Capital Markets: Sean Keane: Misguided move on Reserve Bank

Sean Keane, founder and Managing Director of Triple T Consulting.

Opinion

If Labour hopes to boost savings, other channels will be more effective, says Sean Keane.

The Labour Party wants to expand the Reserve Bank's mandate well beyond traditional areas of monetary policy and financial stability, requiring it to focus on the achievement of a "positive national external balance".

The Bank will be encouraged to use existing tools differently. It will be given an additional tool - a variable savings rate (VSR) - which it can use to force savings rates higher instead of hiking interest rates.

Labour promises "lower interest rates, a more competitive dollar and better jobs with higher wages". The language employed in Labour's "Reserve Bank Upgrade" suggests the party has uncovered the long-sought for elixir of economic life, guaranteeing fiscal and economic nirvana for all New Zealanders. Finance spokesman David Parker will surely be in the running for prizes from Nobel and the UN if this elusive prescription for economic wealth and wellbeing proves effective.

Introducing such a policy in New Zealand is not in itself a bad idea, but the outcomes may prove disappointing. Thought needs to be given to how this might impact upon other parts of the financial system, and whether it is appropriate to expand the role we ask our central bankers to undertake. Risking the policy premium and the potential for unintended consequences

Labour's policy will force Reserve Bank Governor Graeme Wheeler to attempt the near-impossible - balancing the primacy of price stability with additional responsibility for creating conditions that lead to external surpluses. Such conditions will inevitably require the bank to pursue policies that encourage a lower New Zealand dollar though a strong currency has at times been an essential policy tool.

Foreign investors have granted New Zealand a hard-earned policy premium in recent years thanks to the Reserve Bank of New Zealand (RBNZ) Act and the Fiscal Responsibility Act. These laws enshrine balanced budgets and inflation control at the heart of our financial system. Tampering with the RBNZ Act will undoubtedly trigger some loss of foreign investor confidence, especially given the implicit downgrading of the bank's inflation commitment.

The lack of domestic savings is a fiscal issue that can be influenced over the longer term by government policies, and most importantly by the structure of the taxation system. If the Labour Party's objective is to boost savings, addressing it through other channels will be more effective than muddying the clear waters in which the bank currently operates.

Compulsory KiwiSaver increases may cause unintended consequences and savings substitution rather than a net increase in aggregate savings. Some KiwiSaver funds will simply be pulled from bank deposits, weakening the liquidity position of the banks, and forcing them to chase more expensive offshore term funding. Worse still might be a scenario in which banks were forced into more competitive bidding for funding to stop leakage into KiwiSaver.

The new policy could amplify economic imbalances rather than alleviating them. Moves to force Kiwi citizens to save more will affect a much larger group than those impacted by OCR increases. Everyone in the workforce will have to increase savings, including those least able to set aside the cash to do so.

The Australian situation tells us there are no easy wins to be had here. There is no guarantee that changing the RBNZ Act will "fix" our external deficit position. Australia's Superannuation savings are vastly larger than NZ's, yet Australia continues to run external deficits and its savings rates have historically not been much better than New Zealand's. The Australian dollar also remains strong even though Australian interest rates are below those in New Zealand.

There is no clear evidence that compulsory savings schemes reduce external deficits. Macroeconomic policy is much more powerful on spending behaviour when it involves real changes in financial costs. Interest rate and tax increases directly reduce real disposable incomes, and alter behaviours via reduced consumption.

Changes in compulsory savings rates don't work the same way. They impact upon available liquidity, but they don't necessarily change behaviours as people don't perceive any real change in their net economic wealth.

In Australia those paying into Superannuation funds have been able to maintain consumption by unlocking credit elsewhere. They have saved for later, but have continued to spend today in the knowledge they have funds to pay back debt in future.

Conclusion: A well-meaning but misguided policy prescription

Labour is to be commended for making a very real attempt to think outside the NZ box and break the interest rate/foreign currency link that has bedevilled policymakers for the past 15 years. Its policy release reaffirms the bank's independence, and retention of the inflation target. This will be welcomed by global markets. The additional policy proposals create a useful framework for debate, but place too much responsibility on the bank for problems that belong elsewhere.

Labour's policies assume the power to rectify NZ's structural economic imbalances rests with the Reserve Bank. Though it's a commonly held view that central banks have the power to move mountains, they don't. Their ability to influence and change economic structures and long-term policy is severely limited. External imbalances cannot be rectified by changes in monetary policy. Rebalancing requires changes to long-term economic policy settings.

If the Labour Party's objective is to boost savings and reduce external imbalances, then its very reasonable proposals for reform of capital gains taxes in the property sector are likely to be far more significant in achieving those goals.

• Sean Keane is the founder and Managing Director of Triple T Consulting.