Reserve Bank faces mandate change after election

Labour finance spokesman David Parker, left, and Reserve Bank Governor Graeme Wheeler, right. Photo / Greg Bowker, Mark Mitchell
Labour finance spokesman David Parker, left, and Reserve Bank Governor Graeme Wheeler, right. Photo / Greg Bowker, Mark Mitchell

The Reserve Bank of New Zealand is facing the biggest challenge to its mandate since it pioneered inflation targeting 25 years ago.

With polls showing national elections on September 20 will be close, the main opposition Labour Party wants the central bank to target the current-account deficit in addition to inflation, and use pension contributions as a new policy tool.

"Our currency is overvalued and we've got structurally higher interest rates than the rest of the world," Labour finance spokesman David Parker said in an interview yesterday. "It's time to remind ourselves that the control of inflation is in support of a stronger economy and higher growth rates, it's not an end in itself."

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The Reserve Bank was first among developed peers to raise interest rates this year, sending the kiwi dollar to near-record levels and spurring criticism from the opposition that the policy is driving manufacturers out of business.

In an effort to lower rates and weaken the currency, Labour is pledging to broaden the RBNZ's policy goal by re-writing its main objective in the Reserve Bank of New Zealand Act of 1989.

The RBNZ left its benchmark rate at 3.5 per cent this morning. That's higher than the biggest developed economies. Governor Graeme Wheeler, who's raised the rate four times this year, probably will resume tightening in the first quarter of 2015.

Pioneer role

After the 1989 Act made price stability the RBNZ's main focus, it adopted an explicit inflation target in 1990, pioneering a model that is widely used today. Inflation slowed to an average of 2.2 per cent in the 20 years through 2010 from 12 per cent in the preceding two decades, according to data compiled by Bloomberg.

"New Zealand is held up as one of the shining lights of central banking," said Shamubeel Eaqub, principal economist at the New Zealand Institute of Economic Research in Auckland. Labour's changes "would be quite a big departure from where we have been, but also a departure from what others are trying to do, which is move towards our model," he said.

Under Labour's proposal, the bank would remain independent and retain its inflation target range of 1 per cent to 3 per cent. Additionally, the RBNZ would be required to maintain stable prices "in a manner which best assists in achieving a positive external balance."

Savings gap

New Zealand has run a current-account deficit for 40 years, a gap it needs to plug with offshore borrowing as domestic savings are too low.

To help redress the imbalance, Labour would make the country's work-based pension savings plan compulsory and gradually raise the contribution rate to 4.5 per cent of income from 3 per cent. That transition period would take six years and exert downward pressure on interest rates by constraining consumption, Parker said.

The next stage would be to allow the RBNZ to change the contributions via a new tool called the Variable Savings Rate, which could be used instead of interest rates to curb or stimulate household spending.

"I have never heard or read about such a thing being used elsewhere," Professor Allan Meltzer, author of a history of the US Federal Reserve, said in an emailed response to questions. "It strikes me as the worst kind of fine tuning."

'Magical thinking'

"It's driven by a bit of magical thinking that there's a different central bank setting that can somehow fix all the problems in your economy," Finance Minister Bill English said in an interview last week. "The benefit of the current arrangement is people know what it is, they know how it works, they know who decides, and they know what the impact of the decisions are on them."

The RBNZ was "unable to find any examples" of a similar policy to Labour's being employed elsewhere in the world, according to an internal email released to Bloomberg under the Official Information Act. It would be inappropriate for the bank to comment on political proposals, spokesman Angus Barclay said.

Prime Minister John Key's National Party, seeking a third term in office, had 50 per cent support in a Colmar Brunton poll published on September 5. Labour polled 26 per cent and its coalition partner the Green Party had 11 per cent.

'Economic ignorance'

No party has won an outright majority since the introduction of proportional representation in 1996, making the role of minor parties such as New Zealand First, which had 7 per cent support, pivotal in forming coalition governments. The Greens and NZ First both favour widening the RBNZ's mandate.

"Broadening to include growth or the unemployment rate might be welcomed because that would be growth friendly," said Annette Beacher, the Singapore-based head of Asia-Pacific research at TD Securities. "Trying to target the current account just shows breathtaking economic ignorance. It's not going to work."

Giving the central bank the ability to force people to save risks blurring the line between monetary and fiscal policy, which could raise issues around the bank's credibility, said Cameron Bagrie, chief economist at ANZ Bank New Zealand in Wellington.

While some Labour policies are workable, such as a capital gains tax to encourage investment in productive areas of the economy, "some of it I scratch my head at," he said.

- Bloomberg

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