KEY POINTS:
Don Brash deserves much credit for his latest sally into the public eye. His proposal to give the Reserve Bank the power to vary petrol prices to take the heat out of the economy without raising interest rates contains at least one obvious fish-hook, and he will doubtless
be widely criticised. But that does not detract from a worthwhile piece of lateral thinking that should become part of Parliament's finance and expenditure select committee examination of the effectiveness of current monetary policy.
Dr Brash, in his way, and the committee, along more orthodox lines, are seeking to answer a vexing question: how can the economy be slowed to curb inflation except by raising interest rates? This is a destructive mechanism because it drives up the exchange rate and hurts exporters. As the former Reserve Bank Governor points out, there will be export growth only if a way is found to moderate the big three-year to five-year swings in the dollar, which make planning and investment a nightmare. That export growth, in turn, holds the key to long-term economic progress.
Monetary policy, as currently employed by the Reserve Bank, seeks to influence the level of spending in the economy by adjusting the official cash rate. That has proved more difficult since Dr Brash's time as governor for several reasons. One is that most mortgage rates are now fixed, not floating. Changing the rate does not have such an immediate impact. More fundamentally, nothing has been done to tackle a tax system that gives an unequivocal message that borrowing and buying houses is the most sensible approach to investment, and that saving is for the slow-witted.
Various solutions have been proposed, including a capital gains tax, a mortgage rate levy, and changed bank capital adequacy requirements. All have been largely discarded, some because they were politically unpalatable, others because they were deemed impractical. Dr Brash's proposal is, therefore, timely. Its strengths are that the excise tax on petrol is already in place and that motorists are accustomed to petrol price fluctuations. Increasing the tax on petrol to compel people to reduce their spending on other goods and services, and vice versa, would not come as a huge shock. It would have a similar impact to varying the official cash rate but, as a fiscal stimulus, would probably work faster.
The catch is that the power to raise and lower a tax would be handed to an unelected official, the Reserve Bank Governor. This, constitutionally, is uncharted territory. Americans, raised on the tenet of no taxation without representation, would blanch. Dr Brash, however, suggests safeguards that mitigate at least some of the concern. Additional revenue collected from an increase in the tax would have to be broadly offset by reduced revenue over a period of, say, five years. Additionally, the revenue would be held by the Reserve Bank and separate from the other revenue-raising activities of the Government. This would not be revenue raised for Government spending.
Such a step would have to be taken very carefully, not only because it is novel but to ensure the central bank's independence was not compromised. In reality, however, none of the solutions raised so far come without drawbacks. A mortgage rate levy, essentially a tax to push up the cost of borrowing when the Reserve Bank Governor thought this necessary, would raise similar constitutional issues. That idea was quickly abandoned because of public disapproval. The same sentiment deters governments from tackling the tax distortions that have people wedded to housing. But Dr Brash is right in at least one aspect: something must be done. On those grounds alone, his contribution is welcome.
