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Time to let interest rates fall

Written By: - Date published: 1:59 pm, May 16th, 2008 - 23 comments
Categories: economy - Tags: , , ,

The economy is clearly slowing. Fundamentally, it remains strong with high employment, good wages rises, and strong prices for our exports but employment and retail spending both declined in the first quarter of this year, the housing market is flat, and there is a danger that if the Reserve Bank keeps its foot on our economy’s throat much longer it will pass out into a shallow recession.

The markets are already expecting the official interest rate to start dropping; banks are dropping their fixed-term mortgage rates and price of the New Zealand dollar is falling (it’s an under-acknowledged fact that the point of moving up interest rates is mostly to move up the currency, so as to cool the economy to bring down inflation by choking exports and flooding local production with cheap imports). Lower interest rates will allow the economy to spring back into growth by reviving commercial borrowing for investment and letting the dollar drop further, so we get a better price for our exports and aren’t undercut at home by imports.

Reserve Bank Governor Alan Bollard is right to worry that this would entail more inflationary pressure (a lower dollar means oil imports are more expensive and we get more money into the economy for the same amount of export production plus employment and spending would recover) but it’s time to realise that most of the inflationary pressure New Zealand is facing is beyond his control. Oil and food are international commodities; their prices are going up everywhere and there is nothing that the Reserve Bank in little old New Zealand can do about it. There’s no point choking our economy over international inflation; it makes us poorer and does not get rid of the inflation.

So, Mr Bollard, it’s time to bring that rate down. Accept that international conditions mean inflation is going to remain robust and that is no reason to prevent New Zealand from growing.

23 comments on “Time to let interest rates fall”

  1. mike 1

    If Cullen delivers meaningful tax cuts they could be seen as inflationary by Bollard and he could rates high.
    Would have been much better to slowly phase them in as National proposed than doing nothing for 8 years then having to start cutting at the worst time.

  2. andy 2

    the only thing lower interest rates are going to ‘grow’ in this economic climate is yours and my fuel and grocery bill. It will certainly be deflationary on my bank balance..

    So tell me again why we need the Reserve Bank, if banks raise and lower interest rates independently of the RB?

  3. Steve: while reducing the OCR and increasing inflation might serve the poorly polling Labour governments agenda of reducing anxiety among the electorate during election year I think it would be a mistake to choose short term opportunism over longer term gains: I’m sure many retired people on fixed incomes don’t want to see their investments whittled away by inflation. They will have experienced rampany inflation in the 1980’s and will not look kindly on it happening again.

    The exchange rate is already starting to drop inspite of the OCR and the RBNZ is already having difficulty staying within their target inflation band: http://www.interest.co.nz/ratesblog/index.php/2008/04/24/chart-cpi-inflation-2/

  4. RedLogix 4

    An essential pre-requisite for the RB Governor role should be several years working in industrial plants tuning control loops. After they get good at the simple linear ones with no deadtime…they should then be forced to manually tune complex ones with strong cross-coupling to multiple variables, non-linear gains, and variable dead times.

    This experience should give them some actual feel for what they are doing when they get put in charge of our economy.

  5. IrishBill 5

    The monetarist’s mechanical understanding of the link between inflation and interest rates always amuses me. It’s about as cutting edge as the steam engine. I recommend Paul Ormerod’s book “The Death of Economics” to anyone that is interested in a readable thesis on the application of complexity theory in economics.

  6. Australia’s inflation is running at 4.3% and we’re always told we should be emulating them.

    Interest rates are dropping slightly because they rose out of line with the OCR at the height of the credit crunch, which is now easing, and there is an expectation that the OCR will soon fall.

    We do need to sort out the perverse incentives for people to put all their money in houses before we return to really low interest rates, but that’s a subject for another post.

  7. andy 7



    Have you read “the black swan: the impact of the highly improbable”, Nassim Nicholas Taleb.

    The RB has about as much predictive power as you or I! NZ is stuck between a rock and a hard place, either way we are screwed in the short term.

    Captcha: arresting idealists..??

  8. “The Reserve Bank of New Zealand Act 1989 specifies that the primary function of the Reserve Bank shall be to deliver “stability in the general level of prices.” Section 9 of the Act then says that the Minister of Finance and the Governor of the Reserve Bank shall together have a separate agreement setting out specific targets for achieving and maintaining price stability. This is known as the Policy Targets Agreement (PTA).

