Widening movement for monetary policy reform

Written By: - Date published: 11:15 pm, June 24th, 2010 - 42 comments
Categories: monetary policy - Tags: , , , , , ,

It’s good to see a consensus forming in the Left that change is needed to monetary policy, and it’s excellent to see so much agreement from the Right. Currently, the Reserve Bank manages monetary policy by moving the Official Cash Rate in an attempt to keep the rate of inflation between 1-3% target.

In the textbooks, they tell you inflation targeting works by taking money out of the pockets of borrowers and giving it too savers (when the interest rate is raised) to slow down the economy and vice versa when the economy needs a boost. And maybe that is how it works in a large economy that is primarily moved by its internal markets (the people who came up with this idea were thinking about the US).

But it doesn’t work like that for New Zealand. Mortgagees have dulled the effect of monetary policy on them by taking fixed rate mortgages that don’t move with OCR changes. As small trading nation with large current account and capital account flows, moving the interest rate impacts our economy mostly by moving the exchange rate. Higher interest rates bring in more hot money from overseas, that means for demand for NZD, meaning a higher exchange rate – and vice versa. Higher OCR = higher exchange rate and that is bad news for exporters. It is by hurting exporters that rising OCR cools the economy.

And this is doubly problematic because the hot money becomes cheap capital for the banks to loan out as mortgages. We saw this before the credit crunch: a wall of foreign credit that fueled the housing boom, while exporters laboured under a high exchange rate. It will happen again. It is already happening again.

Inflation targeting has always been a blunt tool and, in this country, it is hitting the wrong part of the economy.

The Fabians have been doing a great job bringing this issue to the fore. Now, Labour, in speeches from David Parker and Phil Goff, has confirmed that it will change the monetary policy, joining the Greens in calling for reform. Labour’s idea is to give the Reserve Bank more active powers over banks’ capital ratios (the fraction of capital that a bank is required to hold compared to the amount it has on loan).

Basically, rather than making borrowing more expensive via the OCR, the Reserve Bank could control how much the banks can loan by raising their capital ratios . Both serve to decrease the amount borrowed and increase the amount saved when needed to cool inflation. But the advantage of using capital ratios is it should have less of an impact on the exchange rate and would counteract the effect of hot money.

Labour is also talking about giving the Reserve Bank a wider mandate. Simply focusing on inflation is stupid, it makes inflation control an end in itself, which it shouldn’t be. Labour says it will add objectives such as full employment and a competitive exchange rate for the Reserve Bank to balance.

There’s been positive reception from the CTU, the Manufacturers and Employers’ Association, and the Productive Economy Council says “Goff’s announcement will split the business vote”. It may well happen if National remains stuck in the failed neoliberal ideology.

Unique in the world, we task our Reserve Bank with only one goal – keeping inflation in the target range – and give it one blunt tool to achieve it. Adding other objectives would bring us into line with other countries and giving the Bank better tools is long overdue. We need a smarter, more sophisticated approach to monetary policy and it is great to see the Left pushing for it.

42 comments on “Widening movement for monetary policy reform ”

  1. RedLogix 1

    While I remain sceptical of Goff’s ability to take the PR fight back to the right wing spin machine, this speech and the one from Parker is a pleasure to read. Virtually every point in it is stuff I, and many others, have been making for years. The depth and cohesion on show here stands in stark contrast to anything Key has said…ever. Two aspects stand out in particular:

    1. Finally recognition of the need to tightly regulate the finance sector. When powerful unions dominated the scene over 40 years ago, the mere threat of wage driven inflation caused panicky govts to introduce policies limit their power. To the point where unions in this country are still regulated to within an inch of their lives.

    By contrast when an out of control finance industry unleashed a torrent of credit, that actually caused massive asset price inflation… the establishment refused to bat an eyelid. Mainly because so many of them were making out like bandits on the back of it.

    The consequence of excessive speculative debt is always the same, tears before bedtime. We now have a once in a lifetime opportunity to deal to this…but of course with a PM who is an ex-banker I’m doubtful anything effective will be done.

    2. Both speeches are aimed squarely at the rural farmers and small businesses. This makes a lot of sense. With National having hopped into bed with ‘Waitakere Man’ and now so dependent on the urban Auckland vote their traditional rural power base is necessarily feeling a little jilted; and why we are getting rumblings around the formation of a new Country Party.

