Fixing the reserve bank

Written By: - Date published: 1:14 pm, April 29th, 2014 - 32 comments
Categories: act, don brash, Economy, labour - Tags:

It has been pretty obvious for quite some time to most people that the Reserve Bank system that NZ uses needs fixing. The way it operates right now is pretty ludicrous. The economy heats up for any reason, the Reserve Bank detects a forthcoming threat to the inflation rate, they put up the OCR which in turn pushes up interest rates and dampens out the local demand that drives local inflation.

So far so good. But it doesn’t end there and only a simpleton (Don Brash comes to mind) would think that it did. Problem is that we live wide open and exposed to the world.

So having high real interest rates in a relatively stable country gives a few other effects. Hot money roars into the country looking for something to buy. It discovers relatively risk-free property and prosperous companies. It buys those and on the way through it manages to kickstart more inflation by pushing more money into the economy for consumption. The level of hot money looking for a quiet home also drags the exchange rates up thereby pricing our exports off world markets.

Gordon Campbell on Labour’s new monetary policy:-

The main dimension of Labour’s policy is to offer an alternative to the current reliance on interest rate hikes; mainly, by requiring higher contributions to Kiwisaver, as an inflation fighting tool.

We’re going to give the Reserve Bank another mechanism, which is a variable savings rate through KiwiSaver. The Reserve Bank will be able to keep its inflation anchor but instead of that money being lost to you in higher interest rates it will go into your savings. The benefit for the export sector is instead of jacking up interest rates and pushing up the exchange rate you will still control inflation but you’ll have lower interest rates and a better exchange rate.” Mr Parker said it would apply to working people but it would consider excluding those on the lowest incomes.

Right. Instead of paying higher interest rates to Aussie-owned banks and seeing those profits flow offshore, the Labour plan would channel those funds into domestic savings, and take a lot of the current speculator-driven pressure off the exchange rate. Even at the highest rates of Kiwisaver contributions envisaged by Labour, as Guyon Espiner pointed out on RNZ this morning, this would still be well below the level of compulsory superannuation contributions in Australia.

What does this mean for wage earners? Well No Right Turn takes the downside of it.

Which, combined with their universal Kiwisaver policy means that their “solution” to inflation is automatic universal wage cuts. So, when prices are rising, ordinary people will have less money in their pockets to pay for stuff. Thanks, Labour!

And this is exactly right. However that is exactly how you have to control inflation. The best way to stifle inflation is that you remove money for immediate consumption from the economy. In the old Reserve Bank way, this would mean higher interest rates. In this case through enforced savings, as he acknowledges.

Its a bit more complicated than that, of course, in that savers will get their money back in the long run. What it really does is redirect money from higher mortgage payments to an Aussie bank to your future self. But the immediate effect is the same: less money in people’s pockets while prices are rising. And the effect will be felt most by those who do not contribute to the problem: young people without mortgages. Somehow I don’t think they’ll be thanking Labour for this policy.

But just as importantly, for those younger people it will keep mortgage rates down and has a pretty good chance at least partially constraining the property bubble over the longer term.

Now as an aside Gordon Campbell points out the interesting political consequences of this.

English’s comments were a reminder of what has been a largely hidden dimension of this year’s election strategising. Clearly, a high exchange rate serves the political interests of the Key government, by protecting it from the immediate fallout from a lower exchange rate: which would include, for example, higher petrol prices at the pump, and higher prices for consumables. Most voters are consumers, not exporters – and thus, keeping the dollar aloft serves as a form of Muldoonist economic populism that John Key and Bill English seem very happy to embrace. Cheaper imports underpin spending in the local economy. (On the side, it also makes the imported component of our exports that much cheaper.)

So far, so good, so unsustainable. In a modern economy, no country can afford to put the interests of consumers ahead of its exporters, long term. At 85 cents to the US dollar, the pain currently being inflicted on our exporters is such that it exceeds any gains in efficiency they’ve been forced to make in order to survive. Sooner or later, the government is going to have to look beyond its own short term political interests, and start to govern in the interests of the country. For now – and just as it has done with respect to the age of superannuation entitlement – Labour is playing the role of the unwelcome guest that has to remind voters that the current policy settings cannot endure. In the old fable, the grasshoppers were more popular – but the ants had the better strategies for survival.

You don’t need to tell me that. For the last couple of decades I’ve worked most of the time in tech companies that do more than 90% of their sales offshore. One of the biggest problem has been the complete instability of the NZ currency compared to almost all of our trading partners. It helps a little on components but most local cost is in wages. But the instability of the currency is such that it often better to push the production offshore so the costs components and relatively unskilled labour don’t vary as much as they do in NZ, while keeping the skilled designers here. That way you keep most of your production risk in stable currencies (ie not the NZD), which are usually the same ones you are paid in like USD.

