Are Labour’s proposals for the changing the way the Reserve Bank operates sensible or nutty (as nutty as the current legislation)?

Section 8 of the 1964 Reserve Bank of New Zealand Act stated that ‘monetary policy of the Government ... shall be directed to the maintenance and promotion of economic and social welfare in New Zealand having regard to the desirability of promoting the highest degree of production, trade, and employment and of maintaining a stable internal price level.’

A quarter of a century later, the section was replaced in the 1989 Reserve Bank of New Zealand Act by ‘the primary function of the Bank is to formulate and implement monetary policy directed to the economic objective of achieving and maintaining stability in the general level of prices.’ This reduction of the purpose of the RBNZ in the later legislation is being challenged by Labour’s proposed changes.

One could point out that shortly after 1964 the New Zealand went into a two decade burst of inflation– the greatest the economy ever had – as well as a period of economic stagnation, so the charge under the old act proved ineffective. You may want to argue this was a consequence of events outside the control of the RBNZ. But to argue this is to conclude that monetary policy cannot operate alone to deal with inflation.

The section just quoted in the 1989 Act reflected that at the time monetarist (neo-liberal) thinking predominated (although other paradigms such as New Keynesian think low inflation is generally preferable too). This is nicely illustrated by the term ‘primary function’ in Section 8 and the almost grudging Section 31 which stated ‘the Bank shall, if the Bank considers it necessary for the purpose of maintaining the soundness of the financial system, act as lender of last resort for the financial system.’ It was this section which enabled the RBNZ to give a lower priority to price stability during the Global Financial Crisis in order to maintain financial stability.

I come from an older banking tradition which sees the primary role of a central bank as maintaining order in the money system, so I had no problem with their prioritising financial stability at the time. But what is a central bank to do in between financial crises (as well as trying to prevent them happening)? It sets monetary conditions. Again I have no problems with that. But what should it set monetary conditions for?

I am comfortable with an objective of setting them according to ‘promoting the highest degree of production, trade, and employment and of maintaining a stable internal price level’, just like the 1964 Act said the RBNZ should.

Monetarists are likely to counter that the best a central bank can do is to focus on price stability. I happen to disagree with them but, even so, they should have no problems with a clause like that in the 1964 Act. All it requires is that the RBNZ does its best and price stability, according to a monetarism, is the best they can do. However, suppose monetarism is wrong, and a central bank can do better. The 1989 Act precludes monetary policy from doing so. As usual, the Rogernomes were intolerant of any disagreement with their views.

Why monetarism is wrong is a technical issue even if we ignore the dynamics of monetary control. Monetarists assume there is a stable demand for money; many economists would contest that. The big reduction in inflation since 1989 was not only due to the legislation of that year. There were a number of other important factors: the breakages of the wage and price linkages, the reductions of international inflation rates, a disciplined fiscal stance and foreign borrowing which stabilised the exchange rate. Admittedly belief in the legislation helped reduce inflationary expectations, facilitating the transition to a low-inflation regime – beliefs in magic may be effective among the ignorant.

That is why I am not surprised at the difficulties of the RBNZ has had to get New Zealand inflation to the target of an annual average increase in consumer prices of 2 percent in recent years. (It has just reached it.) Nor would you, if you have doubts about the underlying monetarist theory.

So I am not uncomfortable with Labour’s proposal to include employment as something which the RBNZ should take into consideration in its monetary settings. In fact the Policy Targets Agreement between Governor and the Minister of Finance currently requires the RBNZ to take into account things other than inflation, particularly instability in output, exchange rates and interest rates. Which is why many think the proposed change in legislation will make very little difference except that it will break public thinking out of the monetarist straitjacket. (My impression is that the RBNZ’s thinking is not so constrained – its modelling framework is grounded strongly in the New Keynesian tradition, but the internal dialogue seems eclectic, empirical and draws on a much wider range of economic theories.)

Do I hear some wailing that the change will make the Governor of the Reserve Bank less accountable? What do we mean by that? Did we sack Don Brash when the RBNZ fouled up during the Asian crisis? Certainly not. He may have cost National the 1999 election, but they made him party leader a few years later. Is anyone saying ‘Thank God, Graeme Wheeler is going at the end of the year because consumer inflation has been below the target level on his watch’? Of course not. Can you name a single public sector chief executive who has been significantly penalised (or even incarcerated) because they failed. (You can probably think of a number who should, at least, have been sacked.) Accountability is another magical belief.

