What is good for judges must surely be good for central bankers

On November 21, the SA Reserve Bank cut the repo rate by 25 basis points (bps) , in effect decreasing interest rates across the economy by a quarter of a percent. One news report related to this surprised me. Governor Lesetja Kganyago was asked whether the Bank’s monetary policy committee (MPC) had considered a cut of 50bps. He responded that, unlike previous meetings, the decision this time was unanimous, and there was no discussion about a 50bps cut.

I am surprised, given the tepid level of economic growth in our economy and the horrific rate of unemployment, that not a single member of the MPC thought at the very least a discussion about a larger rate cut was warranted. In earlier meetings, we know there was some disagreement about what the MPC should do but we have no detail on what the actual discussion entailed, or who said what.

Business Day reported recently on IMF research that benchmarked the Bank’s transparency against its peers. While congratulating the Bank for its world-class transparency code, the IMF urged “the SA Reserve Bank to say more about the dissenting votes within the MPC on interest rate decisions” (“IMF says Reserve Bank is a model of transparency but must do more,¨ January 8).

A number of economists in SA, myself included, are of the view that the MPC is too conservative and in recent times could have made larger cuts to the repo rate. This was especially so in September, when the US Federal Reserve cut rates by 50bps and the Bank followed with a cut of only 25bps.

There are good reasons we leave interest rate decisions to an independent central bank, free from political interference. One of these is that politicians will inevitably be tempted to use monetary policy for political ends, which could lead to a surge in inflation.

However, leaving such decisions to experts raises complex issues about accountability to the public. The decisions of the MPC have immediate and lasting effects on our financial wellbeing. An increase in interest rates raises households’ monthly expenditure on housing, disincentivises firms from investing by raising the cost of capital, and affects employment, among others.

In short, MPC decisions can have profound effects on all of our lives, and on the trajectory of the economy. Of course, these are complex decisions, so it’s good that experts in the field are involved in making them, but experts are not always right. Accountability, and therefore transparency, are critical.

For the most part central bankers tend to be conservative. While the IMF congratulated the Bank for its transparency, the recommendation to say more about dissenting voices is actually extremely important because it highlights a potential flaw in our MPC process.

Without suggesting that this applies to the SA Reserve Bank, central bankers also tend to operate in echo chambers and are subject to herd behaviour — they’re prone to act in concert. Powerful individuals such as the Fed chair and other central bank governors can come to dominate decision-making processes in their own organisations, and are under pressure to follow each other’s lead without taking account of local conditions.

This can sometimes result in bad economic outcomes. For example, in response to high inflation in the 1980s, the US Fed aggressively raised interest rates, reaching nearly 20% in 1981. Central banks across the world followed suit. The outcome was a global recession, which had particularly negative effects in developing countries.

I happened to be in Delhi, India, in October last year for a research meeting hosted by prominent Indian economist Nagesh Kumar, head of India’s Institute for Studies in Industrial Development. Kumar had arranged for us to have supper the evening before the meeting so that we would be adequately prepared the next day.

We had to postpone our dinner arrangement by a few hours because Kumar had to do a set of interviews with financial media. I was surprised to learn that he — an industrial economist — was on the MPC of the Reserve Bank of India and had been a dissenting voice in the October interest rate decision. Five of the six members of the MPC in India had voted to leave interest rates where they were in India. Kumar was the dissenting voice, and the media were keen to know the reasons for his views. Luckily, Delhi has restaurants that are happy to serve you well past 9pm.

Economists draw a distinction between the financial economy and the real economy. The former is essentially the world of finance and banking, and the latter where the real economic activity happens, where firms and workers engage in the production of good and services. What is in the interests of the finance sector is sometimes not in the interests of the real economy. At the risk of oversimplification, if interest rates are higher than they need to be, it favours the financial sector and penalises the real economy.

Kumar is an expert on the real economy. His recommendation to cut interest rates was based on his view that the key challenge facing the Indian economy at the time was the need to boost private investment — hence the recommendation to cut the rate by 25bps. He was outvoted, but importantly, in India the minutes of the MPC meetings are released and he could put his views across to the public.

This was a great example of transparency and accountability, but even more important was having a real economy expert on the MPC is a guardrail against herd behaviour — you want committees of this sort to be made up of people with a high level of expertise, but also some diversity of expertise. In the December meeting of the Reserve Bank of India’s MPC, both Kumar and another independent, Prof Ram Singh, director of the prestigious Delhi School of Economics, voted for a rate cut on the basis that the real economy in India needed to be stimulated.

We should expect accountability from all of our public institutions, especially those that affect our economic lives. In such bodies, it is as important to be seen to be independent as it is to be independent, so transparency is really important too. Our MPC is made up entirely of Reserve Bank officials — the governor, the deputy governors, the head of the research department and an adviser to the governor.

In contrast, the Indian MPC has three central bank officials and three independent members. This trend to include independents is growing internationally. The Bank of England has four independents (out of nine members), the Reserve Bank of Australia has six independents out of nine members, and the Norwegian Central Bank now includes five independents out of a total of seven members.

I believe there is a good case to be made for the SA Reserve Bank to follow India’s example and have some independent experts on its MPC, especially individuals who are close to the real economy. And surely the minutes of the MPC meetings should be published.

Like central bankers, judges are appointed to perform important tasks independently of politicians. We hold judges to a high standard of transparency and accountability. When they make decisions, judges are required to write a judgment that includes the reasoning behind that decision, which are made available to the public.

Any dissenting judges are required to provide a dissenting opinion, with the reasons they disagree. Surely what is good for our judges has to be good for central bankers?

• Prof Valodia is pro vice-chancellor: climate, sustainability & inequality at Wits University and director of the Southern Centre for Inequality Studies.

This article was first published on the BusinsessDay