A review of how the Reserve Bank of Australia operates could see the inflation target lowered and bring forward the timing of an interest rate hike.
Earlier this month in a report on Australia, the Organisation for Economic Cooperation and Development recommended a review of the RBA’s monetary policy framework.
It noted underlying inflation – which smooths out wild swings in prices – has undershot the central bank’s two to three per cent target since 2015.
The RBA does not expect inflation to be sustainably within the target before 2024, which means the cash rate won’t be increased from its record low of 0.1 per cent before then.
Westpac chief economist Bill Evans believes the inflation target has been set too high for too long.
He says it was first referred to in 1992, when inflation had averaged 6.4 per cent over the previous seven years and the cash rate was 5.75 per cent.
“Since 1992 the world has changed and the flexibility of central banks has been severely curtailed as policy rates have run into their lower bounds,” Mr Evans says.
“Yet we are still asking the RBA to achieve the same target.”
Other central banks have lower targets. The US Federal Reserve, the European Central Bank and the Bank of England target two per cent, and both the Bank of Canada and Reserve Bank of New Zealand target a one to three per cent with a mid-point of two per cent.
“My view is that markets would welcome a move to align the RBA’s target with other central banks. The rationale and efficacy of targeting a higher inflation rate than our peers are not clear,” Mr Evans says.
Treasurer Josh Frydenberg is open to reviewing how the RBA sets monetary policy, as is shadow treasurer Jim Chalmers, who would also like to look at the overall structure of the central bank.
Matt Comyn, the head of the Commonwealth Bank and Australia’s largest retail bank, believes a review is a healthy thing to do for any institution.
“(But) we don’t have any concerns about the Reserve Bank’s mandate nor the way they fulfil it,” he told a parliamentary committee last week.
But not everyone is happy with the RBA’s performance.
Former Labor prime minister and treasurer Paul Keating launched a scathing attack on the RBA last year, saying it is invariably late to the party when there is a real crisis.
Still, just shifting the inflation goal posts, rather than an extensive review, would bring a whole new dynamic to the interest rate outlook.
Mr Evans expects the first rise could come in the March quarter 2023.
“We think the RBA will achieve its inflation and full employment objectives by early 2023, allowing a move away from the emergency policy settings,” he says.
Otherwise, it will mean the cash rate will have been at a near-zero level for four years come 2024, posing risks for an already inflated housing market and debt-laden households.
“To eliminate these risks the treasurer and the RBA should adjust the current inflation target of two to three per cent to one to three per cent in recognition of the structural changes in the Australian economy and to move into line with the policies of other central banks,” Mr Evans said.