Brian Fallow 's Opinion

The Economics Editor of the NZ Herald

Brian Fallow: Reserve Bank heats dollar debate

41 comments
Australian set-up with multiple statutory goals and a board making policy offers a possible model for NZ.

Labour had considered for some time that New Zealand is just "too damned predictable" in the eyes of the foreign exchange market. Photo / Mark Mitchell
Labour had considered for some time that New Zealand is just "too damned predictable" in the eyes of the foreign exchange market. Photo / Mark Mitchell

The differing responses of Labour and the Greens to Reserve Bank governor Graeme Wheeler's "sorry, can't help" speech on the dollar to manufacturers last week are instructive.

Greens co-leader Russel Norman continued his rhetorical jihad, accusing Wheeler in effect of complacency and being intellectually stuck in the 1980s.

Norman did nothing for his own credibility, however, by lamenting the emergence of a credit-fuelled housing boom and in the next breath calling for lower interest rates, and some quantitative easing to boot.

And he ignored the case Wheeler had just made for ruling out cutting the official cash rate or quantitative easing as options for addressing the "significantly overvalued" exchange rate.

Labour finance spokesman David Parker's reaction was more nuanced.

He liked the fact that the governor had pointedly reminded the market that the bank already has a mandate to intervene directly in the foreign exchange market "when conditions are right", even though no such change in policy was signalled.

He liked Wheeler's comment, "When the New Zealand dollar is coming under upward pressure, we want investors to know that the kiwi is not a one-way bet."

Labour had considered for some time that New Zealand is just "too damned predictable" in the eyes of the foreign exchange market, Parker told the Herald.

He entirely agreed with Wheeler about the fundamental importance of lifting New Zealand's lousy performance in savings and productivity. Labour would look to lift household savings by making KiwiSaver compulsory and instituting a capital gains tax (to make property investment less attractive), Parker said.

As for productivity, it was hard for firms to do a lot of capital investment when they were fighting for their commercial lives in the face of a high dollar.

"So there is a chicken and egg problem there."

Asked what he wanted the Reserve Bank to do about the dollar, Parker said he would have to give the same disappointing answer he had in the past: it was a matter for the bank.

"You have never heard me call for them to lower interest rates or to intervene in the forex market and you never will."

But respect for the bank's operational independence did not mean he accepted that broadening its mandate to include a wider range of objectives would make no difference in practice to its policy calls.

Asked how the bank was supposed to choose, when the multiple objectives conflicted, which trumped the others, Parker said that would be a matter for the Reserve Bank's board. But a different, more representative board.

"And the answer would not always be inflation."

So it sounds like what he has in mind is something like the Australian model, with multiple statutory objectives and policy made by the board, instead of price stability as the legislated primary objective and a single decision-maker.

Parker will no doubt seek the views of Reserve Bank of Australia governor Glenn Stevens on how well the RBA model works in practice and how often the external directors override, or even differ from, the judgment of the cental bankers.

Australia, too, is suffering from an overvalued currency. Its dollar is about 25 per cent above its 10-year average against the US dollar.

Appearing before the Australian Parliament last Friday, Stevens said the level of the aussie was a "relevant factor" in setting interest rates.

"It is not that interest rates are seeking a particular exchange rate response, but they are being set with recognition of the exchange rate's effect on the economy."

That's it in a nutshell.

All else equal, the higher the exchange rate is, the lower interest rates can be.

But Wheeler in his speech pointed out that there is no simple, reliable mechanical connection between the official cash rate and the exchange rate.

He also made the point that the bank's inflation target is flexible enough to give it considerable discretion about the pace at which inflation is returned to target.

So it would be gratuitous to formally require the RBNZ to take employment, output growth and the exchange rate into account when making monetary policy decisions, as if it did not do that already.

But it would be perilous to go further and say that some of the time the bank should target the exchange rate, subordinating other objectives to that one, whatever the impact on the cost of living and the cost of housing.

Consumer price inflation may not be a problem right now, but it would be folly to think of it as an evil like smallpox or polio that we are unlikely to see again.

And asset price inflation, in the Auckland housing market at any rate, is alive and well.

Arguably our mania for bricks and mortar represents scar tissue from the prolonged period of entrenched inflation in the 1970s and 1980s. The process of squeezing that cost-plus mentality out of the system was no fun at all. Parker, to be fair, acknowledges this.

Wheeler said the economy faced both an overvalued exchange rate and overheating housing prices in parts of the country, especially Auckland.

And the starting point for what is now double-digit house price inflation, in Auckland anyway, is house prices and household debt levels, which remain very high relative to incomes.

Hence the focus on new macro-prudential tools to regulate bank lending especially to the residential market.

"They can help to reduce volatile credit cycles and asset bubbles, including overheating housing market, and support the stance of monetary policy, which could be helpful in alleviating pressure on the exchange rate at the margin," he said.

The key words there are "help", "support" and "at the margin".

They could be powerful but they are untested and should not be regarded as new wonder drugs that can take the place of interest rates when it comes to cooling a feverish housing market.

The best we can hope is that they will let the bank reduce the dosage of the tried and tested medication, the OCR.

- NZ Herald

Brian Fallow

The Economics Editor of the NZ Herald

Brian Fallow is the New Zealand Herald's economics editor. A Southlander happily transplanted to Wellington, he has been a journalist since 1984 and has covered the economy and related areas of public policy for the Herald since 1995. Why the economy? Because it is where we all live and because the forces at work in it can really mess up people's lives if we are not careful.

Read more by Brian Fallow

Have your say

We aim to have healthy debate. But we won't publish comments that abuse others. View commenting guidelines.

1200 characters left

Sort by
  • Oldest

© Copyright 2014, APN New Zealand Limited

Assembled by: (static) on production apcf05 at 23 Dec 2014 17:12:31 Processing Time: 507ms