economy if interest rates targeted housing-related debt.
“It may be a fiscal or regulatory or another policy that’s actually most relevant to housing prices or to indebtedness,” he said.
Both Fry-McKibbin and de Brouwer revealed that they had initially believed the Reserve Bank board should continue to set interest rates, but their opinions changed during the panel process.
Ahead of the panel’s report, some critics were worried it might recommend a change to the Reserve’s inflation target. It did not make that suggestion, but did recommend reviews of the RBA every five years.
Fry-McKibbin said there was no compelling evidence for a change to the target, partly because it was well understood by the general public.
She said future reviews could look at changes to the inflation target.
“We have opened a door for reviews of frameworks and other elements of monetary policy on a regular framework. Someone needs to sit down and put the evidence together if they think that there is a better alternative and maybe present that to the next review,” she said.
According to de Brouwer, the current inflation target might be an advantage to the Reserve Bank if inflation around the world proved more difficult to bring down.
“Also if we’re in a slightly higher inflation world, it’s going to be harder for central banks to get back to a two number or two to three,” he said.
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