Imagining Reserve Bank Governor Graeme Wheeler as a popular children's book character. Will he learn the lesson of 'what is smart and what is not'?

My favourite book as a child was a Berenstain bears book called ‘The Bear Scouts’. Daddy bear is a feckless outdoor guide who thinks he knows best. But the little bear scouts who follow the guide book know better.

Dad’s knots come undone, his homemade boat sinks, and his short cut ends up being the longest route, infested with crocodiles. When the kids come home they tell mum ‘Dad has shown us quite a lot, about what’s smart and what is not.’ 

New Reserve Bank Governor Graeme Wheeler is following a Daddy Bear monetary policy - inflation control first, nothing else second. The Herald’s Brian Fallow makes an argument that nothing else would work. Fallow is a great economics writer, but both he and Wheeler are wrong. 

Central banks across the world are following a different guide book, and the sole focus on inflation is out of favour. In most developed countries central banks are shifting to a multi-tasking focus - on inflation, growth and unemployment together. Those that aren't are the economies struggling to recover. 

Nobel Prize-winning economist Joseph Stiglitz states the obvious: managing inflation is surely not an end in itself but a means to an end; monetary policy should be concerned not just with price stability but with real stability - unemployment, wages, employment creation and debt. Across the other side of the political spectrum, the Economist magazine recently praised the new governor of the Bank of England, Mark Carney, for suggesting that the level of nominal GDP might be a better target for central bankers than inflation alone. That is, the bank should focus on the cash value of output without adjusting for inflation.  

Mr Carney talks about the need for the Bank of England to help stimulate a stagnant British economy until it reaches “escape velocity”. The Economist agrees. Against a backdrop of spending cuts and austerity the Economist argues, “monetary policy is the best macroeconomic lever Britain has.” 

In the US, Ben Bernanke just announced that the Fed will not increase interest rates (which are at 0%) until unemployment is below 6.5%. He is saying that after a terrible recession, with unemployment high, a period of rapid growth is needed to repair the damage. By making this statement he's also telling the market the Fed will stick with low interest rates. US businesses don’t need to fear a sudden change of direction and high interest rates.   

But our Reserve Bank behaves as if none of this were happening. Daddy bear Graeme Wheeler says ‘nothing to do with us - the government needs to cut more spending and growth will follow’.  

He is taking the crocodile-infested long route. He told exporters who are hanging on with their nails, ‘don’t expect help from us’. No surprise then, that the day after Graeme Wheeler’s speech, the NZ dollar went up another whole cent against the US dollar.

The message to overseas speculators is that investment in New Zealand remains a one way bet, with higher interest rates than our competitors pay to prevent our dollar falling in case it produces price rises. 

Brian Fallows rejects change because, he writes, “...higher inflation would lower real wages, and real incomes more broadly.”  He’s right that high inflation does lower real wages. A devaluation of the currency lowers real wages.

But it also stimulates demand.  Fallows’ argument is akin to a shop valuing its products by the price it demands for products. If it puts prices up it can revalue its stock - but it might not make any sales.

If a country doesn't target a competitive exchange rate and interest rates, it might not make enough sales either. No one is suggesting that by adding more targets we should chuck out the inflation target. But our biggest problem in 2013 is the lack of growth and jobs - not price rises.

Monetary policy is getting in the way. The monetarists' stronger argument against change is that lower interest rates would increase the risk of a housing bubble.  That is true, although the argument ignores that high interest rates are fuelling a speculative bubble anyway as money floods into the country and banks seek a place to lend it out. That's why household debt has reached wild levels. 

The Reserve Bank does have tools to control how much money banks lend for mortgages. Graeme Wheeler could already use ‘loan-to-value ratio limits’ if he wants. He doesn't because he doesn't see the bank having a role intervening, making his refusal to act political, rather than economic. 

Another argument Brian Fallow makes is that, if the bank succeeds in making New Zealand exports cheaper to foreign buyers, it will also make New Zealand assets cheaper to foreign buyers. But selling those assets is economically precisely no different to selling them debt instruments. Moreover, the argument is wrong anyway because it assumes that the asset price wouldn't change if businesses were more profitable.

The value of assets like our timber mills, dairy processors and aluminium smelters will increase if they are successful export businesses. When they're losing money, they're much cheaper to buy regardless of how high the exchange rate is. And you can't argue both that house prices would be bubbling higher and lower at the same time. 

History is on the side of doing more not less. The New York Times reminded readers recently that when faced with the Great Depression of the 1930s and the high inflation of the 1970s, “monetary policy makers did little because they were convinced that action would be ineffective.” Both decisions turned out to be wrong.  

The new guide book for monetary policy advocates aggressive action in the face of a crisis. That doesn’t mean turning your back on inflation, or undermining the independence of central banks. It does mean an equal focus on growth, and more tools to do the job. 

The evidence is all around us now and it's showing us quite a lot about what is smart and what is not.

Comments (1)

by stuart munro on February 11, 2013
stuart munro

Krugman & Chang Ha Joon say much the same as Stiglitz. Neo-liberalism has failed. Time to look again at the only one that worked - developmentalism.

Thanks to the last three decades of economic management, NZ is well on the way to the status of Japan after WWll & Korea after the Korean war. We need to get out of this hole, and we must not forget to punish the scoundrels who put us in it.

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