Policy interest rate reversals since 2009

I had a look at ten OECD countries/areas whose central banks have since mid-2009 raised their policy interest rates and subsequently lowered them again.  I was curious as to how quickly those reversals came, and what else was going on.

The overnight interest rates for these countries are shown below.  Overnight rates aren’t the same as policy rates, but the OECD has these data readily available.



A couple of cases we can fairly quickly set to one side.  The Bank of Canada began raising its policy rate in mid 2010, and only in late 2014 did it make a single subsequent cut.  Iceland raised rates in 2011, and did not cut again until mid 2014.  Given the turbulent circumstances of Iceland, the stability in policy rates is quite surprising.

Australia and Chile both benefited hugely for a time from the late phase in the hard commodities price boom that peaked in 2011.  In both cases the increases after the 08/09 crisis seemed pretty well-warranted, and in Chile’s case the peak rate was held for two years before some cuts were put in place.  In neither country’s case has inflation been uncomfortably low relative to the target.

I don’t know much about Israel, but the very shortlived nature of the post 2009 peak interest rate, combined with the fact that the policy rate has subsequently been cut to new lows, and that CPI ex food and energy inflation has been running well under 1 per cent for some time suggests a policy mistake.

The Swedish policy mistake has been well-documented by Lars Svensson (and only rather grudgingly accepted by the Stefan Ingves, the Governor of the Riksbank).  Both Sweden and Norway will have been affected by the unforeseen severity of the euro crisis, but in Sweden’s case in particular there was a clear misjudgement by the policy committee.

The ECB’s policy tightening in 2011 proved to be extremely shortlived.  I’m not aware of anyone who would call it anything other than a mistake.  There is probably a variety of factors that influenced the ECB at the time, but they acted too soon, under no (inflation target) pressure, and quickly had to reverse themselves.

Finally, we have the Reserve Bank of New Zealand, the only one of our ten central banks to have reversed itself twice in five years.  The 2010 increases took place at a time when a variety of other central banks were raising policy rates.  There was some reason to think that the recession was behind us, and that it would be prudent to begin raising rates.  I wasn’t involved in the Reserve Bank’s 2010 decisions –  I was on secondment at Treasury –  but from memory I thought they were sensible moves.  As it turned out, by the time the rate increases were being put through the economy was already turning down again, and had a  shallow “double-dip recession”  The February 2011 earthquake was the catalyst for cutting the OCR again.  Initially, it was sold as a pre-emptive step, but we fairly soon realised that the level of interest rates  actually needed to be lower even once the initial shock had passed.

And then the Reserve Bank did it again.  I’m not going to rehearse the ground I covered this morning, but it is difficult not to put this episode –  the increases last year, now needing to be reversed – in the category of a mistake.  It is harder to evaluate other countries’ policies, but I would group it with the Swedish and ECB mistakes.    Monetary policy mistakes do happen, and they can happen on either side (too tight or too loose).  But since 2009 it has been those central banks too eager to anticipate future inflation pressures that have made the mistakes and had to reverse themselves.  As a straw in wind, in a country with an unusual governance model, it should be a little troubling that our central bank appears to be the only one to have made the same mistake twice.  It brings to mind the line from “The Importance of Being Earnest”:

To lose one parent may be regarded as a misfortune; to lose both looks like carelessness.”

Was a mistake made?

Both the Dominion-Post and the Herald this morning devoted their editorials to monetary policy and yesterday’s announcement by Graeme Wheeler.  The Herald, somewhat oddly, commends the Governor on “seeking to get ahead of the curve”.  In principle, I suppose that is always what he is trying to do –  it is, after all, forecast-based inflation targeting.  But I’m not sure that too many people would regard one OCR cut, just beginning to reverse last year’s increases, as “getting ahead of the curve” when core inflation has been so persistently low, and the unemployment rate has remained troublingly high.  A belatedly awakening might be a better description.

But I was more interested in the Dominion-Post’s thoughtful piece.  Here is the heart of it:

This is more than just an abstract number. It is a signal that more was possible. It suggests that, even though growth has been robust for the past couple of years, it might have been higher, with few costs, had the bank kept rates lower. That, in turn, might have meant more jobs and lower unemployment – which, at 5.8 per cent currently, is still too high.

Was it possible to sense any of this earlier? Monetary policy is a difficult business, and reasonable people can disagree. Certainly the plunge in global oil prices, a key factor behind low inflation, was a surprise to most observers. The slump in dairy prices, too, which will likely weigh heavily on the economy, has been steeper and more prolonged than anticipated.

But other factors were perhaps not so shocking – the slow progress of the global economy, the large influx of migrants to New Zealand (in train before last year), the persistence of low wage growth and local unemployment.

Much hinges on the opaque question of the economy’s “capacity” – essentially how hot it is running. It is always difficult to tell at any given moment; the truth gets clearer in the rear-view mirror.

The bank moved swiftly last year when dairy prices soared, the housing market surged, and the economy began hitting its straps. In hindsight, it moved too fast; it turns out there was more capacity – more labour and resources – to go round than it thought.

At the least, bank governor Graeme Wheeler and his team will need to consider if they were too quick to jump then, and too slow to reverse course.

Still, they have done it now, and rightly so.

