The Reserve Bank admitted suffering “considerable reputational damage” due to failures with its interest rates guidance during the pandemic.
In what one former RBA economist described as a “mea culpa”, the RBA on Tuesday published a new review into its handling of COVID-19, acknowledging public anger about rapidly rising mortgage bills.
In 2020 the RBA said rates would not rise from record lows until inflation was back to its 2 to 3 per cent target.
This wasn’t expected until 2024, when wage growth was forecast to rise.
But fast forward to 2022 and inflation has risen far above target to 7.3 per cent, requiring seven rate hikes in a row that have added hundreds of dollars to monthly mortgage bills, with more pain yet to come.
Households squeezed
That has sparked calls for RBA governor Philip Lowe’s resignation, with households being squeezed after making financial decisions with the belief they would pay record-low interest rates for years.
And while the RBA has argued its guidance did alert households to the risk that rates would rise sooner if inflation spiked, the bank admitted on Tuesday it could have done a better job communicating that detail.
“The forward guidance was state-based [inflation], but at various times included a time-based element [2024],” the RBA said on Tuesday.
“This complicated the bank’s attempts to communicate the state-based nature of its policies and it could have done more to emphasise the conditionality of its statements about the future path of the cash rate.”
‘Overly complex’ guidance
Sean Langcake, a senior economist at BIS Oxford and a former RBA analyst, said the review is – by central bank standards – a mea culpa.
“We shouldn’t say forward guidance didn’t work. In some ways this did help make conditions easier at the time,” Mr Langcake told TND.
“But at the same time it has given people a bum steer, that damages credibility, and it’s the reason the pitchforks are out.”
The RBA now admits it has suffered reputational damage because of “overly complex” guidance about interest rates, which led households to focus on the 2024 part of its comments and not more nuanced views about the economic conditions that might lead to interest rates going up.
“It was more straightforward for people to understand and recall a certain time than a set of statements about conditionality,” the RBA said.
“The repetition of ‘2024’ in the bank’s communication served to create a strong anchor point, which held considerable sway in public discussion.”
The RBA revealed it did consider being more upfront about uncertainty, but feared this would “muddy” its messaging, limiting its effectiveness.
“When the cash rate was increased in May 2022, many people saw the bank as having broken ‘its promise’,” the RBA said.
“In hindsight, and focusing only on forward guidance, a less specific time frame, or one covering a shorter horizon, would’ve been preferable.”
Angela Jackson, lead economist at Impact Economics, said the central bank put itself between a rock and a hard place because it also targeted yields on government bonds through to 2024 to keep public costs low.
This target would have been difficult to maintain without strong forward guidance about when (and under what conditions) rates would go up.
“They introduced the yield target and their focus was on ensuring that was met,” Dr Jackson said.
“They were using the forward guidance to keep that target in check but in doing that they led others down a garden path.”
RBA facing trust battle
Sarah Hunter, senior economist at KPMG, said the RBA must now look to repair its reputation with the public as trust is vital in curbing inflation.
“It’s really, really important that they’re credible,” Dr Hunter told TND.
“We have very high rates of inflation, and if we’re making decisions to get back to that 2 to 3 per cent band, we have to believe they will achieve their goals.”
Indeed APAC economist Callam Pickering said it will take time for the RBA to regain public trust, with a risk people may not take it seriously.
“The reason forward guidance worked in the first place was entirely because of the RBA’s existing reputation built over decades,” he said.
“A victory over inflation over the next year or two would certainly help their reputation … that would help rebuild some of the trust lost.”
Dr Jackson said the guidance review will be a first step in rebuilding public trust, which is “incredibly important” for Australia.
“It’s important households and businesses can rely on information from the central bank when making financial decisions,” Dr Jackson said.
“If that information lacks credibility it increases the overall level of uncertainty.”
Back to the future on interest rates
The RBA now says it will adopt a more vague and guarded approach to interest rates guidance moving forward, a move economists said is a return to regular pre-pandemic programming.
The central bank has, however, not ruled out using time-based guidance about rates in the future with an eye to keeping the option available.
“Where forward guidance is appropriate, ordinarily it will be qualitative in nature,” the RBA said about its renewed approach to rates guidance.
“Given the inherent uncertainty in the world, forward guidance will generally be flexible and conditionality will likely focus on the board’s policy objectives – namely, inflation and unemployment – rather than the drivers of these variables (e.g. wages).
“It will typically focus on the short term and be narrative in nature.”
Dr Hunter said the RBA has already begun implementing lessons from its review in the way it’s communicating about the current inflation wave.
“They’re saying this is what’s changed in our view, this is what it means for our projections and that’s then our qualitative guidance.”
