The Money Men by Chris Bowen (superbooks4u .txt) 📕

with Fraser’s departure from the governorship in September 1996. Costello appointed the very well-credentialed deputy governor, Ian Macfarlane, and they jointly issued a ‘statement of expectations’ that the government had of the Bank. This statement formalised the inflation target of 2–3 per cent that the bank had been working under for some time, and it also formalised the independence of the bank in setting interest rates. As Cornish says of the statement, ‘It was a formal recognition of the Bank’s responsibility to conduct monetary policy independently of government, a situation that had also existed informally since the early 1990s.’43

The RBA’s ‘instrument independence’ had now been formalised. It was not a major change in practice, but it had important implications. Its newly heightened independence gave the bank increased credibility and improved investor and business confidence in monetary policy. Furthermore, the inflation target could now be taken seriously and, importantly, would lead to lower inflationary expectations. This independence also gave the bank the confidence to embark on a lengthy period of monetary policy tightening, which coincided with the mining construction boom. The bank continually increased interest rates between 2002 and the onset of the GFC. The importance of this tightening cannot be understated. Australia had had a long pattern of a terms-of-trade boom accompanied by high inflation, leading to a bust. The combination of the pro-efficiency reforms of the 1980s and early 1990s and tight monetary policy meant that for the first time in 110 years, this vicious cycle had been averted.

How much of this tightening can be linked to formalised independence? This is a question that is difficult to answer. The likely correct conclusion is that the RBA would have acted similarly regardless of whether it had had formal or informal independence. The difference is one of degrees. It is highly unlikely, for example, that a reserve bank that did not enjoy formal independence would have increased interest rates during the 2007 election campaign, a move that infuriated prime minister Howard. However, there is no question that the bank would have had a pro-tightening bias regardless of the degree of its independence.

The decision to formalise the RBA’s independence was the right one, and Australia was neither ahead of the curve nor a laggard when it came to the timing of this reform. New Zealand had led the way when David Lange’s Labour government granted its reserve bank independence in 1989. By the time Australia had given the RBA independence, similar moves had already been made by OECD members Chile, the Czech Republic, France, Greece, Hungary, Italy, Mexico, the Slovak Republic and Spain. And subsequent to the Australian action, there were similar reforms in eighteen other OECD countries, including Ireland, the United Kingdom, South Korea and Switzerland. Of more importance was the appointment of Macfarlane as the bank’s governor. Macfarlane was a consummate and skilled central banker. Such was his degree of success in managing monetary policy during the 1990s that it was briefly (and idly) speculated that he was a possible successor to Alan Greenspan as chairman of the US Federal Reserve. In appointing Macfarlane, Costello made the most important personnel decision of the eleven years of the Howard government. MacFarlane managed to keep interest rates calibrated through the expansion so as to ensure that growth did not flow through to inflation, enabling the avoidance of the previously inevitable boom–bust cycle.

The formalised independence of the Reserve Bank should have been seen as an evolution of the informal freedom that had emerged in the 1990s. That it was not was largely the result of a political and policy error by the Labor opposition. Rather than welcoming it as the sensible next step in the process Labor itself had begun, and as being in keeping with international best practice, Labor, under the leadership of Kim Beazley, railed against Costello’s announcement and even threatened legal action. This was redolent of Labor’s opposition to the creation of an independent reserve bank in the late 1950s.

The second major financial reform that occurred during Costello’s tenure as treasurer was the reorganisation of prudential regulation that resulted from the Wallis Inquiry. Costello had promised a major review of Australia’s financial system when he was shadow treasurer, and he delivered on this promise upon ascending to the treasurership in 1996, commissioning Stan Wallis, former CEO of paper and packaging group Amcor, to head the inquiry. The most far-reaching of the inquiry’s recommendations related to prudential regulation, government supervision of financial institutions to ensure ongoing solvency.

The reserve bank had had responsibility for the prudential regulation of banks since the Chifley government’s 1945 Banking Act, as had been recommended by the 1937 Royal Commission on Banking, on which Chifley had served. The Campbell Inquiry, which had recommended the wide-ranging financial deregulation of the 1980s, had been happy for the RBA to keep the prudential regulation responsibility. The approach was disjointed, however. Insurers were regulated by the small Insurance and Superannuation Commission, while building societies and credit unions were regulated by the Australian Financial Institutions Commission. Bringing the regulation of all financial institutions under one umbrella made eminent sense, and the Wallis Inquiry duly recommended this. The controversial element in the inquiry’s recommendations was that instead of transferring the regulation of non-bank financial institutions to the RBA, Wallis suggested that the regulation of all financial institutions be transferred to a new body, which would be called the Australian Prudential Regulation Commission.

Wallis’ rationale was that prudential regulation was so important that it should be the sole focus of a stand-alone organisation. Wallis also argued that a new body would remove a ‘potential conflict of interest for the regulator in cases where institutions require emergency liquidity assistance and the prudential regulator might be too willing to provide it in order to bolster its own reputation for preventing institutional failure’.44

The RBA fiercely resisted this change, arguing in its submission to the inquiry that prudential regulation and the management of monetary policy were complementary tasks that should be kept in the same organisation. It pointed out