Former Economics Editor of the NZ Herald

Brian Fallow: Labour's monetary remedy no panacea

Labour wants the monetary policy objectives of the Reserve Bank - led by Governor Alan Bollard - to be broadened from the present sole focus on price stability. Photo / Mark Mitchell
Labour wants the monetary policy objectives of the Reserve Bank - led by Governor Alan Bollard - to be broadened from the present sole focus on price stability. Photo / Mark Mitchell

Labour says it wants to change the monetary policy framework to make it more supportive of exporters.

It blames the present regime for a volatile exchange rate and interest rates which are persistently high by international standards.

This punishes, it says, our most productive businesses and first home-buyers, "the two sectors we least want to affect".

So has Labour accurately diagnosed the problem? And would its proposed remedies work?

We cannot get everything we want - stable prices, an exporter-friendly exchange rate and unfettered access to foreigners' savings. We have to sacrifice one of those.

We fall way, way short of being able and willing to fund our investment needs from our own savings, so the essential question Labour is posing is whether the internal value of the dollar should be all-important and the external value left to whip around.

It wants the statutory objectives of the Reserve Bank, when it comes to monetary policy, to be broadened from the present sole focus on price stability.

"We agree with the approach taken by Australia that recognises that along with inflation, employment, economic prosperity and the health of the export sector are at least as important."

But, its elderly legislation notwithstanding, the Reserve Bank of Australia has for years behaved as a conventional inflation-targeting central bank.

And the "not just motherhood but apple pie" mandate it has been given has not prevented the aussie dollar from going through the roof and inflicting serious damage on exporters outside the mining sector.

Likewise the US Federal Reserve has a dual mandate, to target inflation and employment. It has cut its policy rate to zero and had two rounds of quantitative easing as well, but the unemployment rate is still 9 per cent.

This should tell us something about the limits of what monetary policy can do for us. The argument against multiple objectives is this: if the objectives do not conflict - which is the normal situation - then those other than inflation are redundant.

If they do conflict, one has to over-ride the others.

Labour insists that "the importance of controlling inflation is a lesson of history well understood".

It is committed to retaining the present 1 to 3 per cent inflation target and the Reserve Bank's operational independence.

So what, really, would change?

Labour says it would change the policy targets agreement - the Government's contract with the Governor of the Reserve Bank - to include a requirement to explicitly consider the effects of monetary policy on exports.

"In practice we believe that, faced with rapid credit expansion, this change would allow the bank to use prudential ratios rather than rely solely on interest rates."

This is a reference to international moves to enable banking regulators to do things like raising and lowering the capital buffers banks are required to have with the aim of moderating or countering cyclical risks.

The Reserve Bank has said it is considering the possibility of additional capital requirements that would increase when asset markets and credit are expanding rapidly and decrease when they are slowing.

"However, it is too soon to say whether time-varying capital requirements will have merit in the New Zealand situation," Deputy Governor Grant Spencer said.

On another such measure, the core funding ratio, the bank has already acted. Since April last year, banks have been required to fund a high minimum proportion of their lending from "stable" or "core" funding sources, namely retail deposits or longer-term (more than one-year) wholesale funding.

This was introduced mainly for financial stability reasons, to reduce the amount of a bank's funding that needs to be rolled over during times of stress. But the Reserve Bank believes it will also take some of the burden off the official cash rate.

"The [core funding ratio] requirement will tend to hold retail lending rates up relative to policy rates, thus mitigating 'carry trade' pressures on the exchange rate during boom periods," Spencer said.

Labour wants the bank to intervene in the foreign exchange market more often and more aggressively.

It is a tool it has rarely employed, reflecting a conviction that the best it can hope for is to moderate the exchange rate cycle a little - shaving a bit off the peaks and troughs.

One of the conditions the bank has set is that it has to be pretty confident intervention would be effective, because the exchange rate is close to a turning point anyway.

Clearly, if the kiwi is climbing because the world is minded to sell US dollars, it would not be wise for the Reserve Bank of New Zealand to pipe up and say, "we'll buy them. How many have you got?"

King Canute meets tsunami.

Labour acknowledges more aggressive interventions would carry "some extra risk" for the Crown, but insists it would be modest.

"By increasing the risk for speculators that the bank will catch them out, volatility will be reduced."

Fostering the view that you had better steer clear of the kiwi, because who knows what its central bank will do, sounds like a policy that would have some pretty negative unintended consequences.

In any case, a massive sudden expansion of the Reserve Bank's balance sheet involves not only risk but cost. The billions of extra New Zealand dollars the bank would create out of thin air to buy foreign currency are real New Zealand dollars. If allowed into the domestic monetary supply they would be inflationary, so the intervention would have to be "sterilised" by the bank borrowing the dollars back.

The cost is the difference between relatively high New Zealand interest rates it would have to pay, and the relatively low rates it would earn on its foreign reserves.

So the question becomes, should the taxpayer face a higher interest bill in order to make life easier for exporters?

In the end it comes down to supply and demand. The Reserve Bank can only influence the demand side of the economy - and that with difficulty and a considerable lag. It can't do anything about the supply side.

But Governments can.

Rather than insisting that it take employment into account when making interest rate decisions - as though it didn't already - it would be more helpful for politicians to focus on policies that would, for instance, create a better match between the skills employers need and those job seekers have to offer.

To be fair, Labour recognises the "monetary policy needs mates" argument. It can point to policies to encourage the hiring of apprentices, capital gains tax on investment properties, compulsory KiwiSaver to build a bigger savings pool and an extra two years in the workforce as measures intended to boost the potential growth rate.

Those are the sorts of places to look for relief from higher interest rates, not the monetary policy regime.

- NZ Herald

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Former Economics Editor of the NZ Herald

Brian Fallow is a former economics editor for the New Zealand Herald. 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

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