The RBA is Broken and This Won’t Fix It

All of the goings-on with the Reserve Bank (RBA) yet not a mention that I could see in the press about the money supply. A new expert panel – the Monetary Policy Board (MPB) – will apparently govern monetary policy, having equal regard to inflation and employment. That’s stupid. Not because employment isn’t important but because there is no trade-off.

Yes, I know William Phillips, a New Zealand economist, found an inverse relationship between unemployment and inflation (the Phillips Curve). But, like a lot of empirical results, it was a time-and-place study with no general application and certainly no application at all over long periods.

Price stability and low unemployment go together. The latter depends upon achieving the former. Thinking that price stability must be forsaken to lower unemployment is trade-union-like economic thinking. And, as with most such thinking, distinctly misguided. You know the kind of thing the unions come up with: wage rises will help the economy by increasing demand for goods and services. Really? Then lets double, triple or quadruple wages to achieve economic nirvana. Unions have a role in protecting workers’ safety and in collective negotiations around the terms and conditions of employment. Best to keep them away, far away, from any kind of economic policy-making and certainly away from the MPB. They are economic ignoramuses. Listen to Sally McManus & Co. Their views, if ever translated into economic-cum-monetary policy, would vandalise the economy.

Of course the whole exercise of revamping the Reserve Bank is misconceived. There is no reason for it. Philip Lowe (and the RBA Board as a whole) made an error of judgement in giving voice to an internal view near to the end of 2021 that interest rates would probably not rise until after the end of 2023. Foot in mouth. A lapse. Not a sacking offence, when that kind of view, as expressed, was hardly novel among market participants here and abroad. To be transparent, I have in the past had an indirect working relationship with Lowe when he was no so exalted as being governor. He’s a sound, very competent chap. Exactly made for central banking. Couldn’t find anyone better. It’s not his fault that his economics and those of his colleagues, on and off the RBA’s board, is wanting. It’s a pandemic of bad economics which has infested the whole profession. Any new governor, any new board, is bound to be similarly infected.

On the substance of policymaking, central banks abroad did no better than the RBA. Some worse. They all kept interest rates too low for too long. They all responded to the unforeseen outbreak of inflation by successively hiking rates without the guiding benefit of a sound theory. Having a separate monetary policy board/committee, as some overseas central banks already do, didn’t help. Why would it? Only those with economic knowledge forged in Keynesian error held sway. To wit, the aforementioned pandemic of bad economics had its way.

Milton Friedman is long gone and those “monetarists” who understand his economics are thin on the ground. You only have to read the monetary policy pronouncements of central banks to understand that the perversion of economic thought wrought by Keynes is the ruling paradigm. In the depths of the self-inflicted economic misery, orchestrated by governments to combat what was a relatively mild virus for all but the aged and infirm, central bankers looked around. What did they see? The saw subdued demand and subdued economy activity, as expected when people and businesses are locked down. That, in their Keynesian worldview, meant that inflation was very unlikely to break out.

What they didn’t see, or at least bring into their calculations in any properly informed way, was that the money supply was growing rapidly. Friedman would have known, as monetarists still know, that if the money grows faster than real economic activity then inflation will result. From December 2019 to December 2021, the money supply defined as M3 (roughly, cash plus demand and term deposits in all deposit-taking institutions) grew by 23 per cent. Narrow money (cash plus demand deposits) grew faster still. From the December quarter 2019 to the December quarter 2021, real GDP grew by less than 5 per cent. Any guesses as to how the excess money growth would find expression? Obviously central banks were oblivious.

On the other side, when monetary policy is being tightened, as now, attention must equally be paid to how the money supply is doing. Once inflation has been set loose by poor policy, Friedman advocated orchestrating a gradual reduction in the rate of growth of the money supply to avoid disrupting the economy too much. What you don’t do is adjust interest rates willy-nilly according to the latest inflation figure. Be assured, central bankers are not focusing on the money supply. They are Keynesians. The new MPB will no doubt pour over the state of the economy to no avail. The best central bank would be few staff and a monetary rule. Keep the growth in the money supply broadly in line with real economic growth. Fat chance.

A panel established to look at the RBA was bound to suggest some meddlesome restructuring to justify their existence. An additional board, why not; a chief operating officer, a communications guru. More cleaning staff perhaps. Tea ladies, there used to be tea ladies. All of that is bound to improve setting interest rates, isn’t it? No, it isn’t. But forget that, look at the shiny new version of the RBA.