Time to reform Reserve Bank goverance – conceptions of monetary policy

I’ve been arguing that it is Time to reform the governance of the Reserve Bank.  Earlier in the week, I pointed out that no other country does things the way we do (giving a single unelected official discretionary control over monetary policy and much of financial regulatory policy), and that New Zealand does not operate any other areas of policy in this way.  Other policy decisions are generally made by elected politicians or by boards, not by single unelected officials.

But, as I have also pointed out, the model adopted in 1989 had its own logic.  Not only did it reflect (slightly uneasily) the public sector reforms then being put in place, that set out to establish powerful but accountable (and dismissable) chief executives of core government ministries, but it also reflected views about monetary policy that were around at the time.  And when the 1989 Act was being written, and debated, it was the monetary policy role of the Bank that got far and away the most focus. The Act said (and still says) that monetary policy is the “primary function” of the Bank.

The gist of the story is this (more extensive background is here and here):

  • Monetary policy in the late 1980s was highly contentious and subject to lots of uncertainty.  Policy was focused on getting inflation down once and for all, in a newly-deregulated economy where many indicators were hard to interpret.
  • But in some quarters, especially in the Treasury, there was a view that the issues could (and should) all be made much simpler, especially once the initial post-liberalisation period passed.  If, for example, the Reserve Bank could be required to target a steady growth rate in the money base, there would be little room for discretion, and no room for debate as to whether or not the Bank had done its job.
  • Even if those sorts of targets weren’t feasible (and I don’t think anyone in the Reserve Bank ever thought they were), perhaps an inflation target itself could a very close approximation.  If inflation ended up inside a target range, job done.   If not, then not.
  • In short, in the minds of some those shaping the Act there was a sense that monetary policy should not be particularly controversial, and should be a largely technical matter, not involving material amounts of discretion.

Against that backdrop (and I’m inevitably stylising views somewhat), a single unelected decision-maker made some sense. The person would have little effective discretion, and could be dismissed if he/she stepped out of line.

Of course, actual monetary policy, whether in New Zealand or abroad, turned out nothing like that stylised story, even in a low inflation environment.  If done sensibly, monetary policy under inflation targeting involves huge amounts of discretion, amid a great deal of uncertainty.  There are choices to be made that have implications for the price level, and for how things like the unemployment rate and the real exchange rate (and the impact those have on livelihoods of people and businesses) for several years at a time.  Oh, and there hasn’t been an election since 1990 when monetary policy has not been a campaign issue for at least some of the parties.

So the single unelected decision-maker is not a model other countries use, it isn’t how we in New Zealand run other areas of policy, and it also doesn’t fit well with how monetary policy actually works, here or abroad.

Here are the relevant extracts from my paper:

As things were seen in the late 1980s:

This outputs vs outcomes framework was an important factor in the debate around how the Reserve Bank of New Zealand should be governed[1].    From the original discussions around the possibility of converting the Reserve Bank into an SOE, through until at least a year after the Reserve Bank Act was passed, elements of the Treasury were heavily influenced by a strand of thought that reckoned that monetary policy could be appropriately, and perhaps best, configured as an “output” problem.  If so, an autonomous decision-maker could be held clearly and directly accountable for delivering a pre-specified desired output.

At one stage, the idea of a statutory quantitative limit on the Reserve Bank’s note issue was floated.  Rather more persistent was the view that a target rule for growth in the money base – something that could be directly controlled by the Reserve Bank if it chose – was the appropriate basis for setting monetary policy.  If so, it would have been easy to judge whether (or not) the Bank had done its monetary policy job.

Within the Reserve Bank and Treasury it was largely common ground that something like price stability was the appropriate medium-term desired outcome.  However, it was also accepted that, in a market economy, inflation was not directly controllable by policy actions, and could be influenced (indirectly) by monetary policy only with fairly long and variable lags, and subject to a variety of exogenous shocks[2].   A robust relationship between the monetary base and medium-term price stability might have provided a suitable foundation for an outputs-based approach.  But such a relationship never emerged.

The point here is not that the governance aspects of the 1989 Act mechanically reflected views of particular individuals about which operational targets the Reserve Bank should use to conduct monetary policy.   It is more that the milieu inevitably, and perhaps even appropriately, affected the thinking about institutional design.  On the one hand, public sector reforms processes put a strong focus on individualised accountability.  On the other, there was a sense – perhaps rarely written down explicitly, but implicit in a lot that was written – that once low inflation had been achieved, the conduct of monetary policy should be relatively straightforward and not especially controversial.  The implicit vision of monetary policy was of an important, but essentially technical, matter.

And now:

Except for fixed exchange rate countries, output-based approaches to monetary policy do not work.  That was fairly generally recognised internationally by the time the 1989 legislation was passed, but ideas around an output-based framework still had an impact on the New Zealand framework.

