The Experts

Did Ken Henry argue for a zero per cent interest rate during the GFC?

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Geoff Winestock has written a brilliant profile on Professor Warwick McKibbin in this week's AFR Magazine. It is just a pity it is paywalled – this is content that is deserving of a wider audience. Winestock covers a lot of important (historically speaking) material in a balanced and accurate fashion. He documents a few things that are contributions to the public record:

McKibbin had an RBA Board battle with Treasury Secretary Ken Henry during the GFC in relation to both the size of the fiscal stimulus and how low interest rates should go. In fact, while I don't believe this has ever been reported, I am informed that Dr Henry wanted the RBA to cut its cash rate to zero per cent in line with other developed world central banks (such as, the Fed and the Bank of England). According to my sources, it was McKibbin who most aggressively led the campaign for cash rate composure, and McKibbin who, with the help of Glenn Stevens, eventually won the Board war with Dr Henry. As it happened, the cash rate only fell to three per cent, which was unusually high at the time. McKibbin's chief concern was that the Government's excessively large fiscal stimulus would ultimately be inflationary given that his modelling suggested that Australia's economy would weather the storm far better than the Treasury's doomsday predictions implied.

Of course, McKibbin has been proven right. Unemployment peaked at a much lower level than the Government expected (5.8 per cent), and we now have a serious inflation problem in Australia with core inflation increasing at a stunning 3.4 per cent annualised rate, which is nearly 100bps pa higher than the RBA's objective. And remember this is at the start of a cyclical recovery. The RBA should be creating spare capacity and slack in the economy before the boom takes place, not once it has all been exhausted.

McKibbin had a frosty relationship with the former RBA Governor, Ian MacFarlane, who was very dismissive of Board members questioning the RBA executive's view of the world (this is one reason why long-time journos will regularly recycle the – now dated – line that the RBA Governor is never overruled). MacFarlane was also totally intolerant of RBA Board members expressing independent views on economic matters and took McKibbin to task on several occasions. In contrast, Glenn Stevens regularly fosters Board debate and differences of opinion. Stevens has also revolutionised the RBA's transparency, governance and communications policies. My own best estimate is that Stevens is the most impressive Governor Australia has had in a very long time.

In contrast to Laura Tingle's report in the AFR that McKibbin did not seek a third term (clearly spun by the Government), McKibbin tells Winestock that he was ‘disappointed’ he had not been offered another stint, which he had let the RBA Governor and Treasury Secretary know he was open to (this bit is not in the Winestock article). Winestock then argues that McKibbin's replacement, John Edwards, who was a long-time advisor to Labor PM, Paul Keating, is not in the same technical league as his predecessor.

While I do not believe that McKibbin is in any way party political (witness his long-time affiliation with the centre-left Brookings Institution), I would venture that if there is a change of government at the next election, the incoming administration would consider offering him the opportunity to join the RBA's Board again. Of course, McKibbin may decide that the financial opportunity costs of doing so are just too high.

Published: Tuesday, May 03, 2011

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