    While there’s a long and bad history between Labour and the farmers, if you talk sense these people they will listen. The world they inhabit has changed a lot in recent decades and maybe the old tribal rules don’t hold so strong as they used to. (Moving frequently around the Wairarapa I’m often surprised at the how soft support for National is, even among people whom a generation ago would have sooner cut their right arm off than vote left.)

    The other thing often overlooked by the left, is that these big rural electorates often return suprisingly large numbers of left voters…. for every conservatively leaning farmer, contractor and small business owner, there are plenty of working people of all sorts, often on very modest incomes. And there’s always a scattering of rural greenies too, folk who often have quite a high personal profile in their communities. But ultimately, more so than city voters, these people will tend take into consideration what they feel is good for their community and region come polling time. Creating a cohesive economic policy that makes sense to them could change the game.

    Now all that’s needed is to articulate effectively this without all the usual media spin and slant.

  2. riddler 2

    What are your formal qualifications Marty?

    I mean no offense, nor accusation, i simply wish to know.



    [lprent: We don’t provide any information about authors apart from what they care to write. Personally I’d rate Martys formal skills in this type of post far higher than mine. I only have a BSc, MBA, and a few other qualifications.

    Read the About and Policy and abide by it on this site. I don’t allow people to try to probe for information about authors that is more than they care to provide.

    Any repetition of questions of this type will be rewarded with a long (>1 month) ban. Is that clear? ]

  3. IrishBill 3

    I’m a fan of using compulsory superannuation with an adjustable contribution rate to control inflation. Currently our exporters are forced to be currency speculators just to provide themselves some cover which is a ridiculous situation.

    • Lanthanide 3.1

      Taken out of employees pay packets I suppose?

      I think the point of the interest rate changes is that if you choose to borrow, you pay extra. If you don’t choose to borrow, or choose to save, then you benefit. Simply taking money out of everyone’s pay packets doesn’t give them a choice as to what they do with their money.

      It might work, but only if the range of increase was on the order of 1% for every 2% of the current OCR regime.

      • Bright Red 3.1.1

        “Taken out of employees pay packets I suppose?”

        Interest rate hikes are taken out of employees’ pay packets too, very high interest payments for those carrying debt (a very large chunk of the working population).

        The attraction of variable super payments is that the money isn’t lost to those workers as it is when their interest goes up, they just can’t consume it now.

        and you allow interest rates to be wholly determined by the market

        • Lanthanide

          Normally when the OCR rises, the main things that go up are mortgage and business loan rates. Retail lending and CC rates normally don’t move around much at all.

          Considering there’s a large portion of the population renting, those people won’t be affected by the rate rise as they don’t have mortgages. Taking money out of employee pay packets doesn’t affect businesses either.

  4. TightyRighty 4

    The problem with asking the banks to control inflation through capital ratios is that while it does help to control inflation, it also helps to put an unnecessary break on the economy, thanks to it’s overly large effect on the supply of money. Seeing as it puts brakes on lending by force rather than by price, no wonder the left has consensus on it. seeing consensus has been reached, the argument is now settled. the old wikipedia/AGW proof.

    • Bright Red 4.1

      the point of monetary policy is to put a brake (not break) on the economy when necessary, tighty.

      • TightyRighty 4.1.1

        Really BR? I thought the reserve bank just like putting the cost of money up for the sake of it.

        • Bright Red

          You’re the one who wrote: “The problem with asking the banks to control inflation through capital ratios is that while it does help to control inflation, it also helps to put an unnecessary break on the economy”

          as if the brake on theeconomy was a negaive side effect, not the point of the operation.

          • TightyRighty

            To increase the cost of borrowing and the reward for saving for the purpose of inflation control, so that workers aren’t locked in rounds of endless pay disputes, is one thing. to put brakes on the economy for the sake of it is completely different. it’s why current monetary policy works. and why forcing banks to adjust capital adequacy ratios as the reserve bank demands, is silly.

            • Bright Red

              I think you misunderstand – the point of increasing interest rates via the OCR is to put a brake on the economy so that that inflationary pressure subsides.

              If inflation in an economy can be compared to an overheated car engine, then the OCR or any other approach is about slowing down the engine so its cools off before it damages itself.

