Inside Economics: One shot or two? Why the RBNZ’s interest rate call is so tricky

Welcome to Inside Economics. Every week, I take a deeper dive into some of the more left-field economic news you may have missed. To sign up for my weekly newsletter, click here. If you have a burning question about the quirks or intricacies of economics send it to liam.dann@nzherald.co.nz or leave a message in the comments section.

Will the RBNZ deliver a single or double shot of rate relief?

Today’s Monetary Policy Review looks set to be one of the toughest the Reserve Bank has made in some time.

Economists are split, market pricing is split, and there is a good chance the Monetary Policy Committee will be too.

That’s because at its core, this decision requires a judgment call about how sticky this year’s inflationary pressures will be.

Food and power prices have been elevated, pushing the top-line inflation up to 2.7% and threatening to lift it above the RBNZ’s upper threshold of 3%.

Given that the RBNZ now has a single mandate to focus on inflation, it’s not surprising it has been wary of slashing and burning rates to stimulator levels.

But all the evidence from the past six months suggests the economy has stalled.

If we want to jump-start it, then – in the absence of incoming fiscal stimulus – monetary policy is the tool we’re left with.

Shadow Board says hold the line....just

On Monday, the NZ Institute of Economic Research released its Shadow Board recommendation. It landed on a cut of just 25 basis points but was very much a split decision.

The Shadow Board includes Business NZ’s John Pask, BNZ’s Doug Steel, KiwiBank’s Jarrod Kerr, Westpac’s Kelly Eckhold, as well as academic economists like Otago University’s Dennis Weessel and Victoria University’s Arthur Grimes and Viv Hall.

It also includes non-economists like Sharesies founder Brooke Roberts and Kerry Gupwell, chief executive of environmental consultants Boffa Miskell.

“Several members considered that the much weaker-than-expected June quarter GDP warrants a 50 basis-point cut now to provide the stimulus required for recovery,” the NZIER said.

“One member suggested that the central bank should keep the OCR on hold, given the recent spike in inflation and that the impact of the OCR cuts to date is still working through the economy.”

Grim business confidence adds to the case for a deeper cut

Also well-timed from the NZIER this week was the Quarterly Survey of Business Opinion – or QSBO (Quizzbo).

It has been billed by economists as the last piece of the puzzle for the Reserve Bank before the big call.

Whether it actually solves the puzzle, who knows? But it is the last piece regardless.

The QSBO has shown a drop in business confidence in the September quarter.

A net 15% of firms expect an improvement in general economic conditions over the coming months on a seasonally adjusted basis.

While the sentiment was positive, this was a decline from the net 26% expecting an improvement in the June quarter.

It was pretty grim all around.

On that basis, if the 25 v 50 basis points really is a line ball call, then this might have pushed things across the line to a deeper cut.

ANZ’s recent Business Outlook survey indicated a big drop in confidence from those who responded after the ugly second-quarter GDP release on September 18.

But NZIER advised that 96% of responses came in before the GDP data.

So, if anything, the outlook has probably deteriorated since this snapshot was taken.

While the NZIER itself has retained the 25 basis point call, others felt this might swing it.

The survey suggested that economic momentum remained “lacklustre” although a little stronger than the second quarter, ANZ senior economist Miles Workman said.

“The RBNZ will have to make a call regarding what that means for the inflation outlook: the starting point capacity indicators, costs and pricing signals are not inconsistent with the RBNZ’s assessment, but underlying economic momentum is looking weaker,” he said.

“Is that a weaker supply story or a disinflationary net demand story? To our eye, it’s a bit of both.”

The QSBO data increased the odds the RBNZ will deliver a 50 basis point, he said.

“Although all up, we still think strategy favours a dovish 25bp cut tomorrow, but today’s data move it towards the coin flip realm. A 50bp cut would not be difficult to justify.”

“This survey will support the RBNZ’s view that the economy’s recovery remains sluggish,” Westpac senior economist Michael Gordon said.

“[It would] likely further encourage those on the committee who believed in August that a larger “circuit breaker” rate cut was appropriate.

Westpac has forecast a 50 basis point cut.

Kiwibank has been pushing for more monetary policy stimulus for about a year – so the team there was unequivocal about the need for 50 basis points.

“Business confidence is waning because the expected recovery in demand has disappointed,” they said.

“For almost two years now, firms have reported a decline in activity. Now, a smaller share of firms are feeling upbeat about the outlook.”

Not even the RBNZ’s dovish pivot in August had managed to boost sentiment, they noted.

“The disappointment in the here and now, plus the loss of optimism about future conditions, has sent investment intentions sharply back into decline.”

“There’s a clear need for stimulatory interest rate settings.”

