Given the intensity and complexity of ongoing debates surrounding the question of central banking, a radical restructuring of the Reserve Bank of Australia has been high on the agenda for some time already. Although several notable reforms were implemented in December 2007 after the new government came to power, they have come in for criticism for being limited and imperfect.
This paper will address the issue of the RBA’s reform based on theoretical models of monetary policy and experience from overseas countries, mostly New Zealand, for the reasons of similarities in the countries’ approaches to monetary policy. This paper has a dual focus: firstly, it contains a recommendation regarding the structure and compositions of the Reserve Bank Board with due regard to its dual corporate governance and policy roles; secondly, it contains a critical analysis of inflation targeting against alternative objectives of monetary policy and a recommendation for the future operation of monetary policy in Australia.
The Structure of the Board
Proper structure and composition of the Reserve Bank Board are the keys to ensuring effective monetary policy in Australia. Worldwide, the emphasis has recently been on in-depth restructuring and redefinition of the role of the board of national central banks. At the end of the previous year, the Labor Government has made an attempt to improve transparency and accountability of the RBA.
However, Kirchner (2008) argues that ‘the new arrangements leave the RBA operating under an outdated and internationally anomalous governance structure that is incompatible with modern demands for central bank transparency and accountability’ (p. 18).
In order to make recommendations regarding the possible restructuring designs, it is necessary to take a look at the current composition and operation of the Board of Directors. As the website of the Reserve Bank of Australia (2008) informs, the Reserve Bank Board currently consists of nine members, three of them being ex officio members, and six of them being external members. Three ex officio members are the Governor (who is Chairman), the Deputy Governor (who is Deputy Chairman) and the Secretary to the Treasury. The Governor and Deputy Governor serve for terms of up to seven years and can be reappointed.
Six external members are appointed by the Treasurer. These members serve for terms of up to five years. A director, officer or employee of an authorized deposit-taking institution cannot sit on the Board.
The Reserve Bank Board usually meets eleven times each year, i.e. each month, except for January. Meetings are chaired by the Governor or by the Deputy Governor in the absence of the latter. As concerns the decision making procedures, decisions must be reached by a majority of the votes of the members present at a meeting, a casting vote belonging to the Chairman. However, the Board rarely resorts to formal voting, since the vast majority of decisions are reached in a consensual manner. The organization of governance in the Reserve Bank is best represented by the organizational chart (see Appendix A).
It is important to note that the role, functions, and composition of the Reserve Bank Board are stipulated in the Reserve Bank Act 1959. The role, functions, and composition of the Bank have not been revised for almost five decades already, hence the debate about the need for a comprehensive restructuring, with reference to the composition and practices of other central banks around the world. The reform in 2007 only addressed a limited range of issues, while a more in-depth restructuring effort might be desirable.
Taking into account the dual corporate governance and policy roles of a central bank, there have been persistent calls for a separation of these two functions. Henry Schiffman (2006), a lawyer and consultant to the IMF, World Bank, OECD and Asian Development Bank, states the following:
‘The two basic functions of a board of directors in any organisation are the establishment of policies for the operations of the entity and oversight of their implementation. If a board of directors contains executive officers, the oversight function would have an inherent conflict of interests’ (p. 43)
As the organizational chart demonstrates, there exists a clear delimitation between the functions of the Reserve Bank Board and the Executive Committee. Formally, the requirement for the separation of oversight and policy making functions is met. However, the Governor of the Board also acts as a Chairman of the Council of Financial Regulators, which operates within the jurisdiction of the Executive Committee. Thus, it might be advisable to limit the functions of the Governor of the Board to oversight only with a view to ensuring the RBA’s fulfillment of its dual role. More radical reform proposals have been voiced with regard to the separation of functions:
‘Monetary policy decision making should be placed in the hands of a Monetary Policy Committee, separate from the RBA board, with substantial external representation from professional business and academic economists, supported by a secretariat within the RBA’ (Kirchner, 2008, p. 24).
Governor’s dominance has been frequently cited as an impediment to a central bank’s efficiency. As Henry Schiffman (2006) suggests, ‘given the importance of central bank governance, countries whose central bank boards do not now act in a collegial fashion may wish to consider changes’ (p. 44).
