Hard money or central bank independence?

Having looked at several Googled images of Glenn Stevens, it’s clear to me that the subbies are asking for ‘stiff upper lip’ pickies of the Governor.

I was very pleased to hear Stevens’ comments yesterday that, if the circumstances were appropriate he’d raise interest rates in the run up to an election (which he’s already done) and if appropriate during an election.

So it seems was Troppodillian commentator Joe Cambria. But (if I read – between his lines – correctly) he’s pleased that the Gov’nr is a hard money man. Even if Joe isn’t pleased about this, it’s not germane to my point here which is to distinguish between the two issues, which are analytically completely different.

One relates to the stance of policy, the other to the institutional issues around Reserve Bank independence. Unlike some other countries (for instance our hapless Trans-Tasman partners in closer economic relations) Australia’s pathway to central bank independence was via ‘muddling through’ rather than any dramatic road to Damascus conversions. By contrast New Zealand proclaimed its Reserve Bank’s independence loud and clear, and built a regime straight out of the textbook only to display before the world much poorer monetary policy judgement than our own muddling lot.

I think muddling through is often underrated – especially by economists who like long clean lines of policy and, owing partly to their training and partly to more general human foibles are uncomfortable with uncertainty and ambiguity. But muddling through shows an appropriate modesty about the power of one’s own or anyone else’s reason that is one of the more powerful insights behind conservative thinking. It is also an implicit part of Fabian Socialism and was a major part of Freidrich Hayek’s anti-socialist reasoning.

Bernie Fraser was the muddler in chief who got us to our own Australian Central Bank Settlement and he’s unapologetic about owning up to other ‘fuzzy’ aspects of his own thinking about macroeconomic management:

¹iscretionary fiscal policy can be as relevant as monetary policy, notwithstanding the view that I think is still held in some quarters that one policy instrument can only pursue one objective at the one time. I am sure that you have all heard of this particular notion and it leads to the view that monetary policy should be confined to combating inflation and that fiscal policy should be confined in a medium term setting to pursuing sound public finances and to contributing to increased national saving.

I have never been personally comfortable with this one dimensional view of economic life. It rather flies in the face of general observation that in economics everything is really connected to everything else. But more specifically, such notions overlook the fact that fiscal and monetary policies both work in essentially the same way, by seeking to increase or reduce the amount of slack in the economy, and this is basically the way each of these policies have their impact on inflation and employment and so on. . . .

I’d add to this that though it’s often proposed in economic chat, the ‘one target – one instrument’ idea is the exact opposite of what the theory tells you if you have fewer instruments than targets, if the instruments are not perfectly efficient or otherwise imperfectly crafted to their targets and/or if the instruments interact. All of these problems are usually present in spades in in macro-economic policy even before the politics influences what the elected government is doing.

If thats Bernie Frasers defence of a relaxed view of targets and instruments, Ted Evans is on the record attacking the idea that more independence is always better than less. I call this the doctrine of engaged independence in a column I wrote on this stuff in late 2005 in the wake of the Robert Gerard fiasco.

But with all the respect I have for ‘engaged indpendence’, I never liked Ian Macfarlane’s comment that (if I recall correctly) the RBA would have to have unusually compelling reasons to change interest rates close to an election. Glenn Stevens has now blown that away like the dross that I think it was. The basic point is that if changing rates close to an election is uncomfortably political – favouring one side of a party political contest over another – then not changing them is mutatis mutandis just as political. It just favours the other side.

If Glenn Steven’s recent comments simply reflect those of a ‘hard money’ man then perhaps he’s just more keen on swatting down any excuses for the Bank not to lift rates. But his argument for his point of view was very much in keeping with my argument. I think that what I called ‘engaged independence’ is a good thing if that means that the Bank works closely with the government of the day to effect more integrated macro-economic policy. Giving the government the ultimate authority to overrule the Bank might be a good thing too – because it co-opts it into supporting the bank and perhaps moderates the possibility that the Bank might become too obsessively keen on hard-money as bankers were in the Great Depression.

But I don’t have much time for ‘engaged independence’ if it leads to woolly ideas that, when you’re close to an election monetary policy inertia is less political than trying to set monetary policy as well as one can according to the responsibilities set out in the Reserve Bank Act.

However hard Glenn Stevens is with money, the words he used to defend acting when appropriate were in line with my argument. They were compelling indeed.

“If it is clear that something needs to be done, I don’t know what explanation we could offer the Australian public for not doing it, regardless of when an election might be due.

“I don’t think there’s any case for the Reserve Bank board to cease doing its work for the month when an election is going to be. I doubt very much that the members of the public would regard that as appropriate.

“So, should those data or other data make a clear case, I feel we have no choice, nor should we.”

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