KEY POINTS:
A few days ago, I found myself at a dinner party sitting beside a man who exports fish. He was very unhappy about the effect which New Zealand's currently high exchange rate was having on his business, and wanted answers to two questions.
First, why are New Zealand interest rates so much higher than those in other developed countries? And second, why doesn't the Reserve Bank simply reduce the interest rate which it controls, for the benefit of exporters?
Because I suspect that many New Zealanders are asking these questions, I felt I would share the answers I gave my friend.
HIGH NEW ZEALAND INTEREST RATES
First, New Zealand interest rates are higher than those in other developed countries for a couple of reasons. Short-term interest rates - the ones most directly affected when the Reserve Bank changes its Official Cash Rate - are relatively high because inflationary pressures are stronger in New Zealand than in other developed countries at the moment.
Consumers have been spending strongly and employers in almost every industry are having great difficulty finding staff, even unskilled staff. Price increases are edging up across the economy.
If the Reserve Bank is to keep these inflationary pressures under control, the official interest rate which the Bank controls simply has to be high by international standards to encourage saving and discourage spending.
LONGER TERM INTEREST RATES
Longer-term interest rates are relatively high essentially because we New Zealanders are world champions when it comes to borrowing. As a result, the banks which satisfy our craving for borrowing have to fund a big chunk of their lending by themselves borrowing from foreign savers.
And to persuade those foreign savers to lend to New Zealand banks in New Zealand dollars, foreign savers have to be given an interest rate which compensates them for the risk of investing in Kiwi dollars. Given our small and highly-indebted economy, and the widespread perception that the New Zealand dollar is much more likely to fall than to appreciate over the next 12 to 18 months, it is not surprising that foreign savers demand an interest rate on New Zealand dollars which is a good deal higher than the interest rate which they can get at home.
EXPORTERS AND HIGH INTEREST RATES
But surely, my friend objected, these high interest rates are damaging exporters?
It is certainly true that most exporters are hurting and many are hurting very badly. Almost the only exceptions to this generalisation are dairy farmers, who have been shielded from the worst effects of the high exchange rate by the very high international prices for dairy products.
But if the Reserve Bank were to cut its official interest rate in an attempt to help exporters in a situation where inflationary pressures remain strong, inflationary pressures would simply intensify: consumers would borrow and spend more, there might be a further escalation in the price of housing, staff would be even harder to find, wages would increase more sharply, and, because the exchange rate would fall somewhat, the price of everything which we import (and export) would increase. It would not be long before exporters were arguing for an even lower exchange rate.
Right now, most exporters would find an exchange rate where one NZ dollar bought US65c pretty attractive. After a strong burst of inflation, they would be looking for a US60c NZ dollar, or a US55c NZ dollar.
AN ADDITIONAL LEVY ON MORTGAGES?
I have no doubt that the Governor of the Reserve Bank is acutely aware of the pain which many exporters are enduring at the hands of the strong exchange rate. Indeed, the Reserve Bank has devoted considerable effort to finding solutions to this problem. So far, at least, all the solutions which have been dreamed up have been rejected as impractical or politically unacceptable for one reason or another.
One of these was the suggestion that the Reserve Bank be given the authority to impose an additional levy on mortgages without increasing other interest rates. This idea went down like a lead balloon with the public, at least in part because it the suggestion was very poorly explained.
POWER TO ADJUST THE RATE OF GST?
What is needed is a way for the Reserve Bank to reduce the general level of spending in the economy without raising interest rates, with all the negative effects that higher interest rates have on exporters through the effect of those higher rates on the exchange rate.
About 10 years ago, when I was still Governor of the Bank, a visiting American academic by the name of Larry Ball suggested that one way of achieving this would be to give the Governor authority to vary the rate of GST in the economy. I could see the logic of Professor Ball's argument, but I was not keen to argue that GST should be varied in that way - increasing when there was a need to slow spending in the economy to counter inflationary pressures and reducing when there was a need to stimulate spending.
One of the huge benefits of the way in which GST has been designed in New Zealand is that it is levied on virtually everything at the same rate, and the rate changes very infrequently. This keeps the compliance costs of collecting the tax to an absolute minimum.
But while I didn't favour Professor Ball's variable GST suggestion, I certainly understood what he was trying to achieve.
VARYING THE TAX ON PETROL
I think the time has come to give very serious consideration to a variation of Professor Ball's idea, namely to give the Governor authority to vary the excise tax on petrol.
The systems are in place to enable the excise tax on petrol to be varied without too much drama. The public are accustomed to the price of petrol fluctuating from week to week; and the public's demand for petrol, at least in the short-term, is relatively impervious to changes in the price of petrol.
The consequence of that is that any significant increase in the excise tax on petrol would compel people to reduce their spending on other goods and services. And any significant decrease in the excise tax on petrol would enable people to increase their spending on other goods and services. Varying the excise tax on petrol would have a similar effect, in other words, to varying the interest rate.
Of course, there would need to be safeguards put in place: Perhaps the Governor would need to be obliged to ensure that, over a period of, say, five years, the additional revenue collected from an increase in the excise tax was broadly offset by a reduction in revenue from a decrease in the excise tax.
And the revenue gained from the increase in excise tax would need to be kept quite separate from the other revenue-raising activities of the Government - effectively held in the Reserve Bank.
It may be that others can come up with an even better idea. But I certainly understand the frustration being felt by most New Zealand exporters.
If we really want to see strong growth in export earnings, it is essential that we find a way to moderate the big three-to-five-year swings in the New Zealand dollar which make planning an investment in the export sector such a nightmare. Giving the Governor the right to vary the excise tax on petrol could well be an effective way of doing this.
* Don Brash was Governor of the Reserve Bank of New Zealand, 1988 to 2002.
