The government should butt out on the RBA and focus on its own failings

The Reserve Bank has been subject to an extraordinary amount of criticism lately from economists, politicians, and members of the public. The prime minister’s unhelpful needling of governor Philip Lowe on Friday about the RBA’s latest interest rate rise was case in point.

The recent RBA review highlighted problems with both its interest rate decisions and how it reaches them. It was a welcome initiative for the RBA’s framework and decision-making to be revisited by independent experts, and appropriate for the government to commission that.

The review suggested sensible reforms. But it is important to highlight what it did not do: It did not suggest that the government use its powers to overrule the RBA’s decisions on interest rates. Doing so has been suggested by some, citing the pain rate rises inflict on Australians.

Economists rarely agree on anything much, but nearly all of us would say that overruling the RBA would be a mistake. Indeed, the review placed great emphasis on independence, even suggesting that this power be taken away from government. Simply put, the government should stay out of the RBA’s decisions on interest rates.

Independence of central bank decision-making is fundamentally important to modern economies. The basic idea is that an economy running too hot leads inflation to rise. The RBA is tasked with the very unpopular job of reigning in the economy and preventing inflation from getting out of control. A government elected on a three-year cycle would be tempted to let the economy boom, leaving inflation to be a problem for the future.

There is not even a meaningful trade-off between unemployment and inflation. Sure, we could get a temporary reduction in unemployment by allowing inflation to rise, but it would not last. As long as unemployment stays too low, inflation would keep rising. Later, we would need to have a period of higher-than-otherwise unemployment to reign inflation back in. In the long run, we do not buy lower unemployment, but we get stuck with high and unstable inflation.

At this point, you might ask: Just because we want to slow the economy, why are interest rates the right tool for the job? After all, higher interest rates inflict real pain. The answer is that it may not be the best tool for the job. There is one other major tool: fiscal policy. In other words, how much the government spends (or does not spend). For example, we could have had higher taxes, or we could have lowered government spending by cutting services or benefits. Each of those decisions would hurt someone too, with different people hurt by different choices.

Maybe there would have been better ways of slowing the economy, but none of those other options are available to the RBA. They are decisions for the government. The present government decided to take an expansionary position, choosing, for example, to subsidise energy use. You may or may not agree with these policy choices, but at the end of the day, the RBA has to pick up the slack. If the government’s spending and taxation choices are too expansionary, the RBA must act by raising interest rates. If you want other tools to be used or think that the burden of fighting inflation should fall on different people, you will have to take it up with your elected representatives in Canberra.