(Image: Zennie/Private Media)

Well, the RBA review is now closed for submissions, and the panel — led by a career central banker, a career public servant and a career macroeconomist — must weigh up the evidence before them.

My great fear is they lack ambition. That they will consider only tweaks, believing them to be paradigm changes. That they will waste a great opportunity to set us up for real change.

The terms of reference for the review are actually broad, asking the panel to reconsider monetary policy from the ground up. But the menu of ideas it can choose from, realistically, is narrow. There are simply very few functioning models of monetary policy regimes around the world. And even though the idea of smashing mortgage-holders’ household budgets to manage price levels in the entire economy is a distinctly weird one, it will be hard to budge.

Australia won’t change the way it makes monetary policy on a blue-sky day, when no other country has moved first. It will take a crisis to get change. But when that crisis comes, a list of good ideas will be vital. I made a submission that exhorts the panel to lift its eyes to the horizon, even as it accepts its hands are tied.

Below is my actual submission, dated November 7 2022:

This review should make conservative recommendations for short-run changes to the conduct of monetary policy. It should not, however, consider or communicate only conservative ideas.

It will serve Australia best by helping envisage alternative regimes that let the Australian public grapple with the questions of what the core functions of monetary policy are, how they are achieved, and with what trade-offs.

Inflation-targeting regimes are now in place across much of the world. At regular intervals, groups of mostly quite independent central bankers meet round tables in lushly carpeted rooms. They enjoy a hot meal and a dry slide deck before shifting a financial instrument by a certain number of basis points. Usually 25. This is not an example of convergent evolution so much as an imported species: everyone emulates the systems that work best.

Global monetary policy frameworks are closing in on a local maximum: tweaking inflation targets by a percentage point here and there, adjusting central bank meeting schedules, measuring the effect of different kinds of jawboning, adjusting bank balance sheets, and even experimenting with targeting certain long-dated bond yields.

This review should help the RBA ascend to that local maximum. It ought also to cast light far and wide to see if there could be a higher maximum — a better way of doing things — elsewhere.

The value of options

Australia has a vibrant public debate and research agenda around the magnitude of changes in the official cash rate. Rate cuts and hikes are bright flowers around which the bees buzz busily. But the roots of the system are less well tended. This potentially sows the seeds for a problem.

Speaking of gardens, a key metaphor for this article is the risk of monoculture: if there’s one major kind of monetary policy system worldwide and it fails, as financial systems sometimes do (gradually and then all of a sudden), who will know what to do next?

I don’t advocate for any one alternative system. I do advocate for boldly exploring new ideas. Economics is a young science. Unlike physics, it has just a few centuries of scholarship under its belt. Unlike biology, it lacks useful laboratories. If by now, after just a few decades of central bank independence and scant experimentation, we have landed upon the singular best way to achieve monetary policy outcomes, we have been extremely lucky. The proposition is not really credible.

Unfortunately, macroeconomic models of alternative monetary policy regimes are not that credible either! Macroeconomic models operate best in a ceteris paribus world and changing monetary policy regimes requires mutatis mutandis. We lack a good understanding of the ways in which our current monetary policy regime might fail us, or the direction in which policy would need to move thereafter.

  • The World Bank has pointed to the increasing synchronisation of global business cycles and global monetary policy cycles as a risk to the conduct of monetary policy. That could become a problem.
  • The amplified reaction of house prices to rate moves is a possible constraint on monetary policy, in both directions.
  • Fiscal policy can move fast to affect aggregate demand and meets once a year (usually!), while monetary policy operates with long and variable lags but meets 11 times a year.
  • The recent insensitivity of business investment to lower interest rates presents a challenge to the theory of how interest rates work.

We can and should make tweaks to address all of the above, but is there a higher-level solution that makes these non-problems? We don’t quite know.

Rectifying this will require meta-cognition: identifying constraints on idea-generation in public economics. These constraints should bother you. They explain why you now face the desultory menu of inframarginal options from which you must choose. Should board members be chosen from industry or academia? Should Dr Lowe face the press each month, or slightly less often?

Please don’t let the passion with which some people prosecute the case for one answer or another convince you these questions are at the heart of your mission. Your official imprimatur for research into genuine insights into ways of achieving monetary policy goals could provide enormous public benefit, in Australia and abroad.

If inflation will not relent, it is easy to imagine a crisis conference being hosted at some point, perhaps by the BIS in Basel in 2025. Australian thinking could help drive that meeting and shape the monetary policy frameworks that define coming decades. Alternatively, we could be carried along by thinking out of MIT and Chicago; or worse still, populist ideas that could be in vogue in Washington.

The review should recommend increased research into potential monetary policy frameworks that may help control inflation and generate full employment, if the current system proves unable.