Who makes the call on the official cash rate?

Tuesday, 22 November 2022

Reserve Bank governor Adrian Orr speaks with Stuff a day after raising the official cash rate in August. (Video first published August 18, 2022)

Reserve Bank governor Adrian Orr has received plenty of brickbats as well as some bouquets for his stewardship of monetary policy during the Covid pandemic.

The debate over interest rates is likely to get more fierce on Wednesday when the Reserve Bank is expected to raise the official cash rate either by 50 basis point to 4%, or by 75 basis points to 4.25%.

A 75bp raise would be largest the bank has ordered since the official cash rate (OCR) was devised in 1999 and would be especially dramatic given that many economists are expecting economic growth to soon stall.

But the decision on where to set the OCR is actually made by a committee; the Reserve Bank’s monetary policy committee, to be exact.

So what is the committee, does Orr really call the shots, and why is one assistant governor unable to say whether it is working as well as it should?

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The monetary policy committee is quite a new invention

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The Reserve Bank’s monetary policy committee only came into being in April 2019.

Former assistant governor John McDermott, who left the bank that year, explains that before that the responsibility for interest-rate decisions lay solely with the Reserve Bank’s governor.

To try to replicate good practice overseas and to recognise the value of diverse opinions, the governor did previously consult with a committee comprised of senior staff from the bank, including McDermott, he says.

“There would be a huge amount of evidence presented,” McDermott recalls. “It was a very thorough process.”

But at the end of the day, the governor could make any decision he wanted, he notes.

So what is the new committee and who is on it?

Responsibility for setting monetary policy, including the OCR, no longer sits solely with the governor.

Decisions are instead made by the bank’s monetary policy committee, which currently has seven members, four of whom are from the bank and three of whom are external economic experts appointed by the Finance Minister.

The four Reserve Bank members are Orr himself, who chairs the committee, deputy governor Christian Hawkesby, assistant governor Karen Silk and the bank’s chief economist Paul Conway.

The Reserve Bank’s interest rate calls are made by a committee who include assistant governor Karen Silk (centre right) and chief economist Paul Conway (centre left).

The external members are Lincoln University professor and agricultural economics expert Caroline Saunders, Victoria University professor and former Treasury adviser Bob Buckle, and economic consultant Peter Harris, who was previously an economist for the Council of Trade Unions.

How does it reach decisions?

We know how it is supposed to work in theory.

The members of the monetary policy committee are obliged under the Reserve Bank’s charter to seek a consensus when making decisions, including on the OCR.

If they can’t reach a consensus, then decisions can be made by a simple majority vote.

If there was a tie, Orr, as chairperson would have the casting vote. But, in theory, Orr could be outvoted on where to set the OCR.

Former Reserve Bank assistant governor John McDermott says the unanimity of the monetary policy committee in a time of extreme economic turbulence is surprising.

And in practice?

This is where it gets more opaque.

McDermott says we know that no OCR decision that has gone before the monetary policy committee has ever been put to a vote, as that would need to be recorded in its minutes of the meetings which have instead always shown its decisions as unanimous.

“Ever since it's been legislated that there will be a committee, there has been not one single dissenter,” McDermott says.

In other words, a “consensus” has always been reached.

But what we don’t know is how lively the committee’s debates may have been or how easy or hard it has found it to reach consensus.

It is possible that over time, former members of the committee might spill some beans.

Monetary policy committee member Peter Harris (left), pictured with Sir Michael Cullen.

But all of the external members of the committee are the same people who were first appointed in 2019 and only two bank members have left the committee since it was created.

They are former deputy governor Geoff Bascand, who declined to comment on the committee’s past machinations, and former chief economist Yuong Ha who could not be reached for comment.

So, for now, only a fly on the wall could know what had gone on behind the committee’s closed doors.

The one bean that spilt

Perhaps the best insight into the work of the committee was provided by Harris in an interview with Bloomberg last year.

He explained that there hadn’t been “100% agreement” on everything but up to then, at least, it had always made decisions that all its members could “live with”.

While a vote at some point in the future could not be ruled out, it was a “last resort” and in its first two years the committee had not really come close to needing one, he said.

“The committee has developed a process that increases the chances of consensus emerging, and increases the chances of early divergences of opinion being reconciled,” he said.

Is the degree of unanimity a cause for concern?

McDermott, who is now an executive director of economic consultancy Motu, says he is unsure if the committee is working as it should.

Given that the majority of the committee’s members are the governor and his direct reports “the bar to dissent is high”, he says.

But he says it is still a surprise its decisions have been unanimous, given the economic conditions, which have seen inflation balloon far above the Reserve Bank’s target band of 1% to 3%.

“In this massively uncertain world that we're in with so many big shocks happening, I think it is a surprise that there's been nobody with a different view.

“It's been an unusual few years. The difficulty of forecasting inflation over the last few years has been enormous and, collectively, that group has all made the same decision and all made the same mistake.”

Despite the instruction to seek a consensus, McDermott believes the committee’s members have a duty to voice any dissenting views they may hold, through a vote.

“It’s no good going along with a consensus when you've been paid for and have a huge responsibility for looking after a national asset. That would be totally irresponsible,” he says.

“If you're on that committee, you've been appointed by the minister and you have got a responsibility to do the job.”

A culture of secrecy?

McDermott says he has stopped reading the Reserve Bank’s minutes as he finds them sterile and not that informative.

He is unable to say if the monetary policy committee has been a success.

“I think it would have been easier to assess had there been more speeches from the members explaining their views.”

But as it was, McDermott could not recall having heard from any of the three external members of the committee.

“If you look in other jurisdictions, you will find that they will make speeches explaining their position and they'll hold media conferences with journalists.

“If they are the people making the decision, why aren’t they making speeches? Why aren't they discussing how they see the world? You don’t do it before the decision obviously, but you do it afterwards.

“They should be explaining how they see the world and how they've interpreted information that the staff have provided them.”

Harris countered in his Bloomberg interview that “too many voices speaking for the committee could undermine its integrity”.

The bottom line?

The fact that monetary policy decisions have been made unanimously by the committee means the brickbats and bouquets can’t be deflected and the buck stops with any and all of its members, including Orr.

Given that the majority of the members are Orr and his direct reports and that the external members of the committee don’t speak out independently, the assumption must be that this is either a tightly managed ship or one whose members see extraordinarily eye to eye – or both.