Pretending it can, or that the Reserve Bank of New Zealand can function independently from the rest of the world, could generate a financial crash.
The very joining of monetary policy and fiscal policy into a single phrase is a criticism of the neoliberal macroeconomics. The reconfiguration under Rogernomics assumed that the two could be administered independently of one another, and gave an authority and power to monetary policy beyond what any reasonable analysis would conclude. It did exactly the opposite to fiscal policy, assuming that the management of taxation, public spending and public debt can do little to sustain the economy or contribute to public welfare, except by keeping each as low as possible. That is not the view of today’s serious analysts who have become much more vocal since the Global Financial Crisis.
However, the crude neoliberal – monetarist – position continues to dominate the New Zealand public discussion even though, if you follow it carefully, the Reserve Bank takes a far more sophisticated approach.
The fact is that the Reserve Bank has much less power than the monetarists think, especially when two key prices – consumer prices and housing prices – have quite different inflationary trajectories.. But even were they in sync, the Reserve Bank’s influence over the economy is limited as long as New Zealand is a small part of the international economy.
Imagine Te Awamutu establishing its own central bank with the belief it would have a massive effect on the local welfare, independently of what the Reserve Bank of New Zealand was doing. As absurd as that assumption is, New Zealand has about the same relative size in the world economy as Te Awamutu has in the New Zealand economy.
The fact is that Te Awamutu cannot issue a currency which operates independently of the New Zealand dollar and monetary conditions. The New Zealand dollar has about the same independence of the international currencies used in the world economy.
Yet much New Zealand commentary ignores such obvious facts, pretending that our Reserve Bank has the same power and influence as has, say, the US central bank. The Federal Reserve has the power to issue an international currency, which New Zealand’s central bank has not.
This column focuses on a single problem which illustrates the interdependence between monetary and fiscal policy. Many people say, why shouldn’t the New Zealand government run a fiscal deficit, spending more than its current revenues and borrowing the difference? After all, the New Zealand government debt is low by international standards – very low actually. What the advocates do not consider is that the offshore debt of our trading banks is high by international standards. All that international banking debt could end up a charge on the New Zealand government.
That is because trading banks can go to their central bank if they get short of cash when access to international funds dries up. That may solve their immediate problem but the effect is that the central bank, and therefore in our case, the New Zealand Government, would in effect become liable for the international debts of the trading banks. Those liabilities are, of course, matched by assets, which are liabilities of the trading banks. The catch is that the Reserve Bank assets are in NZ dollars, but its liabilities are in US ones. Its balance sheet becomes vulnerable to changes in the exchange rate and a substantial depreciation – a likely part of this scenario – would cost the taxpayer hugely – among other things.
That almost happened during the Global Financial Crisis. In the circumstances the Reserve Bank and the Treasury handled the situation brilliantly – much better than the business commentator and other self-appointed monetary experts seem to be able to even understand. At one stage the government ended up owning, in effect, a chunk of the house mortgages of New Zealand.
As sketchy as I have been here, I think we can draw some lessons.
First, the New Zealand government is exposed to substantial foreign-exchange-denominated debt. This fact is quite in contrast to the neoliberal position that private debt has no relevance to government affairs, which is yet another example of neoliberal economics crashing as forcefully as did the world financial system during the Global Financial Crash.
Second, there is not nearly as much room for running a fiscal deficit as it might seem. In my view any additional spending causing a deficit should be on investment, especially income generating investment such as (affordable) housing or some types of infrastructure so it is less of a burden on future generations.
Third, New Zealand will not be as well placed if there is another local or global financial crisis as it was in 2008. The Reserve Bank is to be commended for the prudential measures it has taken (which shift some of the risk from the government to the private sector) but there is no longer the fiscal room we had then.
Sadly, and worryingly, much of the overseas borrowing has gone not into income-generating investment but into the transaction costs of housing speculation – on real estate agents, valuers, conveyancers and the like – into gambling really, with the croupiers making tidy profits. When housing prices turn soggy, or worse, it will not be possible to recover that spending because it is not an investment; it will also be difficult to levy those who benefited from the capital gains from the speculation.
This is a serious caution; there will be a future New Zealand government whose time will be dominated by the problems of high overseas debt (not for the first time in our history). Those on the watch whose negligence caused the high debt will be out of power and hardly held to account.
This column is a revised extract from Unfinished Business - What the 5th Labour Government Did Not Do and the 6th Should a paper to the Fabian Society,.