While in practice most decisions by the Board of Directors are reached consensually, a voting procedure is still in place, and the Governor has a casting vote. It might be advisable to revise the Board’s decision making procedures so that it would meet the requirement for collegiality and balance against the dominance of the Governor.
Another criticism concerns the degree of independence of the RBA’s senior officers that has been significantly expanded after the December reform: the appointments of the RBA’s Governor and Deputy Governor can be terminated only with the approval of both houses of Parliament in the same session.
Kirchner (2008) strongly deems that Governor and Deputy Governor have been sufficiently independent and secured from political intimidation before the reform as well. The new arrangements do not represent a reasonable balance between independence and accountability of the RBA’s senior officers, granting them excessive protection. Kirchner (2008) reminds that following the reform, ‘it will be even more difficult to remove an RBA governor for poor performance, at least in the absence of a bipartisan political consensus’ (p. 19).
Kirchner (2008) suggests examining the New Zealand model with a view to incorporating several of its features in the RBA’s governance arrangements: in New Zealand, there is a clear connection between meeting inflation targets and performance evaluation of the Governor of the Reserve Bank, including a procedure for terminating the Governor’s tenure for nonperformance.
Thus, Kirchner (2008) suggest that ‘[t]he non-executive board members should be empowered to recommend to Parliament dismissal of the governor for nonperformance if the inflation objective set out in the statement is not met’ (p. 24).
As concerns the appointment of external board members, following the reform, the treasurer can make new appointments to the RBA board exclusively from the list of appropriate candidates of the highest professional and personal integrity that is being kept by the Treasury Secretary and the RBA’s Governor.
These arrangements were put in place in order to ensure that political preferences do not interfere with the appointment process, yet they brought about a danger of reducing external scrutiny of the RBA’s operations due to the fact that these arrangement are likely to limit ideological diversity among external members of the Board and have a tendency to entrench ‘the influence of the RBA’s senior officers over the monetary policy decision making process, at the expense of those who may have previously been critical of the bank’s monetary policy’ (Kirchner, 2008, p. 20).
Finally, the role of the Treasury Secretary’s membership in the RBA’s board is not well understood and breeds confusion. In international practice, the ‘[p]articipation of government officials in decision-making organs of a central bank seems at odds with the model of a central bank, which is independent from government’ (Amtenbrink, 2004, p. 17).
Together with a widespread fear that such membership may result in political influence on monetary policy, the lack of clarity regarding the role of the Treasury Secretary on the Board makes it advisable to remove this person from the Board altogether (Kirchner, 2008).
Alternatively, the vote of the Treasury Secretary should be revoked and functions limited to those of communication and support: ‘[g]overnment officials, if considered necessary, should constitute a minority, only be included to ensure information sharing, and, ideally, not have the right to vote’ (Lybek, 2004, p. 8).
Therefore, there is a significant number of reform proposals that might be advisable to implement to ensure the RBA’s effectiveness, independence, and accountability.
The Operation of Monetary Policy
As the website of the Reserve Bank of Australia (2008) informs, the inflation target in Australia fluctuates between 2 and 3 per cent per annum on average over the course of the business cycle. In the Statement on the Conduct of Monetary Policy as of 6 December 2007, Reserve Bank of Australia has emphasized the commitment to inflation targeting as a monetary policy tool and the commitment to the current inflation objective. Since 1993, the year when the Reserve Bank of Australia opted for inflation targeting, inflation has been, on average, around the midpoint of the inflation target band.
There is little consensus among macroeconomic scholars and practitioners concerning the utility of inflation targeting as a monetary policy. In the introduction to their book, Ben Bernanke and Michael Woodford (2005) acknowledge that most policy analysts hold a favorable view of inflation targeting, however, the appropriateness of this policy solely depends on conditions in a given country. There are several alternatives to inflation targeting:
1) Exchange-rate peg
This policy might be effective if a country has a large stock of international reserves or if a central bank is committed to a forceful implementation of the policy. There are several success stories of central banks that managed to reduce runaway inflation by implementing this policy: for instance, French franc has been significantly strengthened by being pegged to German mark.
