Melbourne Press Club

Lunch with Peter Costello

The Windsor

Tuesday, 28 October 2008

The Central Bank Governor has enormous power over interest rates.  With the power should come great scrutiny and accountability.  People forget that the independence of the Reserve Bank is of comparatively recent origin – introduced by an Agreement between the Treasurer and the Governor initiated by the Coalition in 1996 – an Agreement that is still in force and was renewed by the Labor Government. 

The Agreement gives the Reserve Bank the right to make decisions and announce them.  But it does not put the Reserve Bank above scrutiny or make it immune from criticism. 

In fact in the Agreement I explicitly reserved for the Government “the right to comment on monetary policy from time to time”.   In addition the Agreement specified that the Bank should issue a statement on the Conduct of Monetary Policy and the Governor appear for questioning before a House of Representatives Standing Committee.  The idea of the Agreement was to enhance the independence of the Bank but to enhance its public scrutiny as a consequence.

This week the Government worked itself up into a lather over comments made by an Opposition backbencher Don Randall on monetary policy.  The comments should be judged for whether they were right or wrong.  But to suggest that criticizing a decision of the Reserve Bank is to attack its independence is a nonsense.  The Government would respect the right of an MP to query or criticize decisions of the Catholic Church notwithstanding the doctrine of papal infallibility.  There is no doctrine of Reserve Bank infallibility and there never should be.  There is no public institution in a democracy that is, or should be, immune from scrutiny or critical analysis.  And an important institution like the Reserve Bank should be the subject of scrutiny and critical analysis.

Late last year, after the sub-prime fallout had begun, and early this year the Central Bank was raising interest rates.  It has now reversed those decisions.  It is right to do so.  Next week it should cut rates further.  But the earlier decisions of 2007 and 2008 to raise interest rates was taken in the belief the US sub-prime fall-out would not have much effect on Australia.  It might have been a reasonable belief at the time but we now know it was mistaken.

In late 2007, I thought the Bank was underestimating the fall-out from sub-prime.  This is not something I have concluded in the light of gyrations in the last month.  I thought it at the time.  I wrote it in my book which was finished by June this year.  Let me plagiarise myself (p116):

“Stevens was to demonstrate his independence by raising interest rates some three weeks before election day.  Nobody would ever again doubt the independence of the central bank.  There was no movement in December and there was no urgent reason that required a rate rise in November.  I thought in the latter part of 2007 the Bank was underestimating the likely flow-on from the sub-prime crisis in the United States and had to be very careful about adding to credit costs.  But the press was turning this into a test for the new Governor: he was under pressure from the economic commentators.  A more experienced Governor would not have felt the same need to prove himself.”