    A new PTA must be negotiated every time a Governor is appointed or re-appointed, but it does not have to be renegotiated when a new Minister of Finance is appointed. The Act requires that the PTA sets out specific price stability targets and that the agreement, or any changes to it, must be made public. The PTA can only be changed by agreement between the Governor and the Minister of Finance (section 9(4)). Thus, neither side can impose unilateral changes.

    Note, however, that under the Reserve Bank Act the Government has the power (section 12) to override the PTA. It can do this by directing the Reserve Bank to use monetary policy for a different economic objective altogether for a 12 month period, though again it must make the instruction public. A new PTA must then be negotiated to cover the override period and another PTA must be negotiated when the override ends. In either case, if a new PTA cannot be negotiated, the Governor can be dismissed. So far, this override section has not been used.”


    My reading of this is that the Labour Government could force the RBNZ Governor to change his economic objective but only by sacking him. Surely this would be electoral suicide.

  9. RedLogix 9

    We do need to sort out the perverse incentives for people to put all their money in houses before we return to really low interest rates

    Well yes. But what better alternative is on offer? I’ve been around long enough to see far too many stock market investments fail totally… think Feltex. The thing with property is that while you may make less than you hope for, or go backwards for a short period… in the long run very few property investments totally fail. (Unless of course you’ve been sucked into a pyramid scam like Blue Chip.)

    When a bank lends you money (ie invests in YOU) they get a mortgage or some form of security that greatly reduces the risk that they may loose their capital…but the shareholder gets no such safety net. In the event of a business failure, the shareholder is always last in the queue for whatever funds can be recovered.

    While I have nothing against share investments, it should ALWAYS be done with money you can afford to loose. Which for most people is simply not the case. Most people only get one shot at saving a nest egg for their retirement and loosing it is not an option. For this reason alone, property will remain the the best attractive option for most ordinary folk.

  10. higherstandard 10


    ‘We do need to sort out the perverse incentives for people to put all their money in houses before we return to really low interest rates’

    Three words – Capital Gains Tax

  11. RedLogix 11

    HS…Not at all.

    Overseas markets with CGT’s have experienced the same explosive growth over the last property cycle as those without. This link details the huge range of diverse tax arrangements that exist in different countries:


    Besides as the Australians know, CGT’s are very easy to avoid, by simply rearranging the nature of the investment. And in a falling market do you get a tax credit?

    If the CGT is applied to undrealised gains it hugely impacts on the cash flow with a whole range of perverse effects on all sorts of perfectly legitimate investors. We tried this for a while under Muldoon and it was a disaster. And if you make the CGT applicable to realised gains only, you simply create an even bigger incentive for investors to NEVER sell, thereby reducing market supply and driving prices up even further.

    Besides where do you draw the line? Do you apply a CGT to commercial or industrial property for instance? How do you distinguish between these types in the very common case of where the tenant both runs their business and lives on the same premises? CGT’s are VERY complex (read expensive) to administer, the current system has the great merit of treating residential property investment EXACTLY the same as most other business investment. The IRD studied this issue a few years ago and recommended doing nothing.

  12. AncientGeek 12

    Hey Bryan, you lost your mags’…..

    I’ll do a rational comment here on the weekend. Now it is time to partieee…

  13. ghostwhowalks 13

    How come Australia , with its Board of the Reserve bank and the US Federal Reserve and its Committee, the Bank of England and its Monetary Policy committee gets to make a decision we give sole responsibility to one person

  14. Hillary 14

    Redlogix: A family home is not the same as any other type of investment, high levels of home ownership contribute to family wellbeing and social stability. So if a CGT is not the way to protect home ownership, then some other way should be found.

  15. pixie66 15

    The high dollar has shielded us from the full impact of rising oil prices. Is there an estimate anywhere of what fuel prices are likely to be as the NZ $ falls?

  16. RedLogix 16


    That is a very good question. The answer lies in the fact that homeowners are being ripped off by a range of forces that prey upon them. Consider:

    Over the life of a typical 25-30yr mortgage… the bank will make anywhere between 350 to 500% on the original capital. Bank lending practises have been the primary driver flooding money into the system and allowing prices to rise. Every dollar of the rises we have seen in the last few years was done on the back of borrowed money.

    The original developer of the subsdivision will pay directly for all the costs including all design, earthworks, services and roading. Even if the original land purchase cost was zero, the developer would still have to sell sections for at least $150k plus in order to make a profit. In the old days Councils provided these services out of the public purse as a way, but nowadays you get to pay rates for services you have already paid for.

    The cost of building in this country is more or less dictated by a tight circle of suppliers; Hardies, Fletchers and Carters. As a result building costs here are about double in real terms than over the ditch in Aussie. (Builders usually only make about 20-30k on a typical affordable size home build… not a lot really.)

