Posted: March 06, 2005

Central bank independence ... not!

In Friday's Sydney Morning Herald article Stand-off as PM warns on rate rises by John Garnaut it should become clear that the claim of central bank independence, paraded virtuously by neo-liberals as the answer to the Time Inconsistency Problem in economics (developed by Kydland and Prescott, 1977 and Barro and Gordon, 1983) is another Australian myth. In plain English the Time Inconsistency Problem describes situations where individuals continually recast their plans over the short-term and abandon long-term plans that might have delivered superior outcomes. The short-term plans adopted were previously cast aside as inferior. The problem with respect to public policy is that governments may be lured into these short-term choices to maintain popularity even though they produce less benefits than if a long-term plan was maintained, albeit one that was politically unpopular. So the cry for central bank independence is about the distancing of the central bank from political manipulation or popularism. The construction of the Time Inconsistency Problem by neoliberals is seriously flawed (maybe I will outline this in another blog) and fails to grasp the basic democratic requirements that public policy makers should be accountable to the people for their actions. In reality, the central bank is part of a consolidated public sector and it should be accountable for its decisions in the same way as the Treasury is held accountable - through the voting system. Anyway, in the last week we have seen public evidence that the Reserve Bank is not independent.

Garnaut writes that "Prime Minister, John Howard, fired a warning shot at the Reserve Bank on future interest rate rises yesterday, as the bank prepared borrowers for back-to-back rises." Wednesday's National Accounts data that showed that GDP has barely grown in the last year has reinforced the notion that the RBA interest rate rise a few hours earlier was a nonsensical decision. Costello and Howard clearly know that if the RBA is not brought into line with their needs to portray themselves as sound economic managers the wheels will fall off their claim that they are good economic managers. They know that their obsessive pursuit of budget surpluses has driven the private sector increasingly into indebtedness and the sensitivity of household solvency to interest rate changes is now acute. If the RBA proceeds to act as if it is independent and pursues its obsession of low inflation (even when there are no signs of any inflationary pressures) by pushing interest rates even higher, then mass bankrupcties in the private sector (including many aspirational conservative voters losing their homes) will definitely be the result. Then the chimera of sound fiscal management is exposed as cant. Then the fiscal drag will bite the economy and reveal itself for what it is - a policy incapable of achieving full employment in a sustained growth environment.

Garnaut notes Howard's implicit attack on the RBA's interest rate decision. Howard is cited: "Inflation is low, there is no sign that wages are breaking out ... and there are signs that growth ... in the economy has moderated ... If you put all those things together, there is a respectable argument that there should not be another [rate] rise for a while ... I would have preferred, obviously, to see interest rates stay where they were." Immediately following the RBA rise on Wednesday, Treasurer Costello "also played down the prospect of a further rate increase, saying Australians should not necessarily expect another rise in the near future."

So much for the Government not directly commenting on and attempting to influence RBA decisions. Of-course, in my view, the RBA should never be allowed to conduct monetary policy independent of the mandate of the day.

Blog entry posted by bill