The Labour Party has done well to come up with a constructive monetary policy for the coming election. Its proposal to make KiwiSaver compulsory and use its contribution rate as an alternative to interest rate rises is imaginative and reasonable.

It is not a drastic departure from the monetary consensus that has maintained low inflation and underpinned the strength of the economy under successive National and Labour governments.

Most importantly, Labour's new policy would not undermine the independence of the Reserve Bank which would remain in complete charge of the currency and it would be entirely up to the bank whether at any time it wants to recommend an increase in KiwiSaver contributions instead of raising the official cash rate. Either device could take a little money out of circulation when inflation looms.

An increase in KiwiSaver levies might do so without the baleful effect of interest rate rises on the exchange rate.


Labour would go one step further, which might not be wise. It would amend the Reserve Bank Act which currently states the prime objective of monetary policy to be: "maintaining stability in the general level of prices". Labour would add that price stability is to be maintained "in a manner which best assists in achieving a positive external balance over the economic cycle, thereby having the most favourable impact on the stability of economic growth and the level of employment".

That means the bank would also be charged with balancing New Zealand's external trade and payments accounts, which largely reflect exports, imports and borrowing by the private sector.

The only way a central bank might be able to do something about deficits in trade and private sector payments is by engineering a fall in the exchange rate. That is clearly what Labour would like the Reserve Bank to do, but at the same time as maintaining internal price stability.

What would the bank be expected to do at times that those twin objectives were in conflict? If looming inflation required a rise in the official cash rate but the balance of payments deficit required a lowering of the rate, which objective would have priority? Labour possibly believes the bank can do both if it is provided with an extra "tool" in the form of KiwiSaver contribution rates.

Its policy paper leaves open the question of whether the bank would be given the power to vary KiwiSaver contributions itself or merely recommend that the Government does so.

Sensibly, Labour's finance spokesman David Parker seems to prefer the latter. Compulsory savings levies are akin to taxes and it would be unusual to have them set by an unelected central bank. The power of taxation ought to be confined to those answerable at elections.

But if the bank can merely recommend that a government increase the KiwiSaver levy, the tool might seldom be used. If Labour leads the next government it might welcome recommendations, at least until the combined contributions of employers and earners rise from the current 6 per cent to 9 per cent.

Even Labour, though, would be reluctant to raise the levy in normal economic times, and would make exemptions for the lower paid. The bank would usually have to resort to the official cash rate.

Interest rates have proven effective against inflation. They may have unfortunate side effects on the exchange rate, though this is not as certain as it can seem. A floating exchange rate reflects many influences outside a central bank's control.

So long as both parties of government leave the Reserve Bank free to concentrate on what it can do effectively, and preserve its statutory independence from their political pressure, New Zealand's economy is well served.