Brian Fallow on the economy

Brian Fallow is the Herald's Economics Editor

Brian Fallow: Case for committee brought into spotlight

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The end of Alan Bollard's tenure is an opportunity to revise the governor's role, though the Government has indicated it is happy with the status quo. Picture / Mark Mitchell
The end of Alan Bollard's tenure is an opportunity to revise the governor's role, though the Government has indicated it is happy with the status quo. Picture / Mark Mitchell

Regime change at the Reserve Bank is not on the cards when Alan Bollard steps down as Governor in late September.

The Government has indicated a high level of comfort with the status quo.

Before reflecting on what might change it is important to recognise that there is no such thing as a lame duck governor. The decisions Bollard makes over the next eight months, including another five interest rate calls, will be no less important, or tricky, than they would be if he had put his hand up for a third term.

The appointment of his successor will provide an opportunity to revise the policy targets agreement (PTA), the contract between the Government and governor that in effect represents his or her job description when it comes to monetary policy.

The PTA has been amended several times since the pioneering days of Reserve Bank independence and inflation-targeting nearly a quarter of a century ago.

The trend has been for the Governor's riding instructions to become progressively less strict and more flexible, as confidence has grown that low inflation is here to stay. In particular the framework has been stable since Bollard was appointed in 2002. The markets appreciate that.

Key said on Tuesday that while he could not rule out changes at the margin, "for the most part we are comfortable it is working well".

He had had no indication from the Finance Minister Bill English that he is looking at moving away from the sole decision-maker to a committee model.

In any case, "outside of that I don't see tremendous change in the way monetary policy is managed in New Zealand".

In particular Key is opposed to any changes that would risk higher inflation, describing it as a fool's paradise that eats away at savings and encourages the wrong behaviour.

"The 1 to 3 per cent band is about right."

He is right, of course. It has always been a puzzle that calls for the central bank to be less "hung up" on inflation have tended to come from the left, when inflation is hardest on the poor and powerless, who have no one to pass the buck to.

English yesterday also said he did not see any significant changes in the monetary policy regime.

Inflation is not the bugbear it once was, he said. The Government's economic focus is elsewhere and he is not interested in revisiting "esoteric" debates that have already been had repeatedly in recent years without anything changing.

When he was asked about a possible change from the sole decision-maker model to a monetary policy committee, English said: "That has been looked at before. We haven't seen any reason to change it, if only because we haven't got a a lot of monetary policy experts around the country."

All the same, officials at both the bank and the Treasury are reviewing the PTA in light of the experience of the 2000s business cycle.

One concern is that the trend rate of inflation has been close to the top of the bank's target range - it has averaged 2.9 per cent over the past nine years - and inflation expectations have drifted higher accordingly.

That said, the latest inflation data, which found the underlying measures of inflation clustered around 2 per cent, indicate that where it matters, in price-setting behaviour, the regime has survived a severe test following the GST increase which pushed headline inflation well above the top of the bank's range for a year.

The economy has also seen big swings in interest rates and the exchange rate.

The question is how much of that can be laid at the door of domestic monetary policy and how much reflects the rollercoaster ride the global economy has been on over that period.

One of the lessons of the past decade is the limits on what the Reserve Bank can do.

Lax policy early in Bollard's first term may have opened the stable door to the housing boom but when it came to reining it in it was very difficult and slow. The banks were able to mop up cheap money offshore and fund fixed-term mortgages with it more or less regardless of ever-higher levels of the official cash rate.

Similarly the record low OCR prevailing since the global financial crisis, which has seen floating mortgage rates fall to their lowest levels since the 1960s, is only now starting to elicit some signs of life in what has been a practically comatose housing market.

The bank, in short, can only moderate the extremes of the cycle; it can't abolish it.

And doing even that requires supportive policy elsewhere in the economic system. In Ruth Richardson's words "monetary policy needs mates".

That is the essential caveat to Key's bald assertion in his speech last Thursday that "stabilisation is the job of the Reserve Bank".

It is important that the Government's fiscal policy does not amplify the cycle and thereby increase the pressure on monetary policy.

And there is increasing support internationally for the idea that the prudential policy run by bank regulators - helpfully, in New Zealand's case, the Reserve Bank - should seek to moderate credit and asset price cycles, for example by increasing banks' capital and liquidity requirements during booms.

There is also some support among market economists for the idea that it is time to move from having the governor solely responsible for making the call on interest rates to vesting that task in a committee.

Committees are the norm internationally and it is usually a mistake to assume that we are smarter than the rest of the world.

A committee mitigates "key man risk" and the continuity it provides mitigates the need for a new governor to clamber up a steep learning curve.

Early in their terms, both Bollard and Don Brash before him had to learn the hard way that it is easy to over-estimate the economy's potential growth rate, and the amount of monetary stimulus it can handle before inflation becomes problematic.

The argument is that moving to a committee would represent a maturing of the monetary policy regime.

A sole decision-maker was appropriate in its early days when credibility had to be established from scratch.

Now that it has been, the argument goes, it is time to vest that credibility explicitly in the institution rather than the man.

The case against a committee is that it could potentially complicate the relationship between the governor and his most senior subordinates if they could not only counsel against something he might want to do, as they can now, but vote against it in a binding way.

The other problem would be to find suitably qualified people from out here in the world to serve on the committee who were not conflicted.

It is also suggested that it could complicate the crucial task of communicating with the markets and the wider community.

All of which tends to elicit the response that if the Australians can do it, we should be able to.

- NZ Herald

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