Former Economics Editor of the NZ Herald

Brian Fallow: Printing cash is for the desperate


The biggest risk with monetising the debt is inflation.

So has the remedy for a high dollar been under our noses all the time, as the Greens suggest, in the ability of the Reserve Bank to print money to buy Government debt?

Alas, no.

The Greens' proposal seems so simple. Rather than issue billions of dollars of bonds to the market to cover the cost of rebuilding Christchurch and accelerate the replenishing of the Earthquake Commission's natural disaster fund - a majority of which on past performance will be bought by foreign investors, creating additional demand for New Zealand dollars - the Government can get its friendly central bank to buy them.

The Crown would end up paying interest to itself. How elegant.

If it was as easy as that and the ramifications ended there, every country would be doing it all the time, rather than the handful for whom it is a desperate last resort.

What the Greens are proposing is not really quantitative easing. The object of the exercise is not to ease monetary conditions.

Indeed they claim as a merit of their proposal that it is designed to minimise the impact on domestic demand. It is a moot point whether New Zealand needs easier monetary conditions at this stage.

The Reserve Bank thinks not. The markets think maybe, but just a little.

What the Greens are proposing is monetising the debt - not a term of approbation in the markets - or more simply, printing money.

It is a technique which can be used for easing purposes but in this case the objective is the narrower one of attempting to influence the exchange rate.

It has been used by countries - Japan since the 1990s, the United States and Britain since the global financial crisis - which have run out of more conventional means of stimulating their economies.

When central banks have already cut their policy rates to zero, further monetary stimulus has to take unconventional forms like buying government stock or mortgage-backed securities to bring down longer-term interest rates.

Similarly, when governments have run up their debt to scarily high levels, they get wary of further fiscal stimulus.

But in New Zealand these conditions, fortunately, do not apply. Neither fiscal policy nor conventional monetary policy is maxed out.

To start monetising the debt - buying government securities with credit the Reserve Bank has created out of thin air - would, as former governor Alan Bollard has explained, leave the financial market wondering what the hell we were doing.

And that is a risky strategy when we are up to our nostrils in debt to the rest of the world already and have to finance a current account deficit of $10 billion a year and rising.

It would almost certainly increase the risk premium built into New Zealand interest rates, economists warn.

The risk premium is the spread between the benchmark swap rate, which represents the market's view of where the official cash rate will be over the next, say, two years, and what banks actually have to pay for funding over that maturity.

The spread has widened dramatically since the global financial crisis.

It reflects the perceived riskiness of lending to a country which is small, has a relatively narrow economic base and which is already a net debtor to the rest of the world to the tune of $142 billion.

One of the things New Zealand has going for it when it comes to attracting the imported savings we need - let's face it, we are lousy savers ourselves - is the quality of our institutions including the independence and, yes, the orthodoxy of the central bank.

Messing with that is liable to widen the risk premium and systematically raise interest rates, all else being equal.

But the biggest risk with monetising the debt is inflation.

The dollars the Reserve Bank would conjure up under the Greens' plan are the genuine article, the same currency our wages and salaries are paid in and over $100 billion of household bank deposits are denominated in. Creating billions more, all else being equal, will dilute the value of those which already exist.

And if it succeeded in lowering the exchange rate that would push up the cost of imports and other tradeables which make up about half of the consumer price index, again, all else being equal.

The Greens and Labour seem to be saying that we would have been better off in recent years with a lower interest rate and a lower exchange rate.

Their common policy, supported also by New Zealand First, of changing the Reserve Bank's statutory mandate is predicated on the debatable assumption that doing so would mean lower interest rates, which would in turn deliver a lower exchange rate. Lower interest rates and a weaker dollar constitute looser monetary conditions.

But inflation has averaged 2.6 per cent over the past 10 years. So the question is how much higher should it have been, in their view? Is 3.6 per cent okay? Or 4.6 per cent? Or 5.6 per cent?

Greens co-leader Russel Norman has two lines of defence against the charge that his policy would be inflationary. He cites academic research which found that in the US "although typical quantity theory of money predicts a relation between quantitative easing and high inflation, empirical data reveals that there is no direct relationship between the two".

But Infometrics economist Matt Nolan argues that QE was undertaken overseas to counter the fact that policy was too tight and they were trying to fight deflation.

"In essence the fact that inflation stayed near the target band in these countries is evidence that QE is indeed inflationary as you would expect, just in the way they were intending."

In other words, if you are in danger of being sucked out to sea in a deflationary rip, inflationary QE is just what you need.

But that is not New Zealand's situation.

Norman says that "we haven't had a major inflation problem in New Zealand for two decades". If, however, even lower mortgage rates were to reignite a housing boom and threaten a repeat of the inflation pressures of the middle years of the last decade, the Reserve Bank should use macro-prudential tools like raising the amount of capital banks need to carry or regulating loan-to-value ratios.

Combined with a capital gains tax to discourage investors from bidding up the prices of rental properties, that should do the trick without the need, or without as much need, to raise interest rates, he says.

Well, maybe.

Given that the mid-2000s housing boom has not been followed by a bust, leaving affordability metrics at horrible levels, and given the gruesome evidence overseas of what happens when a bubble bursts, it is a big risk to run.

But the bigger risk, Norman says, is to carry on as we are. "What we are trying to do is save jobs."

- 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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