The Experts

RBA Board in disarray

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For some time now, I have argued that the RBA's decision-making ability is likely being compromised by the five business people that sit on its Board. These professionals are clearly conflicted when it comes to raising interest rates. That's not to say there's been any form of questionable behaviour by any of them. It's just that the private businesses they represent – to say nothing of their own personal investments – are in most cases some of the worst affected by tighter policy.

Jillian Broadbent is a Director of our largest retailer, Woolworths. Roger Corbett used to be CEO of Woolworths, and is now Chairman of Fairfax, which is heavily dependent on the cyclical advertising industry. Graham Kraehe is Chairman of BlueScope Steel, which is one of the more currency-sensitive exporters. Catherine Tanna runs British Gas in Australia, which presumably suffers when the exchange rate appreciates. And then we have the example of former Board member, Frank Lowy, whose wealth derived from the nation's biggest shopping centre empire. You don't need a PhD to figure out the impact of higher rates on retail consumption.

The number one rule that members must abide by when they agree to serve on the RBA Board is that they never, ever make comments on the conduct of monetary policy that could adversely impact the community's perception of it, or betray Board disunity. Public communications are the Governor's responsibility, as Chairman of the Board, and the face of the Bank. Roger Corbett appears to have fallen foul of these protocols.

In an interview given to Dow Jones last night, Mr Corbett seems to have contradicted the RBA's positions on inflation and interest rates, and described Australia's two-speed economy, which is something the RBA has worked hard to play down as a formative influence on policy, as a ‘major problem’.

He also sympathises with the consumers the RBA is deliberately seeking to suppress via higher interest rates, alleging, “The consumer is definitely feeling the pinch in New South Wales and Victoria … This ongoing debate about the economy, and the obvious implication that if things continue there will be further increases in interest rates, is very sobering for most Australians.”

It is, however, Mr Corbett's comments on inflation that are most remarkable. On the same day that the RBA released its Board Minutes with projections that core inflation in Australia will hit an unacceptably high (top of its target band) three per cent annualised rate by the end of this year, and stay there until 2013 at which point the RBA believes it will breach its two to three per cent band, Mr Corbett has tendered a very different perspective:

“But despite the rise in utilities, Australia isn't suffering a wider breakout in price pressures. We haven't got inflation. We have got very moderate inflation. Are there issues which Australia will have to face going forward? Undoubtedly.”

It is difficult to see how one can argue that Australia doesn't have inflation, only “very moderate inflation”, when the year-on-year headline inflation numbers printed at an above-target 3.3 per cent in March, and the annualised pace of core inflation in the March quarter was 3.4 per cent. This is to say nothing of the fact that the RBA's own analysis suggests Australia faces a serious inflation challenge between 2011 and 2013 even if it allows for two more rate hikes.

The ABS's cost of living indexes, which were released this week, paint an even more worrying picture, with the average working family experiencing a 4.9 per cent rise in its cost of living over the last year, which likely explains why consumer inflation expectations have been drifting up since the GFC.

Mr Corbett also highlights the Aussie dollar as "one of the most constraining influences across this country" with the implication that it is doing some of the RBA's work for it. This is being portrayed as a subject of considerable Board debate.

For the avoidance of any doubt, financial market participants last night took Mr Corbett's comments to conflict with the RBA's more hawkish stance, and believe they lend direct credence to rumours that the business members of the RBA's Board are at loggerheads with the executive. The media too has started picking up on this dynamic. Today, The Australian’s headline reports, ‘Interest rates to rise despite RBA board concern’. The opening paragraph continues:

“THE Reserve Bank will push ahead with an interest rate rise … despite growing concerns from its corporate board members … that the economy is troubled outside the powerful mining sector … The decision will anger the nation's chief executives, who are stepping up a campaign for the RBA to keep rates steady … One of the RBA's board members, the prominent retailer and Fairfax chairman Roger Corbett, yesterday said the economy was remarkably weak outside of the mining sector.”

Corbett's dovish remarks shed light on the market's recent complaints about the RBA's ostensibly confusing communications. The market interpreted the one page statement following the May Board meeting as being more dovish than it had expected.

A few days later, the market raised the probability of rate hikes after a “surprisingly hawkish” Statement on Monetary Policy, which is produced by the RBA's internal executive. There was active talk of a disconnect between RBA insiders and their more rate-sensitive Board members. Today The Australian reports one strategist as observing, “the board membership contains many industry people who may feel that the margin pressure on non-commodity exporting businesses resulting from the strong dollar is a sufficient constraint on business that additional interest rate hikes are not yet justified”.

To serve as a member of the RBA Board, one must, as a minimum, always abide by the crucial principles of (a) public solidarity with the Governor, and (b) never undermine perceptions of the Bank's commitment to price stability. More particularly, Board members are simply not permitted to make remarks that can be regarded as statements (god forbid, conflicting ones) on the current stance of monetary policy.

For years I have argued the RBA needs a strong, independent Board. But like Professors Warwick McKibbin and Adrian Pagan, a current and a former Board member, I believe we need specialists not lay business executives. The only credible claim in favour of the conflicted business people is that they give the RBA access to good information. I've previously made the point that this view is redundant given the RBA's unparalleled access to corporate Australia, and its direct monthly business surveys of hundreds of individual companies. If they want insights, they can get it in a heartbeat.

One possible indication of the RBA's diluted inflation-fighting respect in financial markets is the fact that investors have hardly altered the probability of rate hikes despite the RBA's belaboured attempts to set pricing right. These flaws in current market pricing were a consistent theme referred to in yesterday's Board Minutes.

The RBA's Board woes are also another reminder of why it is such a shame that its one truly unconflicted and most technically adroit member, Professor Warwick McKibbin, is being removed from it because of his comments on public policy. Ironically, McKibbin, who is universally regarded as Australia's leading macroeconomist, has been excoriated for engaging in debate on non-RBA related policy matters, but has always been careful to avoid opining on rates.

All told, this state of affairs is very disappointing. The poor folks inside the RBA have given their careers and lives to this wonderful institution. Taxpayers could not ask to be served by a more talented or ethical bunch of people. Without a shadow of doubt, they have the toughest job in the economic bureaucracy today.

Contrary to some absurd suggestions, Glenn Stevens deserves every cent of his well-below-market pay packet. A few commentators have made farcical comparisons to back their view that Stevens is paid too much. Let me objectively lay that debate to rest.

Glenn Stevens runs Australia's central bank, which is our single most important financial institution. It is the backstop for the entire banking system, and exerts a decisive influence over the path of Australia's $1.4 trillion economy. Stevens gets paid about $1 million per annum.

In its 2010 Annual Report, the CBA discloses that its top 12 executives are all paid, on average, $5.4 million per annum. Assuming that broadly similar pay benchmarks are used across the other three major banks, that tells us that there are at least 48 bank executives, setting aside all their smaller bank peers, who receive, on average, more than five times as much total annual compensation as Glenn Stevens. (If we ignore Ralph Norris's 2010 remuneration of $16.1 million, the average/median pay for the 11 other CBA executives is still $4.2 million to $4.4 million per annum.)

A conservative assumption is that Stevens could get at least a second-tier job at one of the major banks. The precedents set by David Morgan (Westpac), Andrew Mohl (AMP) and John Fraser (UBS) imply he could actually run one. This, therefore, is his opportunity cost. Even supposing he could only pick up a subordinate position, Stevens is, in fact, very poorly paid if one accepts the principle of market-competitive benchmarks.

My own figuring is that the criticisms of his paltry pay are more a function of relative justice concerns on the part of those making the claims.

Published: Thursday, May 19, 2011

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