              The OCR is intended to work by reducing employment, wages, and economic activity so as to reduce inflation and make a healthier economy in the long-run. See page 6 of this RBNZ bulletin http://www.rbnz.govt.nz/research/bulletin/2007_2011/2007jun70_2.pdf

  5. Damian 5

    This could be a good point of difference with the NACTs. HoneKey as a former money trader would rather stick with the staus quo as variability in exchange rates allows him and his mates to make money. Also there appears to be a degree on positive feedback to this as shown by comments to a similar article at interest.co.nz. It’s not the circut breaker Labour needs but just goes to show if you focus more on policy that matters to people, people will listen.

  6. The Baron 6

    This all sounds well and good until we see that Full Employment is on the wish list too. Rather than leading to a more managable monetary policy, instead we see what can only be described as pie in the sky, impossible to achieve stuff.

    • RedLogix 6.1

      So why do the Australian’s include it? It’s improbable that any nation could achieve and sustain absolute full employment; but it’s obviously one of a number of desirable goals.

      Virtually all dynamic economic macro models map some kind of relationship between employment, inflation, economic growth and credit creation. It’s NZ that’s out of step with the rest of the world by not including the employment component in it’s official macro policies.

      • The Baron 6.1.1

        Please note I didn’t say that some sort of employment component was necessarily a bad thing – I said a FULL employment goal was a bad one.

        Yet again though, we see monetary policy debate turning into a game of “here’s my wish list” rather than a careful consideration of the way these things balance together – and the consequences of that balancing act. Monetary policy doesn’t work by simply issuing a new set of dictums – all of these actions will have consequences.

        Some of the consequences that occur to me from the outset are (and I am by no means a pro here):

        – Dampening demand for credit through bank controls = harder for anyone to buy a house
        – Loosening inflation controls means greater value destruction, and savings erosion
        – Messy set of targets that will limit RB accountability

        Its irresponsible to leave these elements out of this debate, in my mind. I’m not saying anything about right or wrongs yet (apart from the idiocy of a full employment goal) – only that sensible decision making and debate in this regard requires analysis of ALL factors of these changes – not just the good bits thanks Marty.

        • RedLogix

          Dampening demand for credit through bank controls = harder for anyone to buy a house

          No…harder for people to bid silly prices on houses.

          Loosening inflation controls means greater value destruction, and savings erosion

          While at the same time you’re completely blind to the same effect caused by asset price inflation.

          Messy set of targets that will limit RB accountability

          What other countries seem to cope with ok. Maybe we could consider buying Treasury one of those new fangled computator thingies I’ve read about in overseas magazines.

        • Draco T Bastard

          full employment = X% of people unemployed at any one time

          The difference is that the left want that number to be as small as possible while the right want it to be as big as possible.

          Basically, all you’ve done here is show your ignorance.

        • Ari

          I’d rather people be stuck renting than that they bought a house they couldn’t afford and had it foreclosed when the market caught up.

          Inflation is already out of control, the current policy is completely ineffective in addressing it, so we should actually see an improvement for people actually trying to save under the proposed policy.

          The RB isn’t exactly accountable as it is, because its only goal is purely theoretical and it doesn’t have the tools to actually achieve it! Nobody can blame the RB for failing because it hasn’t even tried! I’d rather it be useful than simplistic, although getting it useful and accountable at the same time would be awesome. You have any more specific criticisms so we can talk ideas, or are you just trying to smear the idea of actually regulating the economy by saying broader targets than inflation necessarily imply a lack of accountability? Because they don’t, it’s just a problem one has to address in regulation. And in case you haven’t noticed, Labour governments in the last two decades have been a lot better at that than National ones.

    • Bright Red 6.2

      We’ve had full employment for long periods in the last century. From the 40s through to the early 80s, in the late 2000s. And it was government policy during our greatest period of prosperity.

      Full employment doesn’t mean everyone is in work. There is always some unemployment due to the normal churn as businesses open and close and people’s life circumstances change. Full employment means there is no structural unemployment – full employment is usually taken to mean about 3% unemployment because you can’t practically get lower than that in most cases.

      • The Baron 6.2.1

        Oh, so full employment doesn’t actually mean full employment – but 3% unemployment. Well if we write the goal that way then I’ll be hunky dory.

        I’d also note that our full employment policies at the end of the period you quote were delivered through massively bloated state enterprises, that operated mainly as employment sinks rather than productive businesses delivering services to citizens. That led in part to our massive debt burdens by the time Lange came along. Hardly the utopia you portray – and gives me a shiver that the Fabians are keen for us to repeat our silly errors of the past.

        • RedLogix

          Well if we write the goal that way then I’ll be hunky dory.