Your designers are paid local wages and have a low risk exposure to the exchange rate. But for designers to lose touch with the production systems means that eventually the imperative to move more of them offshore gets higher as well. So we lose another company.

But as those damn late night ads used to say “but there’s more”. No Right Turn again…

The non-headline stuff is where the real meat in the policy is. First, amending the Reserve Bank’s purpose to manage the balance of payments. There’s a consensus on the left that there needs to be some amendment, but whether it should include employment, the exchange rate or the balance of payments is disputed. Whichever it ends up as, it means the Reserve Bank will have to think about the consequences of its interventions, and should stop them from Brashing the economy to target a single part of it.

The head of the reanimated corpse of Brash should now be spinning furiously along with those fools from ACT who are into simplicity (because they can’t handle the real world). Having to deal with more than one objective! We don’t want to burden the poor economists at the RB with too much to consider. However looking the balance of payments is pretty good. It includes the exchange rate and the export economy.

Secondly, there’s a commitment to “[take] the pressure off the Reserve Bank’s OCR by using government policy to address the sources of inflation in the non-tradable sector”. I suspect this is the bit which is going to be doing all the heavy lifting. The core drivers of inflation are house and electricity prices, and Labour has strong policies to target both (Kiwibuild and a capital gains tax; NZPower). Deflating the housing market by taxing the crap out of speculators and increasing supply to the people who need it should remove the need for the Reserve Bank to intervene in the first place. So we might not need their economic sadomasochism after all.

The do-nothing government movement loses its do-nothing figleaf because it is cannot shove everything off to the Reserve Bank. They’re effectively now concerned with the exterior economy. The government becomes largely responsible for the rigidities of internal economy. That is a pretty good mix.

Of course it does rather leave up in the air the ability of MPs to take on the task. Currently I can’t think of many in the current National or Labour with a good track record of solving structural blockages locally. In fact the only one I can think of offhand is David Cunliffe with the Telecom breakup.

32 comments on “Fixing the reserve bank”

  1. Colonial Viper 1

    And this is exactly right. However that is exactly how you have to control inflation. The best way to stifle inflation is that you remove money for immediate consumption from the economy.

    Don’t think so, you are only looking at one side of the equation. Under this system the poor get hit when inflation is running high and their benefits/minimum wage does not keep up. But to keep inflation low you hit the poor by taking money out of their income so they can’t spend it. So they get hit over and over again.

    Now lets look at a historical example. In the 1950’s and 1960’s workers incomes were increasing rapidly such that there was a new burgeoning middle class with increasing incomes, much better off per capita than ever before.

    BUT no rampant inflation? Why? Because the other factor which controls inflation is productivity of manufacturing, competitiveness of supply and having spare productive capacity on hand to soak up increased demand.

    So let’s get serious about what the current style of inflation control is all about. It’s about rationing downwards the amount of products and services that the poor are permitted to access, while preserving the buying power of those sitting on lots of capital.

    Which is very useful in a world of depleting resources where the 0.1% are very concerned that their paper wealth might suddenly not be worth more than the sheets it is printed on.

    • lprent 1.1

      BUT no rampant inflation? Why? Because the other factor which controls inflation is productivity of manufacturing, competitiveness of supply and having spare productive capacity on hand to soak up increased demand.

      Mostly there were a whole lot of kids. If you ever look at the economics of the 50s-60s in NZ what you find are immense building programmes for thing like schools, suburbs, roads, etc as people poured into the cities and had children. At a family you find the same thing with fridges, washing machines, rumpus rooms, etc. Damn near every country that wasn’t in abject poverty had a population boom after WW2, and it lasted to the 70s.

      Most of the time the capacity was literally built just in time to satisfy the demand. And of course we had some obvious labour supply rationing. Few women worked but a lot of them could and often did. They went out and worked whenever the wages got good enough.

      Plus of course we and most countries had closely controlled currencies and licensing for imports. They were effectively partially sealed at the borders. That meant that if you look at the balance of payments for NZ in the 50s and 60s they were small compared to the rest of the economy. They aren’t now because we’re now a full-blown trading economy.

      In the current rapidly greying world of those kids from the 50s and 60s in most developed world from the US to China, and with few constraints on the transfers of money, then what you have is excess savings sloshing around the world looking for a reasonably safe place to land.

      The population is pretty stable compared to the rate of growth we had back then. We could try more immigration as a system. But we have problems fulfilling our current limits when competing with other locations.

      If we locked our borders, then it will take us at least 20 years to develop a internal economy to replace the external trading. Basically we’d have to do a more gentile version of year zero in 1979 cambodia.

      • Colonial Viper 1.1.1

        So you know what is weird about what you just wrote?

        So in the 50’s and 60’s there was a big boom in the number of kids, lots of building activity, families feeling wealthier and spending it on homes and things for the home, the economy barely keeping up with spending demand, lots of trade barriers…YET (and this is my point) no skyrocketing inflation, no excessive profiteering, no tolerated price gauging.

