Vernon Small’s politics column in today’s Dominion-Post had this paragraph:

English has not overtly disciplined the central bank over its persistent failure to keep inflation close to the 2 per cent target, though he noted yesterday there was a mechanism in his policy targets agreement with the bank governor to address that.  There had been “ongoing discussions” over the bank’s performance and it was a question of how long it went on  –  currently more than two years (or “a wee while” as English archly put it).

It isn’t entirely clear how much of this is accurately reported, and how much is Small’s interpretation/translation of what he thought English said.  That isn’t my concern here. I want to focus on what options are open to the Minister of Finance if he was concerned.

The first is that there is no such procedure in the Policy Targets Agreement.  The PTA sets out the target, and how the Bank is supposed to respond, and report to the public, when inflation moves materially away from target.  The agreement also notes that

The Bank shall be fully accountable for its judgements and actions in implementing monetary policy.

but this adds nothing to the provisions of the Reserve Bank of New Zealand Act, which contain both the accountability provisions and remedies open to the government.

The Act is quite an elegant structure. The Minister takes the lead in setting the [inflation] target and the Governor has sole personal responsibility for implementing monetary policy in pursuit of the target.  The Minister also appoints the Bank’s Board, whose primary responsibility is to act as monitoring agents for the Minister – and, to a lesser extent, the public.  The Minister also has The Treasury, who have no formal institutional role in the monetary policy governance process, but act as the Minister’s own professional advisers and these (and many other) issues.

The Board can recommend that the Minister dismiss the Governor, and the Minister can seek the removal of the Governor with or without a recommendation from the Board.  The Governor can’t, of course, be dismissed on a whim, but only on the grounds laid out in the Act.  The essence of the framework is that the Minister appointed the Governor to do a job –  in respect of monetary policy, as specified in the Policy Targets Agreement –  and if the Governor isn’t doing his job satisfactorily he can be dismissed.  That was one of the ideas at the heart of New Zealand’s far-reaching public sector reforms in the 1980s –  operational independence for chief executives, but the loss of the sort of “tenure until retirement” such chief executives had previously had.  It was why, unlike the situation in most other countries, our Governor is the sole decision-maker on monetary policy: Ministers responsible for the legislation in the 1980s thought it wasn’t credible to fire a whole committee, but it was quite credible to dismiss a single individual[1].

But dismissal is an extreme option.  I’ve long argued that it is not a particularly credible threat either.   A Governor’s failure would probably never be black and white, and he has large institutional resources to defend his position, as well as the threat of seeking judicial remedies (interim injunctions, and/or overturning the decision).  Given how disruptive (including in international financial markets) and uncertain all that would be, all but the very worst Governors have effective tenure to the end of their terms. And that is probably how it should be.   The option of non-reappointment at the end of a five year term is another matter.

If perhaps there is some buyer’s remorse, I’m sure no one is talking of such options at present.

But what other options does the Minister of Finance have?

He could simply pick up the phone or arrange a meeting with the Governor.  No doubt the two of them talk about various things.  But while the Minister of Finance is quite within his rights to want to be sure that the Governor is operating monetary policy consistent with the Policy Targets Agreement, he wouldn’t (or shouldn’t) want to be seen to be putting pressure on the Governor in respect of a particular OCR decision.  Operational decisions around the OCR are the Governor’s alone (with plenty of advice of course).  Maintaining that distance, and respecting appearances, is one reason why it was most unfortunate that the Governor recently appointed the Minister’s brother as one of his monetary policy advisers.

The Minister could seek a report from The Treasury on their view of how well the Governor was doing consistent with the Policy Targets Agreement, could let it be known such work was underway, and could arrange for such a report to be published.  The New Zealand Treasury offers independent professional advice to the Minister of Finance and would have to take seriously such an exercise.  It might be expected to consult externally (but confidentially) to canvass opinion.   At present, for example, most financial market economists –  not the only relevant observers but not unimportant either –  in New Zealand seem quite comfortable with the Governor’s handling of monetary policy.

The Minister could also seek formal advice from the Bank’s Board, and let it be known that he was doing so.  This would be a totally orthodox approach – the Board exists as a monitoring agent for the Minister – and it was, for example, the approach taken in the mid-1990s when inflation first went outside the target range.   The Board has a number of able people on it, but as an effective agent for accountability risks being too close to management.   The Governor sits on the Board, the Board meets on Bank premises, it has no independent resources, and it has been chaired exclusively by former senior managers of the Reserve Bank.    It was striking that last year’s Board Annual Report (which is just embedded in the Bank’s Annual Report document) had nothing substantive on the deviation of inflation from the policy target.

Although it has no formal status, the practice has grown up of Ministers writing to chief executives, in this case the Governor, in an annual “letter of expectation”.  If the Minister has had concerns one assumes that he has used his letter to pose questions to the Governor around the deviation of inflation trends from the midpoint of the inflation target.  under the Official Information Act I have requested copies of such letters (I requested them  from the Reserve Bank, who have now transferred my request to the Minister of Finance).

The Minister also has reserve powers to act directly.  Section 12 of the Act allows the Minister, transparently and for a fixed term, to impose another “economic objective” than the “stability in the general level of prices”.  These powers have never been used, although the previous Minister of Finance talked openly of the possibility of doing so (at that time, discontent with the Reserve Bank resulted in a select committee inquiry into the future of monetary policy).  Using the section 12 powers does not technically alter the governance structure.  A new Policy Targets Agreement needs to be put in place, and the Governor then has responsibility for operating with that.  I’ve previously argued that the section 12 powers might be able to be used to direct the Bank to put short-term rates at a particular level, but there are other ways of skinning the cat that could, in effect, require the Bank to cut the OCR if the government were really concerned that the Bank was not operating consistently with the current Policy Targets Agreement.

I’ve been quite open that I don’t think the Reserve Bank –  the Governor –  has been making the right calls on monetary policy.    Interest rates have been too high now for some considerable time, and it is beginning to get beyond the point where reasonable people just see things differently.  I do think there is an onus on the Board to be asking some particularly searching questions, and to be letting the Minister –  and the public –  know the conclusions they reach, and any reasoning behind those conclusions. The Board is required to satisfy itself that each Monetary Policy Statement is consistent with the Policy Targets Agreement, and there is another Statement coming out next month.    There must now be some question as to whether they could do so if the current policy stance is maintained.

I don’t think it is time for the Minister of Finance to act, but he probably doesn’t need to.  Even garbled newspaper stories that talk of the Minister of Finance disciplining the Governor will no doubt have caught the Bank’s attention.

[1] Experience suggests that dismissing whole committees is perhaps less difficult than was then thought.  The Hawkes Bay DHB and Environment Canterbury examples spring to mind.