          Anything around or better than 3% is pretty much is the conventionally accepted definition of full employment. Your line that it should be 0% is just a dickheaded distraction.

          I’d also note that our full employment policies at the end of the period you quote were delivered through massively bloated state enterprises, that operated mainly as employment sinks rather than productive businesses delivering services to citizens.

          Actually no, that line is just another morsel of neo-lib nonsense that modern analysis has de-bunked. It turns out that while these large state-run ’employers of last resort’ were inefficient measured as stand-alone enterprises, when their total contribution to the economy is fully aggregated they performed rather well.

          They did actually deliver services, they did actually provide employment with dignity and in doing so ameliorated the substantial social costs of unemployment, and they did actually keep cash flows within the NZ economy, thereby helping to reduce the structural current account deficit issue we’ve been plauged with for decades.

          In addition many of these state enterprises provided excellent apprentiships and technical training to a high standard. Bear in mind that fully 70% of the skilled technical people in this country are over 55yrs old and are simply not being replaced in adequate numbers in recent times.

          The only reason why the neo-libs ran that lie was to justify privatising them at fire sale prices in order that they might be asset stripped.

          [Edit]:That led in part to our massive debt burdens by the time Lange came along.

          The really massive debt burden (as a % of GDP) got racked up in the last decade… the private sector racking up almost $190b in debt. Nothing to do with the state sector.

          • The Baron

            I’d be interested in learning more about this debunking of employment sinks that you talk of – would you care to provide me with some sources please?

            • RedLogix

              It’s not in any one place, but is a common theme found in the Post-Keynsian and Chartalists studies. A google on the term “employer of last resort” is an starting point. Also interesting are quite specific schemes to create real 0% unemployment like this from Wray and more generically this about Minsky.

              Besides it’s not rocket science…the argument I laid out above is pretty straighforward . Once you lose the very narrow framing of the neo-lib economic orthodoxy of the last three decades then a lot more options open up.

      • jcuknz 6.2.2

        I thought the full employment of the past was due to the fortunate position of having a tight control on imports and the incredibly favourable trading position of England taking all our produce .. it changed with the European Union I believe and we are unlikely to find an alternative. Is it not better for us, although not for the slave labour of countries we currently import from, to pay more for goods produced here in NZ. But people being people we often compare prices and moan that “we can buy cheaper in Fiji” was the cry of yesteryear I remember … we are our own worst enemy?

        But to get away from that red herring It does seem rather silly that we shoot ourselves in the foot each time the OCR is raised.

  7. Olwyn 7

    @ The Baron: Just because something has been done badly in the past does not mean it cannot be done well in the future. If we took that attitude to all systems, Capitalism would be long gone, with its tendency to generate crises. I think that using upward of 4% unemployment and denigrating the unemployed so as to keep wages competitive is disgraceful in the way that racism, slavery, etc are disgraceful. People who support this sort of thing not only lack sympathy for others, they also imagine that they are so far above the storm that such a fate could never be visited upon them.

    • The Baron 7.1

      And your solution is then…?

      Come on oh wise Olwyn, tell us what the humane/sympathetic/honourable monetary policy solution is.

      • Olwyn 7.1.1

        I do not have a solution, and neither it seems do you, but Goff’s suggestion, which Marty has highlighted, does seem like a step in the right direction.

        • The Baron

          As does every solution that promises the earth, but doesn’t tell you the consequences.

          Consequences which can be very real and very damaging when you’re talking about monetary policy – and even less sympathetic than the status quo.

          You need to start thinking a bit more for yourself rather than relying on your favourite colour of politician to tell you what right and humane is, me thinks.

          • Bunji

            What, like the neo-liberal orthodoxy that promises we’ll be richer because there’ll be a bigger pie, and the consequences that actually the vast majority aren’t, and wealth is concentrated into the hands of 2% of the population.

            – Periods of moderate inflation have actually been good for the weaklth of the 85% of the population that are workers (it’s the richest 2% whose wealth is eroded), so if inflation gets a bit higher due to multiple targets, it’ll most likely bring greater equality.
            – Full-employment (or near to it, and I thnk we can do better than 3%) also drives salaries and wages up (maybe we can catch Australia!), causing greater equality.
            – Greater equality of wealth tends to increase investment in production (unlike the neo-liberal years, where investment has declined massively). If more people have wealth to invest in their ideas, more of that wealth will be invested.
            – if everyone has less access to cheap credit, house prices will just be lower, in a reversing of the nuclear arms race.
            – business is desperate for a more stable exchange rate, the current forex lotteries don’t encourage any sort of investment.