For a time perhaps, some hoped that even though an inflation target was for an outcome, it might still be amenable to output-like accountability regimes.  If inflation outcomes were inside the target range, the Reserve Bank had done its job, and if not, then not[3].  But it has not proved to be that simple, for a variety of reasons.  Even core inflation outcomes can be away from the target midpoint for years, and considerable amounts of judgement are required to interpret the Policy Targets Agreement (including, but not limited to, questions around avoiding “unnecessary variability” in output, interest rates and the exchange rate).

Monetary policy setting, in the forecast-based approach adopted across the advanced world, involves considerable discretion.  Reasonable people can reach quite different views

And since Reserve Bank discretion involves choices that can materially affect output and unemployment, for periods of perhaps 1-2 years at a time, or the real exchange rate (and hence relative returns across major sectors of the economy), these choices matter to many people.  To be clear, monetary policy choices materially affect only the price level in the long run, but transition paths (especially when discretionarily chosen) have real implications for real people.

At the time the 1989 Act was passed, monetary policy was highly controversial (as, of course, was much of the rest of the reform programme). But the implicit view was that once low and stable inflation was established monetary policy would be a fairly low-key matter, not exciting much debate or political contention.  In fact, since 1989 there has not been a single general election in which at least one party has not been campaigning for change to the monetary policy aspects of the Reserve Bank Act[4]. Latterly, the tide has been rising, and at the last election for example all the parties on the political left were campaigning for change.  The point here is not whether (or not) the advocates for change are correct, simply to highlight that monetary policy remains contentious, and that to vest all powers in such a controversial area in a single unelected official increasingly seems anomalous.


If a central bank has discretion – and all modern ones (not adopting fixed exchange rates) do – then preferences and values come into play, and it is not obvious why the preferences of a single unelected official should be given such a high weight.

One previous Reserve Bank Governor sometimes liked to argue that he wasn’t very powerful at all – that he was tightly constrained and really had little choice around the decisions he took.  If he really believed it (and he was talking only of monetary policy in any case), I think he must have been the only one to have done so.

Reflect, for example, on the last boom during the 2000s.  Core inflation ended up persistently well above the target midpoint (with no action taken against the Governor by either the Board or the Minister).  That suggests that a different Governor could equally legitimately have made choices that delivered inflation as far below the midpoint of the target range.  Over a 10 year view that difference might not have made much difference to the end-point level of GDP, but it almost certainly would have made a huge difference to the trajectory of GDP, and of many economic activity/price variables, including house prices, debt, the exchange rate, and exports.

Or consider the years since 2007.  Actual decisions have been widely regarded as PTA- consistent, but different Governors could have made a plausible case for a materially looser stance.    That is real, and largely untrammelled[5], power of the sort that societies such as ours very rarely repose in a single person –  elected or not –  no matter how able.  (Indeed, this was the gist of Lars Svensson’s case, in his 2001 review for the previous government, for a formal decision-making committee. Svensson thought very highly of the then Governor, but argued that we needed to build institutions to cope with the less good ones –  less technically able, less inclusive, less good judgement or whatever.)

[1] These issues are treated in Singleton, in a Bulletin article on the origins of inflation targeting http://www.rbnz.govt.nz/research/bulletin/1997_2001/1999sep62_3reddell.pdf, and in  this Reserve Bank piece on monetary policy accountability and monitoring http://www.rbnz.govt.nz/monpol/about/2851362.html

[2] As the Bank itself noted in one 1988 paper, the problem with inflation targeting (relative to, say, money base targeting or a fixed exchange rate) is that it had a “trust us, we know what we are doing” dimension.

[3] The high tide of this sentiment was Don Brash’s unequivocal statement in a radio interview in 1993 that if inflation went above 2 per cent (the top of the then target range) he would lose his job (this statement is reproduced in an interview with Dr Brash included in the September 1993 edition of the Reserve Bank Bulletin).

[4] As far as I am aware, this degree of electoral debate over central banking, spanning multiple elections, is unique to New Zealand.

[5] The note on accountability and monitoring, referenced earlier, discusses some of the practical constraints on what appears in statute to be the Board’s considerable freedom of action to hold a Governor to account.

3 thoughts on “Time to reform Reserve Bank goverance – conceptions of monetary policy

  1. You’re not getting a lot of pushback on this line of reasoning, it seems.

    Also of interest is the fairly good performance of the RBA Board (which has a lot of nonspecialists) over the past few decades.


  2. Yes. As I noted, I don’t know anyone who would particularly defend the current model now. It was designed on what looked like reasonable assumptions in 1989 (so I’m not relitigating the choice for 1989, given what was known then), but most of those assumptions (about the role of the Bank, about monetary policy, about other countries) turned out differently than the designers expected.

    The RBA Board has a few problems in principle – CEOs of large borrowing companies setting the interest rate – but in practice the arrangement has worked well, in conjunction with consistently strong management teams.


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