Because I am not hooked on this odd notion of accountability, I am not too fussed that the Governing Committee (i.e. the Governor, his deputy, the assistant governor and the chief economist) should formally decide the monetary settings. It already does so informally with the Governor seeking a consensus with his colleagues after robust internal debate. The change I would make is to have all four appointed by the Board of the Reserve Bank, the junior three on the recommendation of the Governor.

I am less attracted to the notion of adding three independent experts to the mix. The problem is finding them, as those with expertise are already engaged. Never forget we are a small country; three of our experts are equivalent to 15 Australians, 60 Brits and 200 odd Americans on a per capita basis – I doubt the US could identify 200 experts for their Federal Reserve Board.

What I fear is that we may dilute the operational independence of the Reserve Bank. Sure, it has made mistakes over the last quarter of a century but it would have made a lot more if there had been political interference, as occurred under Muldoon.

Subject to the previous paragraph, I am comfortable with the broad thrust of Labour’s proposals, although the devil may be in the detail. They are yet another example of winding back the neoliberal extremism of the Rogernomes. But practical policy creep over the years means the proposed changes may not make a lot of difference.

Comments (4)

by KJT on April 25, 2017
The Reserve Bank, Debt and the Property Market Kia-ora

In New Zealand we have the "Reserve Bank Act".

Which basically requires the reserve bank to kill the rest of the economy, whenever Auckland house prices, or wages, rise.

Originally enacted, as a circuit breaker, to cap excessive inflation in the 80's, politicians have kept it, long past its use by date, because in their limited view, what works once, briefly, will work perpetually.
It could be argued that it was somewhat successful in curbing very high inflation, on that limited occasion, though others would note that the end of very high inflation ended with the slowing of the rise in oil prices.

Now, every time the New Zealand productive economy struggles off its knees, the reserve bank delivers another knockout.

Howdaft.  Puts it so much better than I can.  I have republished his article here.

I have highlighted some in bold.

