Glenn Stevens' high wire act on rates

The Reserve Bank of Australia has begun softening up the public for interest rate rises.  Given that the official rate is at 3 per cent, it's not surprising that rates will soon begin to rise.  So why the need to soften up public opinion?

Unemployment is still expected to rise and increasing rates under those conditions may seem counter-intuitive to many Australians.  Last week the RBA governor Glenn Stevens got asked whether he considered himself bound by a "precedent" to not raise rates while unemployment was rising.

His reply was rather sensible:  "I have never heard nor I have never seen written down a rule of thumb that says we wait until unemployment has peaked before we lift the cash rate".  It is a bit rich to argue there is a precedent simply because the RBA has never before undertaken such an action, especially given that the RBA has only been nominally independent of government since the mid 1990s.

But there is a problem with Governor Stevens' response.  The Reserve Bank Act of 1959 sets out the functions of the Reserve Bank Board in section 10.  Section 10(2) is of particular importance.  The Reserve Bank is required to conduct monetary and banking policy "directed to the greatest advantage to the people of Australia" -- whatever that means -- and three functions are specifically highlighted:

1. the stability of the currency of Australia;
2. the maintenance of full employment in Australia;  and
3. the economic prosperity and welfare of the people of Australia.

The RBA has a rather uncomfortable balancing act.  To be fair to Governor Stevens he probably wasn't thinking about his legislative duties when answering the question.

How the RBA trades off its obligations, especially in the current economic environment, is going to be a matter of great public interest and debate.  But it is not just the RBA that needs to step up.  After all, the RBA is an instrumentality that is wholly owned and controlled by the government.  Senior management of the bank are appointed by the government and section 11 of the Reserve Bank Act allows the government to overrule the bank on monetary policy.  In other words the elected government of the day is responsible for the conduct of monetary policy.  Of course, this is not to say that there are no advantages to having a nominally independent body managing monetary policy, but that independence does not absolve the RBA or the government from accountability to the electorate.

It has been 18 months since Wayne Swan was asked in the Parliament whether he could specify what the non-accelerating inflation rate of unemployment (NAIRU) was;  in the old days that was called the natural rate of unemployment.  Treasurer Swan didn't know then and to the best of my knowledge hasn't specified a rate since then either.  Yet how can Australians form an opinion as to the effectiveness of monetary policy if we have no idea what constitutes full employment?  This is no minor quibble;  the maintenance of full employment is a legal obligation that falls on the Reserve Bank board.

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