Reserve Bank Blunders

Reserve banks are responsible for monetary policy, setting interest rates independently of governments.  Their boards are not elected by the public.  They can get their economic forecasts spectacularly wrong, resulting in sub-optimal interest rate settings.

The legendary US Federal Reserve chairman Alan Greenspan admitted his failings after he left office.

“I made a mistake in presuming that the self-interests of organisations, specifically banks and others, were such that they were best capable of protecting their own shareholders and equity in the firms”

Alan Greenspan, former US Federal Reserve chairman, before the US House Committee on Oversight and Government Reform, October 2008

“In other words, you found that your view of the world, your ideology, was not right, it was not working”

Committee Chairman

“Absolutely, precisely”

Greenspan, in reply

Greenspan has described the global financial meltdown as a one in a hundred year event.  But that does not exonerate him for his role in creating it.  By lowering interest rates too far and turning a deaf ear to warnings, he lent respectability to the agents of destruction.  As chairman of the federal reserve, it was his job to prevent such outcomes rather than to claim to be a victim of a rare event.

His successor, Ben Bernanke, told Congress (the Joint Economic Committee) in November 2007 that the resilient US economy would strengthen in the second half of 2008 and escape a recession, defined as two successive quarters of shrinking output.  Since he uttered those words, the economy has shrunk and is still 1.3% smaller in the June 2010 quarter than it was in the December 2007 quarter.  There were four successive quarters of negative growth starting with the September 2008 quarter when he had said that was when the economy would strengthen.  His forecast was appallingly inaccurate.

In Australia, the Reserve Bank of Australia (RBA) has got it badly wrong several times in recent years.

As interest rates take up to 18 months to fully flow through into economic activity, any time that the Reserve Bank reverses direction within about nine months it is a tacit admission that they have fundamentally misread the economy.

This happened in 2000 when the GST was introduced and monetary and fiscal policy collided head on. The GST stopped the housing industry in July 2000, but the Reserve Bank raised interest rates in August 2000 after several rises since October 1999. They had to slash interest rates from February 2001 to avoid a severe slowdown.

In 2008, the Reserve Bank raised interest rates in February and March but by September they were slashing rates.

The last rate cut was in April 2009 but by October 2009, they were lifting rates again.

Clearly they seriously misread the economy in early 2008 and again in early 2009!

It seems that the view of the world of central bankers is based on ideology, rather than an impartial assessment of the world as it really is.  It is a good thing that politicians do not decide monetary policy.  But it is a bad thing that power has been ceded to unaccountable economists living in ivory towers.

Charlie Nelson
October 2010

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Reserve Bank of Australia's dramatic mood change in 2011