"The issues of house price rises in Auckland and Christchurch is prompting comment that it may be time for the Governor of the Reserve Bank to raise interest rates.   It is noted in the media that an increase in interest rates will result in foreign money seeking higher returns to enter the domestic market and this will also increase the value of the already overvalued dollar.  What hasn’t been commented on is that an increase in interest rates will also penalise every business and household in the country including everyone resident in Auckland and Christchurch who already have a mortgage and have no intention of buying or selling a home.  There will be no beneficial behaviour change within that wide group who are not seeking to get further into debt but it will impose hardship and constrain the rest of the economy.  The interest rate rise would be imposed simply as an attempt to limit price rises in response to artificial shortages of housing in two localised parts of the property market. The more sensible action would be to address the cause of these shortages rather than attempt to alter the market response by raising interest rates.The Reserve Bank Act is not only completely ineffectual at slowing property prices it is the root cause of property price inflation.  Because the Reserve Bank Act obliges debtors to pay over the market price for debt, it also guarantees lenders greater than normal market returns on investments.  The result is that foreign cash looking for high and secure returns has flooded into the New Zealand property market.  The banks are incentivised to actively inflate the property market because of the high returns it provides (thanks to the Reserve Bank Act) and because of the flood of money that they have to invest.  As a result the more the Reserve Bank increases interests rates above the natural rate for the marketplace the more money that flows into the property market, the less risk averse lenders need to be because they receive higher margins on loans and this results in banks adopting laxer lending practices, this then leads to property price inflation which results in the rate of increase in capital value of the property (in the overheated parts of the market) to exceed the cost of debt - for a while at least – the negative real rate of interest in this small part of the property market consequently further incentivises borrowing.The end result is that we are as a nation carrying far more debt than is necessary for the economy to function effectively, we have a ruinously over valued property market, we have a grossly overvalued exchange rate, we are bleeding our scarce foreign earnings on interest payments on all the debt and meanwhile our productive sector is crippled by both the cost of borrowing and by the over-valued and highly unstable exchange rate, Instead of suppressing inflation, the Reserve Bank act causes inflation.The Reserve Bank Act is singularly the most stupid element of the reforms of the 1980’s.  It is utterly illogical in that it defies the simplest of precepts of economics.  The answer to the problem of inflation is simple.  If a government wishes to increase the cost to the consumer of any element of the economy without increasing the supply of that element it imposes a tax not a compulsory price increase – alcohol and tobacco are excellent examples of this concept in action.   The government also targets only those activities it wants to constrain.  So when it taxes alcohol it does that based on alcohol content – it doesn’t tax all liquids.A tax also allows for redistribution and targeting by the government to occur so if the tax imposes on lower income households this can be resolved through social payments with the tax on debt as a source of funds.  Similarly the tax can be linked to the asset class or region causing the problem so there may be a lower tax on business debt.  This is not difficult; the banks already set interest rates by the manner in which the debt is secured, the tax could be similarly targeted.   This is only one possible mechanism as there are is a range of possible taxation responses to this problem which these need to be linked into a wider strategic review of the role of taxation in the economy.At a more fundamental level any market failure or physical circumstances causing the price pressure also needs to be addressed.  Auckland prices are being driven by a range of other policy actions by government that put inflationary pressure into the market.  These include allowing uncontrolled foreign ownership of residential real estate, immigration – from both within New Zealand and from off-shore - and from a failure to fully price the true cost to the national economy of growth of the major cities and the cost of internal migration of business and residents.  Property in the larger cities but particularly in Auckland is being subsidised in a number of ways while the rest of the national market is in one form or another languishing with surplus housing and infrastructure.  In addition to fostering policy that actively inflates the cost of housing nationally and causes our international debt to be excessive and our currency to be over-valued we are not as a nation using our existing investment in infrastructure wisely. We need to be asking ourselves collectively why we, who as a nation have the highest natural capital per capita and arguably the best system of society in the world, are one of its debt basket cases.  We are only being prevented from being another Greece or Cyprus by the dairy industry.  We also need to ask why we are not so much better off as a nation when countries like China and Singapore are doing so much with so comparatively little.  The answer is quite simple and that comes down to the vision and courage of their political leadership, could I commend you to read George Monbiot’s recent post as it very accurately describes the malaise that we have inflicted upon ourselves with our reforms and our reliance on “The Market”  to provide."Posted by at 9:19 AM Labels: , , , , , , ,
by Fentex on April 28, 2017

 ...the more the Reserve Bank increases interests rates above the natural rate for the marketplace the more money that flows into the property market, the less risk averse lenders need to be because they receive higher margins on loans and this results in banks adopting laxer lending practices, this then leads to property price inflation which results in the rate of increase in capital value of the property...

Perhaps I'm thick but hasn't the explosion in housing prices occurred during a period the Reserve Bank HAS NOT increased interest rates? I'm pretty sure those big mortgages are only possible because interest rates are low, sooooooo, that paragraph seems nonsense?


by Joseph Cook on April 28, 2017
Joseph Cook

High debt = high inflation?  Japan shows that presumption is wrong!  

Why does the government not have the power to emit credit and money directly?  We should revoke all the powers of the Reserve Bank as they are completely undemocratic and a serious liability to the wellbeing of the Nation!  The Reserve Bank is simply not needed, the way it is.  All finacial aspects of interest to the nation must be put into the hands of democratic government, and government should be made more democratic.  Why can New Zealanders not be given interest free loans, and mortgages, to get their own housing, aford everything they recquire and live a fulfilled life... all for the interests of a plutocratic minority that garners wealth by usury, war, misinformation, and injustice!!!!  

Who are these traitors to the nation?

by Andrew Hart on April 29, 2017
Andrew Hart

I remember Don Brash recommending citizens not to buy houseing and save, (he did the opposite). He asked for restraint from the unions in seeking wage increases, (he did the opposite again). Then he recommended cutting benefits to the unemployed because it encouraged inefficiency. This position of Reserve Bank Governor is obviously a political position.

In the USA the Federal Reserve is a private organisation owned by the banks.

I find it hard to take this discussion seriously

Last week a Guardian reader said  that he was borrowing money at 1%  on his mortgage and lending it out at 3%. (Strange days).


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