Cranky Keating swings at the Reserve Bank — and misses

When Paul Keating delivers a spray to the Reserve Bank (RBA) and accuses it of indolence in supporting the economy in the middle of a recession, it’s a serious moment in policy debate.

As treasurer, Keating saw first hand the role monetary policy can play in sending an economy into recession. As prime minister, he had to watch the RBA put fighting inflation ahead of economy recovery. So his serve at Philip Lowe and deputy governor Guy Debelle, carried across all major newspapers, comes loaded with history and experience.

Except he’s got it wrong — and perversely so.

“Monetary policy can now no longer add to nominal demand,” Keating says, “something that now only fiscal policy is capable of doing.”

He’s dead right — further stimulus is now a matter for the government and its fiscal plans, not the RBA. But then he devotes several hundred words to belting the bank because it is “way behind the curve in supporting the government in its budgetary funding measures”.

That’s despite, as he admits, the RBA “showing some unlikely form in pursuing its 0.25% bond yield target for three-year Treasury bonds and a low-interest facility for banks”.

The three-year bond rate of 0.25% target reinforces what was already the case before the pandemic: the government doesn’t have to worry about the cost of borrowing in devising how much fiscal support to provide.

Josh Frydenberg and Scott Morrison are already in the process of delivering more than $200 billion in deficit spending into the economy; they haven’t been sitting in ERC sweating over spending decisions based on whether the three-year bond rate is 0.25% or 0.1%.

As Debelle said in his Tuesday speech that incurred Keating’s wrath: “The current level of government bond rates is not a constraint on the fiscal decisions of the Australian and state governments … There is not, in my judgement, a trade-off between debt and supporting the Australian economy in the current circumstance.”

How much support the government provides to demand is simply a political decision — as Keating knows better than anyone else — and nothing to do with the RBA. The latter could start buying bonds straight from Treasury and push the bond rate to whatever level it likes, it won’t change the amount of fiscal support.

And the RBA is already going hard to support the government elsewhere, as Debelle pointed out, increasing the size of the RBA’s balance sheet from $170 billion in February to $300 billion now, in addition to cutting the cash rate to 0.25%.

The key support has been via the bank’s term lending facility (TLF) to protect bank lending to businesses, originally set at $84 billion when the bank moved rapidly to support the economy on March 19. That’s since been boosted to $200 billion, with the cut-off extended to June 30 next year because the bank saw rising demand and the need to maintain as much capacity as possible to support banks and companies. According to Debelle, around $75 billion had been lent to banks under the TLF.

Debelle noted that the banks have used the TLF funding to replace offshore wholesale funding while leaving their domestic wholesale funding unchanged. That has made the Australian financial system more secure against a financial crisis developing in the US, Europe or elsewhere as second and third waves of the pandemic threaten to shut down major economies or prolong the global recession.

That speech had other impacts. By flagging that further rate cuts might be considered, Debelle prompted speculation the RBA would cut the cash rate to 0.1% at its October or November meeting. That sent the dollar back down toward US$0.70 cents, helping exporters.

Debelle also repeated what Lowe has been saying for some time: the recession is all about demand. While the virus is having an effect, “So too is the shortfall in demand that occurs in recessionary conditions. That shortfall in demand will be a significant brake on the recovery. Until households and businesses are confident about future demand and income, they will be reluctant to spend and invest.”

In fact the RBA has been consistent on this broader theme for more than a year. From long before anyone had even heard of COVID-19 it reacted to persistent stagnation in the economy by calling for the government to provide more fiscal support for demand — calls that, until the pandemic was shuttering the economy, the government ignored.

It’s strange of Keating to miss a chance to belt the Coalition’s economic management, but he appears to have been hellbent on giving the central bank an uppercut instead.

Keating also insists he’s the true author of central bank independence, particularly because he was the first PM to suffer from the bank putting rates up to fight inflation.

“Peter Costello’s letter later about so-called independence was simply a costless acknowledgment of a structural change that I had already set into place,” he says — a peculiar comment from the man who famously declared he had the RBA in his back pocket.

He might have been correct about the RBA’s failures in the early 1990s recession. But Keating’s well wide of the mark about the 2020 version.