            I think the widening of aims and changed monetary policy is a most excellent idea. I like Irish Bill’s variable compulsory super too, but don’t see it as an either/or situation. Always good to have more than one tool in your toolkit. If you only have a hammer everything looks like a nail, as they say.

          • Olwyn

            What a patronising answer. Do you think that concern for your fellow humans is at all times and places unaffordable?

            “I’d also note that our full employment policies at the end of the period you quote were delivered through massively bloated state enterprises, that operated mainly as employment sinks rather than productive businesses delivering services to citizens. That led in part to our massive debt burdens by the time Lange came along.”

            Even if you are right in this observation, it does not mean that the subsequent hollowing out of the productive economy, the invention of an underclass and burgeoning prison population are as good as it gets.

            There is I think some truth in the idea that people will choose to work for the public service or in some professional capacity if they can, and the productive base cannot reliably support too many going this way. But it is also true that if a free rein goes in the other direction people with money to invest prefer to have stuff than to do stuff. Which also has negative consequences.

  8. Draco T Bastard 8

    and the Productive Economy Council says “Goff’s announcement will split the business vote’.

    It will do. Importers like a high NZ$ so that things can be imported cheaply while exporters like a low NZ$ so that there is more demand for their produce.

    The big problem with our floating exchange rate being controlled through the (normally high) OCR is that it kills business opportunities in NZ forcing us to have higher unemployment. It does this by making foreign made products artificially cheaper than the same product made in NZ. This results in more imports, less exports, higher trade deficit and lower employment.

    The Berl Report on the trains shows how much more benefit (effectively reducing the price by 2/3rds) we get from building the trains in NZ compared with importing them but the price is what this incompetent government is using to justify importing them. If the exchange rate was lower (as it should be) then the price to import would be higher and so the justification for importing wouldn’t be there. This would result in those trains being built here and bringing all the other benefits as well.

    Basically, the focus on inflation with the only control being the OCR has resulted in the NZ$ being priced higher than it should be which has resulted in an increase in inefficiency (it really is more expensive to import). Another example of market failure. IMO, time to re-peg the NZ$.

  9. Pascal's bookie 9

    It’s just crazy talk of course, the single tool single focus model is best and meddling meddlers should just accept that. There is nothing to discuss. Don Brash sez, and afterall, he and his ideas got rejected by the people so we have to pay attention to him.

    ‘cept the IMF doesn’t think so.


    • Rex Widerstrom 9.1

      Interesting you’ve had to go to the ABC for that link, Pb. I heard that story when it came out… was it even reported in NZ, I wonder, outside perhaps of the back of the business pages?

      It’s worth quoting from.

      Saul Eslake, former ANZ chief economist, and now program director at the Gratten Institute, says… “debate ought to include whether the objectives of central banks remain appropriate, and whether there ought to be broader consideration given to not only other objectives but to other means of achieving those objectives over time“.

      Not only does the central bank have too few levers to pull to control the economy, I believe it shouldn’t be the only one in the driver’s seat as it effectively is at present. The RBNZ wasn’t elected, doesn’t have to consult, and is anwerable to no one. After all, if Fred’s Bank loses its depositors money, its directors and currency traders will find the regulators and the SFO want answers. If the economy tanks, the RBNZ board just shrugs.

      Spreading both the objectives and the decision-making responsibility will permit not only the advantages Goff has enumerated (and Marty has done an excellent job of summarising) but spread the risk and broaden the number of minds tasked with considering these issues. That can only be a good thing, IMHO.

      • Lanthanide 9.1.1

        “but spread the risk and broaden the number of minds tasked with considering these issues. That can only be a good thing, IMHO.”

        Too many cooks spoil the broth, or alternatively, no one with sufficient power to force through the appropriate actions can result in nothing getting done.

  10. Name 10

    Looking at what Reserve Banks have achieved in the US, the UK, Ireland, Iceland, Greece, Spain, Portugal, Japan &tc in the last decade I think you might as well give them a dart-board and a jar of fortune cookies as any set of targets.

    Give any economist a single target and at least he knows what he’s looking at. Give him two and all he can do is argue with himself. Give him more than that and his head will explode at the sheer imponderability of it all.

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