However, this approach has several serious disadvantages. It imposes severe constraints on the uses of monetary policy for other purposes, such as short-run stabilization. A peg is frequently followed by strengthening of the currency in comparison with that of the country’s trading partners, which has a tendency to make the country’s exports less competitive and contribute to the depression of domestic economic activity.
Another disadvantage is associated with the fact that shocks in the anchor country are transmitted to the pegging country. Exchange-rate peg has also failed to deliver price stability (Bernanke et al., 1999). Furthermore, a speculative attack on the pegged currency is a reality in the world of highly mobile capital (Obstfeld & Rogoff, 1995; in Bernanke et al., 1999).
2) Real Targeting
This set of strategies encompasses focusing on real targets such as employment growth, unemployment, GDP or investment, subject to an inflation constraint. The advantages of this approach include direct impact on social welfare and pressure on a central bank to explore new tools of monetary policy with a view of achieving the target (Epstein, 2005).
Real targeting, for example, monetary aggregates or nominal GDP, is deemed superior to exchange-rate peg, since it helps to ‘balance the policy goals of sustainable economic growth and price stability’ (Clark, p. 11). However, Ball (1987; in Dennis, 1998) has argued that nominal GDP targeting can lead to instability.
Considering all the advantages and disadvantages of different alternatives to inflation targeting, it appears that the present monetary policy remains fairly appropriate for Australia. The most frequently cited criticism of inflation targeting is that it draws central bank’s attention away from more valuable macroeconomic objectives, such as GDP targeting or employment generation. Perhaps this criticism is true for emerging economies; Australia has been committed to neo-liberal policies for a long time, and it has generated economic prosperity. Thus, the approach suggested by Bell (2004) implies a return to more rigorous inflation targeting, following the practices the Reserve Bank of New Zealand utilizes. This approach might be the most advisable strategy for ensuring the stability of Australian economy.
Amtenbrink, F. 2004, ‘The Three Pillars of Central Bank Governance – Towards a Model Central Bank Law or a Code of Good Governance?’, Available Online: www.imf.org/external/np/leg/sem/2004/cdmfl/eng/amtenb.pdf
Bell, S. 2004, Australia’s Money Mandarins: The Reserve Bank and the Politics of Money, Cambridge: Cambridge University Press.
Bernanke, B, Laubach, T., Mishkin, F. S., & Posen, A. S. 1999, Inflation Targeting: Lessons from the International Experience, Princeton: Princeton University Press.
Bernanke, B., & Woodford, M. (eds.) 2005, The Inflation Targeting Debate, Chicago: University of Chicago Press.
Clark, T. E. 1994, ‘Nominal GDP Targeting Rules: Can They Stabilize the Economy?’, Available Online: ideas.repec.org/a/fip/fedker/y1994iqiiip11-25nv.79no.3.html
Dennis, R. 1998, ‘Instability Under Nominal GDP Targeting: the Role of Expectations’, Available Online: http://ideas.repec.org/p/fth/aunaec/347.html
Epstein, G. 2005, ‘Alternatives to Inflation Targeting Monetary Policy For Stable and Egalitarian Growth: A Brief Research Summary’, WIDER Jubilee Conference, Available Online: http://www.peri.umass.edu/fileadmin/pdf/working_papers/working_papers_51-100/WP62.pdf
Kirchner, S. 2008, ‘A ‘New Era’ for the Reserve Bank?’, Policy, vol. 24, no. 1, pp. 18-24.
Lybek, T. 2004, ’Central Bank Autonomy, Accountability, and Governance: Conceptual Framework’, Available Online: www.imf.org/external/np/leg/sem/2004/cdmfl/eng/lybek.pdf
Schiffman, H. 2006, ‘Good governance for central banks’, Available Online: www.centralbanking.co.uk/conferences/archv/2006/pdf/schiffman_from_cbj.pdf
The Reserve Bank of Australia. 2008, Homepage, Available Online: http://www.rba.gov.au