    There are many elements to a solution.

    1. Housing NZ should be turning over 5-10% of its total stock every year and replacing them with new affordable homes that it builds. NZ has a LOT of rubbish housing stock that needs either upgrading or bulldozing. HNZ should be leading the way in this.

    2. All Residential LAND should be owned by the govt. Leasehold should be the norm. This would prevent banks from using land as security which is the main driver of price speculation.

    3. The Govt should be the lender of first resort for all first home buyers. The shared equity scheme currently being trialled in a limited form is fundamentally a good idea. Indeed, most residential mortgages should be with New Zealand owned banks. It is flat out dumb to be paying billions of dollars in interest to Australian banks.

    4. The interest paid by New Zealanders on their family home mortgages should be either tax deductable. This would eliminate most of the fiscal differential between home ownership and residential investment.

  17. Billy 18

    I found this terrifying:

    All Residential LAND should be owned by the govt.

    but happily so kooky that no-one will take it seriously.

  18. RedLogix 19

    Actually no. Hong Kong and Dubai are two countries that have long done something similar, and much the same effectively applies in Singapore. Besides there are actually quite a few areas of New Zealand where there are large tracts of leasehold land, the landlord being either Maori or Church interests. Leasehold land is a perfectly normal arrangement… nothing kooky about it at all.

    And what do you actually want to OWN the land for anyhow? I can accept that in the case of farming the land itself is the means of production, but for residential purposes the productivity of the land is not the purpose of the exercise, rather it is right to OCCUPY that is of interest to the occupier. This is exactly what a lease achieves.

    All I am proposing is that the Crown should be the titleholder of ALL residential land, and that perhaps Local Govt could administer the leases, charging rental instead of rates. The leases could allow owners exactly the same rights to build and improve as they have now, and permit the lease to be sold on the open market, exactly as it is now. But the crucial difference is that a bank would not be able to count the land value as part of the mortgage security… thereby immediately in one stroke eliminating a primary driver of both rising land values and inflation in one stroke.

    It’s actually a perfectly sound idea. But of course there are far too many vested interests making too much money off the present dysfunctioanl arrangements… so yes you are right Billy… it will never likely be implemented.

    captcha: made reserve reserve = crown land ???

  19. Draco TB 20

    Every dollar of the rises we have seen in the last few years was done on the back of borrowed money.

    You mean ‘printed money’ right?
    Fractional reserve banking means that when you go to the bank to borrow money the bank prints the money at that time. They’re effectively loaning you your money at interest.

    But of course there are far too many vested interests making too much money off the present dysfunctioanl arrangements

    Bingo. Capitalism itself is a have and has been for centuries.

  20. Phil 21

    “Fractional reserve banking means that when you go to the bank to borrow money the bank prints the money at that time. They’re effectively loaning you your money at interest.”

    Fractional reserve banking only exists in the fairy land of social credit nutballs, and is a gross confusion of banking terminology (which, I will conceed, is not that difficult to do…)

    You need to spend a bit of time understanding what “Capital Adequecy Ratio” means.

  21. Phil 22

    “The leases could allow owners exactly the same rights to build and improve as they have now, and permit the lease to be sold on the open market, exactly as it is now. But the crucial difference is that a bank would not be able to count the land value as part of the mortgage security thereby immediately in one stroke eliminating a primary driver of both rising land values and inflation in one stroke”

    Erm… no.

    Why would the bank treat the loan application ANY differently, if the tradable rights held by the prospective borrower haven’t changed one bit? The land itself is not the issue – it is the ownership of the right to onsell that makes the security.

    Oh, it’s alos worth pointing out that the trade of property between, say, you and I, is not included as part of inflation – it’s a net-zero transaction between households and othr sectors (which is what inflation actually measures). The associate costs of purchase lijke lawyers, real-estate agents etc ARE included, as are purchases of new property, and rental. But you selling a house to me, is not.

    What you’re suggesting is nothing more than window dressing and renaming. More crudely, you’re putting the pretty girl in a black dress instead of a red one – it doesn’t have any impact on whether or not you want to take her to the prom.

  22. Jum 23

    The Reserve bank will have a chance to show its political objectivity this year. I remember their verbal and physical disappointment when they discovered Labour had gained the treasury benches again in 2005.

    Lowering the interest rates by June/July will prove that objectivity. Lowering rates after the election, hoping Labour will be blamed for the rise in everything, pre-election, will be proof positive of the opposite. I think they’re doing a Bill Ralston on John Key’s instructions.

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