        This is what I mean. A productive economy which makes stuff, is competitive, and is happy to supply the necessities of life to ordinary people without making a gouging profit margin on everything, limits inflation perfectly well.

        Further, you describe how there is all this excess global hot money looking for places to invest and cause asset price hikes. Agreed. Yet instead of causing that global capital pain in order to control price increases we’ve decided once again to target the pain at workers and the poor.

        It’s not good enough.

        • One Anonymous Bloke 1.1.1.1

          Wait a sec. If the reform is going to reduce incentives for capital gain and speculation in favour of investment in manufacturing and “human resources”* how will that kill the poor? Please forgive my ignorance.

          *Will someone bring me the head of the person who coined that atrocious blather?

        • lprent 1.1.1.2

          If you know some magic way to get people to breed, then do so. The nearest we ever got to it in my adult lifetime was after working for families started kicking in.

          The point I was making was that you get very limited inflation when there is a pretty specific long term process of infrastructure investment in a relatively closed economy because it is relatively easy for the government to speed up or defer investment. It is damn hard to do the same after the infrastructure has been built because most of what is built is of limited economic value (think “Think Big”). It is also very hard to do when you don’t have barriers to the economy (we don’t). It is also very very hard to do when you don’t have the required industry in place to build it (just look at how hard it is to concentrate a build force for ChCh – would have been a trivial task 40 years ago). It’d take 20 years to put the latter back into place.

          In the meantime we’ve hit the end of the utility of the OCR for inflation control. They’re extending to toolkit to compulsory savings which over the longer term and with the greying population is going to benefit most of those who have to do it. The alternative is to raise OCR rates and for people not to save and to see the money flow out of the country. Which do you think is the worse of those two alternatives?

          I haven’t seen anything else that I’d consider more effective way of retaining that capital in NZ.

  2. greywarbler 2

    cv
    You might have cracked it there.

  3. Disraeli Gladstone 3

    To me, NRT is right in saying that it’s the younger generations that are going to be hit by compulsory Kiwisaver with the potential for rising contribution rates. Not only are they not really part of the problem with having no mortgages, they’ll also be wanting to pay off their student loans as well. Interest free or not, a student loan is becoming more and more of a shackle and graduates should be allowed to have the choice of using their savings to pay off their loans.

    Ugh. I like the less flashy part of Labour’s policies, but I could really only support a compulsory Kiwisaver with various exceptions for people struggling and for students with debt.

    • Naturesong 3.1

      Easy fix.

      Invest in New Zealand;
      Scrap student loans and make education free for New Zealanders again.

      • One Anonymous Bloke 3.1.1

        +∞

      • Disraeli Gladstone 3.1.2

        Agreed.

        But we all know Labour won’t do that, sadly.

        • Lanthanide 3.1.2.1

          I think it’s proper that a student loan, which allows for education that benefits both the individual and the community, is paid for by both the individual and the community.

          I think the current scheme is about right.

          • Colonial Viper 3.1.2.1.1

            Good if you study something which corporate money values Lanth. The things that society really needs to prosper – an understanding of theatre, language, literature, music, all those things can go into the financial bin.

            • Disraeli Gladstone 3.1.2.1.1.1

              Exactly. University has become a way to get a job. Which is fine, for some. However, university should also still be about education and becoming a well-rounded person. And as we make education more market-oriented, we move further and further away from that ideal.

              It’s also all well and good for a bunch of middle-aged politicians and pundits to talk about “proper” when we all got our education for free.

              • McFlock

                the other point is that ongoing training also has value for the coutry as well as the individual, not just a one-off degree. Placing a maximum on loans is stupid, from that perspective.

                • Disraeli Gladstone

                  Oh, I agree. I said in the other thread for this policy that of all National’s policy for their last two terms, the restriction on adult learners is the worst. Asset sales are flashy and emotional, but hitting people’s ability to retrain in an evolving world is downright cruel.

                  • blue leopard

                    +100 Disraeli Gladstone

                    Although I think that the way those on welfare have been treated is worse […yet there is even more likelihood of getting stuck on welfare if you can’t afford to retrain….]

          • One Anonymous Bloke 3.1.2.1.2

            Yes, no overt right-wing narrative going on here at all, move along.

            “Proper” gave you away, Lanth. Fuck your proper, what works (pick any reliable measure you want) best?

          • McFlock 3.1.2.1.3

            But a loan reduces the incentive to get the education – funny how the articipation rate in tertiary education rate is falling.

