Negotiations over the reform of the Reserve Bank of Australia took an unusual turn this week with the Greens he demanded government uses its reserve powers to chop rates of interest immediately.
Labor initially hoped to pass the reforms with the support of the Coalition. However, after a yr of negotiations, they refused. Labor’s attempts to save lots of the reforms through negotiations with the Greens now appear doomed to failure.
The Greens’ proposal for the government to chop rates of interest immediately could seem appealing, especially to thousands and thousands of mortgage holders struggling to fulfill their obligations amid the cost of living crisis.
However, for the government to take direct control over setting rates of interest can be contrary to each long-standing historical trends and international financial norms, including central bank independence.
Where did this independence come from?
The idea of central bank independence has a protracted history.
Classical political economist David Riccardo warned already in 1824 This:
the government cannot safely be entrusted with the power to issue paper money; it will definitely abuse it.
Even the authoritarian Emperor of France, Napoleon Bonaparte he claimed in the creation of the Banque de France, which:
I would really like to see the bank more in government hands, but not an excessive amount of.
However, for many of the twentieth century, the common sense view was that monetary policy was a very important tool for government to administer the economy. According to Keynes’s worldview At that point, it would have been absurd for governments to desert such a very important economic lever as rate of interest control.
Snapshot
The prevailing wisdom began to alter after stagflation The Crisis of the Nineteen Seventies. Stagflation is a term meaning high inflation at the same time as high unemployment.
Neoclassical economists corresponding to Milton Friedman argued that only repeated and long-term increases in rates of interest could end the crisis of stagflation.
However, Friedman suggested that governments couldn’t be trusted to keep up high rates of interest because that will also cause unemployment. Therefore, an independent central bank was needed. It can be insulated from partisan political control and could do what was needed to stabilize the economy.
And what is it like in Australia?
In Australia, central bank independence developed slowly and informally.
The Reserve Bank of Australia was separated from the Commonwealth Bank and began operating independently in 1960. It was headquartered in Sydney to extend its independence from politicians in Canberra.
The RBA became de facto independent from government following financial deregulation under the Hawke government in the early Nineteen Eighties. Subsequent declarations by federal treasurers Peter Costello AND Wayne Swan confirmed the Government’s recognition of the RBA’s independence.
The government still has the power to overturn the RBA’s rate of interest decisions, but this “emergency power” has never been used.
Why independence is essential
Although central bank independence is often related to lower inflationThe historical performance of independent central banks is not without flaws.
For example, in Australia the unemployment rate was historically lower before the RBA gained independence. This reflects the RBA’s willingness to make use of higher unemployment levels as a mechanism to lower inflation.
Independent central banks also bear part of the blame for the outbreak of the global financial crisis in 2007. Many commentators suggested that then-Federal Reserve Governor Alan Greenspan’s decision to maintain rates of interest artificially low was accountable for the subprime housing bubble in the US. This ultimately led to a worldwide recession.
But the Greens’ try to use lower rates of interest as a negotiating chip satirically reinforces the importance of central bank independence. If governments took direct control of setting rates of interest, we’d expect monetary policy to be influenced by short-term election concerns relatively than the long-term health of the economy.
Creating a precedent whereby rates of interest may be cut to suit the needs of the current government would even have long-term inflationary effects.
What’s more, it will likely proceed to drive up house prices. That will exacerbate the housing crisis.
In contrast, the initial reforms proposed by Labor look like balanced. They recognise the competing political interests involved in the development of monetary policy while avoiding partisan interference in the day-to-day running of the RBA.
Although the Coalition has expressed concerns that Labor would use the reforms to fill the RBA board, each the Governor and the board have already been appointed by the current government, acting on the RBA’s recommendations.
It ought to be possible to search out a smart compromise that can improve the functioning of the bank while maintaining political independence.
If the alternative was to completely abolish central bank independence, the coalition should return to the negotiating table.