Review of the Reserve Bank of Australia: An RBA Fit for the Future

ACIS Founding Chairman Dr Ian Enright was asked by Insurance Business Australia to contribute his thoughts on the impact of the RBA Review on the insurance industry. The Insurance Business Australia article is available here. You can read Ian’s full article below.

Analysis of Insurance Issues

By Dr Ian Enright

The interest rate set by the Reserve Bank of Australia (RBA) implements monetary policy and it is a critical feature of Australia’s economic policy. The other critical features are fiscal policy and, particularly for the insurance industry, the development of national infrastructure (the built environment, planning and resilience are all part of infrastructure policy). The changed interactions of monetary, fiscal and infrastructure policy will be a complex and important outcome of the Review of the RBA.

The interest rate is important for the insurance industry, for policyholders and for suppliers. It affects premium rating, premium funding, financial limits and reserving, among other aspects of insurance. An increasing interest rate can effectively erode the cover provided by a policy as the cost of restoring the loss or damage increases. It can also reduce the commutation values of a portfolio or the value of longer-term benefits in income protection products and the newer marques of disability covers.

The Federal Government’s endorsement of the Review of the Reserve Bank recommendations does not directly affect the interest rate. But that is not the whole story. The Review recommends, and the Government accepts, two fundamental changes to the RBA’s framework: its charter (engraved in granite in Martin Place) and its governance. The charter for “economic prosperity and welfare of the people of Australia now and in the future” is to become an “overarching purpose”, not a separate objective for monetary policy. The Review states that the “economic prosperity” aspect of the current charter provides too much discretion to the RBA, and suggests the RBA’s focus should be on price stability and full employment. The governance framework will include a Governance Board (for oversight), a separate Monetary Policy Board, more diverse skill sets and more economic and financial market expertise on the Boards, and the removal of the government power to override the RBA.

There are two currently unanswered questions. The first concerns the change in the charter for economic prosperity. What will that mean in practice? Coombs and Fraser, former RBA Governors, stressed the importance of economic prosperity for all Australians. Coombs noted a view that the RBA was the “Peoples’ Bank” for correcting the inherent inequalities of the capitalist system. Fraser alerted us to the dangers of a monetary policy superimposed on a neoliberal economic system (that is, a system with low tax, low government services and high concessions for business). The RBA was intended to be an instrument for the creation and maintenance of a fairer society. Yet we are told that today economic inequality is surging:

• 93% of the wealth created in Australia between 2009 and 2019 has gone to the wealthiest 10% of people, while the other 90% received just 7% of the wealth – the worst decade of the studied cycles since 1950, according to the Australia Institute;
• 300,000 Australian households have negative cashflow, according to Deloitte Access Economics; and
• the poorest Australians on unemployment benefits (about 950,00 people according to Whiteford and Bradbury in their article in The Conversation) live on $50 a day (which amounts to 2/3 the rate of the single rate of age pension) for 12 months, according to the Interim Economic Inclusion Advisory Committee.

The RBA sets a minimum unemployment level for the control of inflation. Wages for the employed are being structurally lowered. Economic equality is a great driver of social prosperity. Our economic prosperity depends on consumers buying and the poor are our best consumers. Will the change to the RBA charter and its governance produce any change on analysis or policy implementation here?

The second unanswered question concerns the governance changes. What changes might occur here? The RBA Governor dismisses the prospects of practical change. The raising of interest rates to combat inflation is a blunt instrument, particularly for supply-side inflation and particularly from increases in household energy costs and the disruption of international and national supply chains. The economist John Quiggin describes monetary policy targeting inflation by interest rate adjustments, despite being augmented by asset purchase (quantitative easing) and soft guidance, as a limited and failed tool. Could the governance changes and a more diverse skill set on the RBA Boards produce more timely data, a “richer suite of models and data”, better economic modelling and more targeted flexible monetary policy? The Review recommends that the cash rate should “remain the primary tool of monetary policy.” Or will our default position remain that when inflation rises, our poor who are the most adversely affected by inflation pay the largest price for the cure? With the result being a material transfer of wealth to our financial institutions?

So, there are a number of potential indirect effects of the Review changes for insurance. Firstly, if interest rates stay high or rise, and there is no other monetary tool to defeat inflation, premium costs will increase and so will claims costs. Secondly, insurance cover becomes worse value for money and more policyholders will lapse their policies, not renew or reduce their covers, which will lead to worsening underinsurance. Thirdly, if insurance customers perceive that our financial institutions are profiting from the misery of the cost-of-living crisis, there would be an erosion of the most valuable economic commodity of all. Trust.