After yesterday's rate cut Reserve Bank Governor Graeme Wheeler talked to Liam Dann about the issues behind the decision.
Rate cuts are supposed to bring the currency down, this didn't. What's happened?
Since the June statement we've seen the Bank of Japan ease, Bank of England ease, we've seen the Reserve Bank of Australia ease. If you combine that with quantitative easing that is larger than at any other time - and it was pretty large in 2009 - and with negative interest rates in countries that account for a quarter of world output, you're just in a phenomenal situation.
Isn't it worrying that as rates head towards zero the power of central banks to move markets is waning?
Absolutely. There's no question about that. I think that there are a lot of issues around negative interest rates. It signals that, by and large, central banks have pretty well run out of options.
We've cut six times since June . We've reduced the OCR by 150 basis points and the TWI [trade weighted index of currencies] is 1.5 to 2 per cent higher than when we started cutting last year.
So is it worth cutting at all?
There will be some who say: Look, you've got the economy running strong - maybe getting towards 3.5 per cent growth - why are you cutting interest rates? You can make a sound argument. But if you don't reduce rates you run the risk that the exchange rate will appreciate even more, given that your interest rate differential will get even wider. Secondly, you've got negative tradeables inflation, which we've had for four years. And the longer it continues the more drag it has on actual inflation outcomes. The risk is that inflation expectations start falling. Once you find inflation expectations unhinged and unstable - and we're not in that situation, far from it hopefully - but once it happens it's very difficult to get those expectations up again.
Watch: Economy Hub - Rate cut analysis: What went wrong?
Do you just have to accept the limits of your control over the currency?
Yeah that's some of the frustration, we would like to see it lower. That would help us in terms of dairy, manufacturing ... it would also help us in terms of our inflation objectives and reduce the risk of a potential fall in inflation expectations.
What about the argument that we are fighting the wrong battle?
Should we revise the inflation target or give up on it?Hypothetically, let's say the target was 0-3 per cent and there was no mid-point. The market might decide: Well, you are within the band so you don't need to do any cutting - and the exchange rate will go higher. There aren't easy solutions here. No one's adopted nominal income targeting or anything like that. There's about 30 central banks and most of them have inflation targeting at around 2 per cent. No country, that I'm aware of, has moved away from inflation targeting because there isn't a better framework.
Are low inflation and low rates just the new normal now?
There are structural features to it. It's linked in some economies to demography. So in Japan, with a falling labour force and ageing population. There's factors linked to technology costs. We've got a global oversupply of manufactured goods. There's a number of features other than cyclical factors. But if the global economy starts to grow above trend rates, then we will start seeing inflation pressures pick up. You've got countries that account for two-thirds of world output with interest rates below half a per cent. You've got US$12 trillion [$16.5t] of government securities with negative yields. That's not sustainable. I don't believe we are going to see that for decades to come. I don't believe we are in that kind of world.
Has the Reserve Bank shifted focus from house prices, for now?
We've always said we can't fix the housing problem. We can reduce the financial stability risk. That's what we've tried to do with LVRs [loan to value ratios]. I saw the latest REINZ [Real Estate Institute] figures and they seemed to show the Auckland rate of inflation slowing. It's too early to say of course, but at least it was somewhat encouraging. Having said that, we see very high house price inflation in Hamilton, Tauranga, Otago, even Wellington. That's worrying. We're likely to report to the Minister in the next couple of weeks, seeking his approval to get debt-to-income ratios as a macro-prudential instrument. I think that's a likely outcome. It's unlikely that we'd be introducing anything by the end of the year but we're doing a lot of work on the costs and benefits associated with debt-to-income ratios.