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Fran O'Sullivan: Flaws in Labour's inflation plan

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Forcing up mortgage rates is tried and tested but raising KiwiSaver contributions would be politically tough.

David Parker has managed to reignite debate about inflation. Photo / Sarah Ivey
David Parker has managed to reignite debate about inflation. Photo / Sarah Ivey

When the Reserve Bank Governor wanders up to the Minister of Finance and says "Hey, 'Mr Government' how about raising KiwiSaver rates as I need to bring inflation down?'," does anyone seriously expect any politician will reply, "Yep, I'm happy to force New Zealanders to double-up their KiwiSaver contributions instead of you, 'Mr Independent Central Banker', hiking interest rates?"

I don't think so.

If Labour finance spokesman David Parker is proposing a job swap with the Reserve Bank Governor he should say so.

Full marks to Parker however making the achievement of a current account surplus his prime economic goal and doing some out-of-the box thinking on monetary policy.

It is high time New Zealand paid its way in the world - something we haven't done for 40 years. It is also 25 years since a previous Labour government gave the Reserve Bank the independence to focus on fighting inflation - so why not take another look at the tool kit the central bank uses?

There is considerable sophistication behind Parker's "Upgrade to Monetary Policy" which is designed to improve macroeconomic stability.

But it's also important that Parker starts presenting the "variable savings rate" as another tool in the Reserve Bank's inflation fighting kit - not an either/or to raising interest rates.

Because the maths don't really compute when it comes to portraying "new tool" as a potential substitute for the Official Cash Rate in the electorally appealing but rather simplistic way it was been presented.

Right now the central bank increases the OCR when it wants to push inflation down. Banks raise interest rates on mortgages; mortgage payers have less to spend; this flows to the broader economy; inflation pressures are dampened.

It's a blunt instrument.

Parker's thesis is that the additional interest that mortgage payers ultimately have to stump up after the Reserve Bank raises the OCR might help combat inflation but much of it is lost to the economy as it vanishes overseas to foreign lenders. That's why he wants the Reserve Bank and the Treasury to investigate a "new tool" - a "variable savings rate" - which will not only compel participants in a compulsory KiwiSaver scheme to increase their savings rate to reduce consumption pressures but be tucked away for them to use at a future date.

As Parker put it at the policy launch yesterday morning: "Instead of paying more interest on your mortgage, under the new rules a similar amount of extra savings would go into your KiwiSaver."

Labour also contends that making changes in savings rates as an alternative to changes in the cash rate would mitigate the currency effects of higher or lower interest rates and reduce overseas transfers on the proportion of higher interest rates which currently go to overseas lenders.

At a philosophical level the proposed policy is appealing. Particularly to those inhabitants of the mortgage belt where residential house owners are already having to adjust their income expectations as the Reserve Bank continues to raise the OCR.

Latest Reserve Bank figures show that in February 2014 there were 1.4 million residential mortgages; 780,000 of these were floating mortgages. A further 667,500 mortgages were at fixed rates (a big increase since February 2012) indicating many in the mortgage belt have already responded to Reserve Bank Governor Graeme Wheeler's signal he intends to reduce aggregate demand in the economy by fixing rates.

But the more interesting comparison is the size of the lever that Wheeler can pull. At February 2014, the residential mortgage pool was $191.8 billion. $75 billion was at floating rates with a further $64.9 billion on one-year rates.

This means it doesn't take too many rate hikes to suck a few billion dollars out of homeowners' pockets and reduce demand.

Increasing KiwiSaver contribution rates is not going to have the same blunt - and well-understood - effect.

At June 30, 2013 2.15 million people were enrolled in KiwiSaver - 53 per cent of the eligible population. Labour's plan to make KiwiSaver compulsory will increase overall saving and is well overdue.

But it's not a "net net" by any means.

That's because KiwiSaver contributors are at this stage putting only about $1.5 billion into the scheme each year (2013 figures).

Hiking KiwiSaver rates to the level needed to match the effect on demand of movements in the OCR is likely to prove politically difficult.

That's why Labour should not compromise the Reserve Bank's statutory independence by asking it to make recommendations to the Government to increase KiwiSaver rates.

If this "new tool" is really to be part of the central bank's inflation-fighting arsenal Labour should leave it to the governor to decide when to deploy it.

What Parker has done is stimulate debate. That's no bad thing after 25 years.

- NZ Herald

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