I happen to agree with the editorial, but that isn’t really my point.  I’m hardly alone in lamenting the quality of a lot of public debate and media coverage of policy issues, but I was impressed that a newspaper editorial in this country could, in a calm way, highlight the uncertainties that monetary policy makers face, and the scope for reasonable people to disagree on the outlook for the economy.    And that the paper could suggest, in a very moderate tone, that it might be time for some critical self-examination by the Governor and his team .  It was the sort of balanced perspective that, say, those charged with holding the Reserve Bank to account, such as the Bank’s Board, might have read with profit, or which their advisers might have written.  (Of course, it is an open question whether it is the sort of piece that sells more newspapers.)

I noticed media accounts of the Governor’s appearance at FEC yesterday report him again denying that he made a mistake last year, whether in raising the OCR so much or holding it up for so long.  I’m not quite sure what he hopes to gain by this stance.  The Governor used to tell staff that his aim was for the Reserve Bank to be the “best small central bank in the world”.  One of the marks of a successful, learning, organisation is the ability to acknowledge mistakes, learn from them, and move on.  I suspect that there is a more chastened attitude internally than is evident publically, but this is a powerful public organisation, and we should reasonably expect to see more evidence of an ability to acknowledge mistakes.  A misjudgement  about monetary policy is not the worst thing in the world  –  it is in the nature of the game.   If anything, a refusal to acknowledge the misjudgement is more worrying, and detrimental to our ability to have confidence in the Governor, or in the single decision-maker governance framework.  It might, for example, be easier for a committee to acknowledge a mistake than for an individual to do so.

But was it a mistake?  The Governor appears to put a great deal of weight on the high dairy prices at the start of last year.  Even then, the Bank’s forecasts did not have export prices staying up indefinitely.  But the Bank’s optimistic forecasts for dairy prices back then required something quite out of the ordinary.  In the last decade, since EU policies began to change and dairy stockpiles were exhausted, global dairy prices have been much more volatile than previously (and production is much more responsive to changes in output prices and input costs).  At the start of 2015 a reasonable person might not have forecast dairy prices falling quite as low as they have or for long, but they would not have assumed the persistence of anything like the WMP prices seen in 2014.


This is what the Governor had to say in the March 2014 Monetary Policy Statement as he initiated the tightening cycle

Overall, trading partner growth has seen demand for New Zealand’s goods exports remain robust. Increasing rates of urbanisation and protein consumption in China are supporting demand for many of New Zealand’s commodity exports

Consequently, global prices of New Zealand’s commodities are extremely high, particularly for dairy. Dairy prices increased substantially in the first half of 2013 and remain at those high levels.

Rising demand in New Zealand’s trading partners, and particularly China, will result in continued growth in demand for New Zealand’s exports over the projection. Export prices are expected to remain high relative to history, though ease by about 3 percent over the next year due to an assumed moderation in global dairy prices.

The Bank –  and the Governor –  seemed beguiled by China.  A rather more reasonable approach would have been to have assumed that large fall in dairy prices were likely, even if the Bank could not be quite sure when they would occur.  Forecasters have to have a specific track.  Policymakers need to exercise judgement.

And context matters greatly.  When the first OCR increase was put in place, the unemployment rate was still above 6 per cent, less than one percentage point off the peak during the 2008/09 recession.  The recovery had not (and still has not) ever achieved the sorts of real GDP growth rates seen in earlier recoveries. And, of course, headline and core inflation were both (still) below the midpoint of the target range.  Private sector credit growth was running at around 5 per cent per annum, less than the (then) rate of growth in nominal GDP.

There just was no urgency[1].  There was slack in the economy,  continuing low inflation, modest credit growth.  Reasonable people might have been able to differ about the first OCR increase –  for what its worth, I advised against it, but I was a minority voice –  but the Governor went on tightening, moving at each of four successive reviews, even as dairy prices started falling sharply and core inflation just kept on staying low.  As late as December last year, the Governor was talking about the likely need for further OCR increases.

But he was wrong.  His approach last year was a mistake.  It appeared to be driven, at least in part, by a belief that there was something anomalous about the OCR as low as it had been, and that getting interest rates nearer the Bank’s estimate of neutral would be “a good thing”.

In one sense it shouldn’t be a great surprise that such mistakes are made. The single decision-maker system system is not well-designed to minimise the risk of mistakes (some of Alan Bollard’s early moves were also mistaken, as he later acknowledged).  And the Governor does not have a strong background in monetary policy or macroeconomics, and had not worked in New Zealand for 15 years when he took up the job.  Last year’s OCR adjustments were the first OCR changes he had made.

It would be better if the Governor simply acknowledged that he had made a mistake.  They happen.  It would be better for him, for the organisation (externally and internally –  learning organisations have to create room for staff to make mistakes), and for the country which entrusts so much power to the Governor.  If he is so unwilling to acknowledge a pretty clear-cut mistake, how willing is he to engage in critical self—scrutiny (or encourage it among staff) in areas where there might be rather more shades of grey?

[1] And, thus, the situation was quite different at the start of 2007 when, with unemployment already very low and core inflation very high, a lift in dairy prices, from relatively low levels, prompted Alan Bollard to raise the OCR four times in successive reviews.