            Great for the knowledge economy, that /sarc

  4. Ray 4

    Well I that it is an interesting way to control inflation and it is time we had a conversation about that possible problem
    All that lowering the dollar will do is put more money in farmers and export business pockets, ok a lifted tax rate will maybe fix that but the rest of us face lifted costs thanks to fuel prices
    It was all very well David Parker saying fuel prices are based on oil prices but they will only go up if our dollar has to fall in relation to the US $ and the Greens Peak Oil arrives at the same time

    Not sure how compulsory saving for old age is going to help those on hard low wage jobs especially if the age to get it keeps on rising

  5. aerobubble 5

    Trish Sherson, from ACT, said that its good that housing and the dollar are over priced, totally ignoring the GFC that crashed economies with high debt, high house prices. Its truly imagination that sees anyone commenting on the economy who then totally ignores the printing that is actually pushing up demand in our economy. Demand that needs exchange in return, that has kept our low value primary goods flying offshore. Our economy is not strong, we’re just temporary meat to chew on until the world economy fixes itself, and then we are in for one almighty collapse (as other timber, milk, etc gets flowing) and on top Key’s running up government debt, just icing on the avalanche. So for Trish Sherson to say on Politics on Nine to Noon, that our economy is string is just so dull and boring, as well as not true.

    And now this, http://www.scoop.co.nz/stories/PA1404/S00405/parker-wrong-nine-times-in-one-interview.htm. Clearly National have no clue they think our current growth from the bottom of the GFC is a good look, when anyone with an ounce of economic credibility is worried about the diaster Key is heading us for. They never were forced to declare the reasons why the GFC happened so low and behold they now can smarmy the spin and ignore its effects for the last six years.

    Unless we start clawing some of the profit back into savings, switch out of the low commodity economy into a high value economy, unless we disincentives sloth in our managing classes and re-educated them about the wider effects of the global economy. Its banking collapse would be a good starting point….

  6. Tangled_up 6

    “What it really does is redirect money from higher mortgage payments to an Aussie bank to your future self. But the immediate effect is the same: less money in people’s pockets while prices are rising. And the effect will be felt most by those who do not contribute to the problem: young people without mortgages.”

    With the current system does the cost of higher mortgage rates not get passed onto young people without mortgages (renters) also?

    • With the current system does the cost of higher mortgage rates not get passed onto young people without mortgages (renters) also?

      Very diffusely. There are long lag-times due to fixed mortgages and the Residential Tenancies Act, and many older rental properties are freehold anyway, meaning that they’re simply not affected. Which acts as a check on the ability of others to recoup their increased costs. Whereas variable mortgage rates go up within a week.

    • You_Fool 6.2

      Yes, but in a less transparent manner. Rent prices are “market based” and are therefore theoretically don’t rise and fall with interest rates.

      Of course in real life interest rates go up, rents go up. Rates come down rents stay the same until next time rates go up.

  7. blue leopard 7

    Thanks for this article lprent,

    Like others have commented (on other threads) it is pretty hard to get one’s head around financial policies and their ramifications and you have provided some explanation on these matters.

    I hope you do more of the same. 🙂

  8. Huginn 8

    Thanks for this
    I’ve noticed that National’s open support for a high exchange rate seems to be shifting to the centre of their economic strategy. They really need to be called out on it.

  9. Ad 9

    Everyone in an armchair wants structural change.

    The political sweet spot is to find structural change that people like.

    I wouldn’t go any further than they have on this- the one structural shift I think Labour is capable of doing (inside the caucus they have) is housing. Meaning: shifting New Zealanders into investing away from housing and towards more productive assets, while supporting more housing being built. They will use a wide range of tools and incentives, but they are as close to a sweet spot as they are going to get.

    It hits in the centre of the tennis raquet of bourgoeise mortgage belts, political and financial banking commentariat, MSM commentators (so far), and likely coalition supporters.

    Our addiction to housing as a form of capital is the one structural shift they can and should make in a first term.

    • Colonial Viper 9.1

      Our addiction to housing as a form of capital acceptable as financial collateral is the one structural shift they can and should make in a first term.

      Just clarifying. However I don’t think that this can be done in one term as it is the retail banks which gives housing the financial prominence it has, and they do that because of how profitable fuelling housing asset price bubbles is to them.

      • Ad 9.1.1

        Check how much the low-end mortgage market has shifted in just one quarter.
        This is pushing through an open door.

  10. captain hook 10

    check out tranny whipped paul henry using his gig on tv3 to push the national party barrow. he mouthing off about being forced to save but he doesn’t have the mental equipment to understand about being forced to give money to banks. you know, shifty’s mates. he is just another dweeb who needs money to make himself feel like he is somebody when all he is is a big mouth almighty with too much stuff.

  11. lurgee 11

    Not exactly germane, but I’ve always been in favour of compulsory Kiwisaver, and that a iwisaver account should be set up for every New Zealander at birth, with a government contribution, to establish something like the idea Tom Paine outlined in Agrarian Justice – a payment to every citizen on reaching maturity.

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