Leadership changes at the Reserve Bank are once-in-a-decade events, so the arrival of a new governor and the writing of a new Policy Targets Agreement (PTA) with Finance Minister Bill English offer a rare opportunity to change the way monetary policy is managed.
Former World Bank managing director and Treasury deputy secretary Graeme Wheeler takes over from two-term governor Alan Bollard on September 25.
English and Wheeler will negotiate a new PTA and it's unlikely to change much from the one signed in December 2008, which gives the central bank the mandate to target inflation at 1 to 3 per cent on average over the medium term. That's a pity.
The current monetary policy is working with the Government's fiscal policies, our floating exchange rate and a housing shortage to reinforce imbalances in our economy. Government borrowing, safe-haven demand from foreign investors for bonds and property, and a surge of reinsurance funds for earthquake claims has boosted demand for the NZ dollar.
This has pushed our currency above US80c, with a 30 per cent fall in commodity prices in the last year.
Exporters are struggling, and five years after the beginning of the global financial crisis we have yet to see any of the expected rebalancing towards exports and production.
Bollard acknowledged as much in an excellent speech this week that emphasised how little deleveraging of debt and rebalancing had actually happened. The tragedy for Bollard and the economy is the reason there has been little rebalancing - it is the same reason he can more easily hit his 1 to 3 per cent inflation target. The high NZ dollar is proving effective at doing the Reserve Bank's dirty work of slowing down the economy and keeping inflation low.
Exporters face a double whammy of lower commodity prices magnified by a higher dollar. Meanwhile, consumers and importers benefit from downward pressure on import prices. As a result our current account deficit is forecast to worsen towards 7 per cent of gross domestic product, and we will do little to pay down our still-high foreign debts.
Yet again we see house prices rising (up 9.4 per cent in Auckland last month from a year ago), household debt rising (up $5.335 billion to $187.951 billion in the past two years) and the dollar rising at the same time as the economy slows down and unemployment rises (up to 6.8 per cent from 6.7 per cent).
The situation could be made even worse if the Reserve Bank uses its blunt instrument of a rate cut to offset the effects of a "eurogeddon"-type meltdown in Europe.
Safe-haven capital inflows and even lower interest rates could see Auckland house inflation skyrocket and the NZ dollar strengthen.
Before Wheeler's appointment, the Reserve Bank said it was looking at loan-to-value ratio limits and other "macro-prudential tools" to reduce the risk of housing bubbles.
These are tools used in Hong Kong, Singapore and more recently Canada to try to slow the housing sector without an economically damaging interest rate hike.
Wheeler and English should look hard at using these tools. Otherwise they risk proving Einstein right: "Insanity is doing the same thing over and over again and expecting different results."