This year marks 25 years since the Reserve Bank Act 1989 was passed. While it has enjoyed a high degree of cross-party support over that period, the original settlement is unwinding and it is now time for a review. That need not involve throwing the anti-inflation baby out with the bathwater, nor the politicisation of a significant public institution.
Last week was a big week for the Reserve Bank. The Bank’s March Monetary Policy Statement, released on Thursday saw the expected announcement of the decision to move to tighten monetary policy – a 25 base-point increase in the Official Cash Rate. This marks the start of a tightening cycle – one that has been quite openly foreshadowed by the Bank for some time. It may well engender some debate, if not on the merits of any decision, then perhaps on the consequences. Those consequences have been immediate and not unexpected – retail interest rates have gone up, and the NZ dollar has strengthened.
2014 marks 25 years of the Reserve Bank of New Zealand Act. On the 4th of May 1989 the Reserve Bank of New Zealand Bill was introduced into the Parliament. The ‘settlement’ represented by this statute has been a largely bi-partisan one. The National Party Opposition supported the Bill introduced by the Fourth Labour Government in 1989, and for most of the period since successive governments have sought to ‘de-politicise’ matters relating to the Reserve Bank and the conduct of monetary policy in particular.
This has manifested itself in cross-party consultations on matters to do the Bank, including amendments to the original Act (which, while viewed by some of its architects as a supremely prescient piece of law making, has required an occasional amendment). There has also been adherence to a convention that the government of the day not directly comment on monetary policy settings, and in particular decisions of the Governor.
The quid pro quo for that has been an expectation that the ‘independent’ central bank will confine its public statements to matters that relate to its core responsibilities (former Governor Don Brash ‘annoyed’ governments of both persuasions with speeches delivered to off-shore audiences that addressed policies outside of the Bank’s remit.
In 2014 the cross-party settlement is over. The Labour Opposition has made an explicit commitment to re-visit the Reserve Bank Act with a view to changes in tasking and governance, as has the Green Party. The NZ First Party has been a consistent critic of the Act (but – some minor tinkering with the wording of the Policy Targets Agreement aside – failed to do anything about the legislation in the first MPP coalition government).
The ‘settlement’ provided by the 1989 legislation started to unravel in 2002. The Labour and Alliance parties promised a review of monetary policy and the Act in the lead-up to the 1999 election, and Professor Lars Svensson – then of Princeton University - was commissioned to undertake the review. He reported back to the Government in February 2001, and the Finance Minister at the time – Dr Michael Cullen – released the Government’s response soon after and announced his intention to seek cross-party support for some legislative changes. He was successful in this and amendments were duly passed. The settlement endured.
But not all of Svensson’s recommendations were accepted. Svensson recommended that, rather than target a range (under the Policy Targets Agreement signed by Cullen and then Governor Don Brash in December 1999 the policy target shall be was 12-monthly increases in the CPI of between 0 and 3 per cent) Svensson recommended a point target of 2 per cent. Cullen demurred and the agreed range stayed in place, with an expectation that the full width of the band would be used as necessary. Svensson also recommended a move away from a single decision-maker – the Act requires the Governor to be a sole decision-maker – and the formation of a Monetary Policy Committee. On this matter as well, Cullen demurred – subsequently citing two principal concerns, a limited pool of expertise, and a risk – evidenced in other jurisdictions – of committee members being unduly influenced by how their actions might be received when minutes were subsequently released.
One of the first signs that the settlement may be coming under pressure arose not from political actors but from the actions of the Bank. Having rejected the Svensson recommendation of a mid-point target Cullen was not well pleased when, in May 2002, following an appearance before Parliament’s Finance and Expenditure Committee, then Acting Governor (and now Reserve Bank Board Chair, Dr Rod Carr) wrote to the Committee suggesting that the Bank was operating with a point target.
Concerns were communicated in private, and the Act itself became the subject of some scrutiny. By 2007 Cullen, in an on the record speech, would question the intellectual and institutional framework for the conduct of monetary policy and the need for the inflation disease to be cured without killing the patient.
In terms of party policies, the settlement is no more and there is a debate to be had. That will be about objectives and tools, but it will also be about the governance of New Zealand’s central bank. In his own unassuming way the present Governor has made quite significant changes to the internal processes for making monetary policy decisions – indeed Bank documents refer to decisions of the Governors, although, in terms of formal accountability, decisions are his alone.
The Reserve Bank now has a Monetary Policy Committee, but it is an internal one. What role should the Board of the Bank (the non-executive directors) play? Should the Board’s role extend from governance to active participation in the process of formulating monetary policy, and if so who would we want on such a Board? What voices need to be heard?
The settlement is over and the debate is now joined. That is quite healthy the more so when the debate is about the conduct of policy and the actions of an institution that will have a material impact on the economic and social well-being of the community as a whole.