Single target blues

As mentioned above, the Reserve Bank is now required by law to maintain a single focus on inflation targeting.

In my Sunday column, I suggested the decision by National, Act and NZ First to bring back the single mandate in 2023 has turned out to be an own goal.

Politically, it would be helpful for the Coalition if the RBNZ could put a bit more weight on employment conditions and cut rates faster to stimulate the economy.

They’d be more likely to see the economy boom again before the next election.

Prime Minister Christopher Luxon referred to the column in his weekly chat with Mike Hosking, suggesting I’d argued that the removal of the dual mandate was a mistake.

The PM disagreed.

To his credit, he stuck with his belief that a single mandate is better for the country.

Regardless of what I think, our political leaders should have principles that run deeper than their pragmatic needs in an electoral cycle.

So, good.

But I think it’s also important to say that I’m agnostic about the mandate.

I don’t know if the return to a single mandate was a mistake for the country overall.

My argument was meant to be that it was a political mistake for the coalition, which is now under pressure for failing to deliver an economic recovery.

(I’ll take the blame for not being clearer about that).

The single mandate was a core feature of the groundbreaking Reserve Bank Act in 1989 (which made New Zealand the world’s first central bank to adopt formal inflation targeting).

Labour, with coalition partners NZ First and the Greens, introduced the broader dual mandate – targeting inflation and unemployment – in 2018.

That wasn’t completely weird. The US Federal Reserve and the Reserve Bank of Australia have dual mandates.

But serious monetarists believe strongly in a single inflation target.

The idea is that price stability is crucial to a healthy economy, and (via the money supply) it is the one thing over which a central bank has direct control.

Therefore, it is the one thing it should target.

There’s something to that argument. But it does mean the central bank’s hands can be tied when the people are suffering through a stagflation-style downturn – where low demand is causing job losses but high costs are keeping inflation elevated.

Unfortunately for advocates of the dual mandate, New Zealand’s experiment with it (from 2018-2023) was somewhat distorted by Covid, the ensuing economic stimulus and the inflationary aftermath.

Did the dual mandate exacerbate inflation? We’ll never really know. The Federal Reserve seemed to get through better than we did, regardless of the dual mandate.

If we’d had the dual mandate through the deflationary era of the 2010s, it might not have mattered much at all.

In my view, a good central bank will always take a broad view of the economy before narrowing its vision to ensure it achieves its mandate.

Unemployment and other areas of economic suffering can’t just be ignored.

But yes, it is true that without the bedrock of price stability, things usually just get worse.

Economists send ‘we told you so’ letter to the Government

Last year, a group of 20 economists led by Dr Ganesh Nana and Professor Susan St John wrote an open letter to the Government calling for an immediate end to public spending cuts.

“Failure to correct this course will lead to higher economic scarring, with the costs borne by those with the least ability to pay, as has been demonstrated repeatedly in New Zealand’s history,” the group wrote.

“It will also undermine the resilience of the private sector – particularly exporters – and will continue to constrain the capability of firms to scale up.

“A focus on government debt ignores impacts on private sector debt and external debt.”

Former Productivity Commission chair Ganesh Nana. Photo / Mark Mitchell

The group, consisting of very senior but mainly left-leaning (or at least, Keynesian-minded) economists, was somewhat predictably ignored by the Government.

Well, a year on, they’ve written another open letter to say: we told you so.

They didn’t quite say that in so many words, but almost.

“[The Coalition’s economic policies ] have failed to mitigate the recession, and as we signalled in our letter last year, likely exacerbated it,” they wrote.

“We believe our earlier concerns are now clearly visible and evidenced.”

“The economist Lord Keynes is credited with saying, “When the facts change, I change my mind. What do you do?”. The economic facts have changed since last year. We hope that means you are open to changing your mind, too."

I don’t like the group’s chances of making much headway with this Government, but I admire their persistence.

There is certainly a strong case to be made that making public spending cuts (or reducing the fiscal impulse...for those who point out nominal spending hasn’t actually fallen) is problematic when you are headed into a downturn.

“Your policy approach is not based on sound economics – it is an approach rooted in a political cycle, not an economic cycle," the economists conclude.

I don’t know about the economics - I’m pretty sure the old left/right debate will never be settled.

But if the Government’s approach is primarily rooted in the political cycle, then I’m not sure that’s going too well either.

Liam Dann is business editor-at-large for the New Zealand Herald. He is a senior writer and columnist, and also presents and produces videos and podcasts. He joined the Herald in 2003. To sign up to my weekly newsletter, click on your user profile at nzherald.co.nz and select “My newsletters”. For a step-by-step guide, click here. If you have a burning question about the quirks or intricacies of economics send it to liam.dann@nzherald.co.nz or leave a message in the comments section.