Should the statutory objective for monetary policy be changed?

Since 1989, section 8 of the Reserve Bank of New Zealand Act has read as follows:

The primary function of the Bank is to formulate and implement monetary policy directed to the economic objective of achieving and maintaining stability in the general level of prices.

That provision was widely seen as one of the centrepieces of the new Reserve Bank Act in 1989. It does not directly guide day-to-day monetary policy, but rather it should constrain the Minister and the Governor in negotiating Policy Targets Agreements (PTAs). PTAs must, by law, be consistent with section 8: as the Act puts it, the targets are “for the carrying out by the Bank of its primary function”.

The wording raises a variety of geeky questions.   Should, for example, the Act really describe monetary policy as the Bank’s “primary function”, or just treat monetary policy as one of a variety of functions Parliament assigns to the Bank?   Is it really sensible to talk of stable levels of prices, when neither the Bank (nor ministers, nor Treasury) has ever shown any interest in stabilising the level of prices, as distinct from the rate of change in those prices (“the inflation rate”). More troublingly, perhaps, can a medium-term trend inflation rate of 3 per cent (which we had got up to prior to the 2008/09 recession, and which would double prices every 24 years) really be described as “price stability”?

I’m not going to try to answer those questions today. But they illustrate that there is no particular reason to think that the current specification of section 8 should be treated as sacrosanct. My impression over many years at the Reserve Bank was of a tendency (I may have shared this attitude at times) to treat section 8 as the battle standard of orthodoxy, such that any change would be akin to allowing the barbarians to overrun the fortress.

Going into last year’s election, each of the Opposition parties (Labour, Greens, New Zealand First, Internet-Mana) was campaigning to change section 8 of the Reserve Bank Act.   Of course, typically they were looking for rather more change than just a change of overarching statutory objective, but two parties were quite specific in what they were looking to do with section 8 itself

In Labour’s case, as I noted a couple of weeks ago, they came up with this formulation

“The primary function of the Bank with respect to monetary policy is to enhance New Zealand’s economic welfare through maintaining stability in the general level of prices 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.”

And New Zealand First has sought to introduce legislation amending section 8 to read as follows:

The primary function of the Bank is to formulate and implement monetary policy directed to the economic objective of maintaining stability in the general level of prices while maintaining an exchange rate that is conducive to real export growth and job creation.”

In both cases, it would appear that the framework of a Policy Targets Agreement would continue.   Labour was quite explicit about maintaining the inflation target.

In fact, looking around the world’s advanced economies there is a wide variety of ways in which countries have written down what they are looking for from their central bank and monetary policy. In a fairly short issue of the Reserve Bank Bulletin published late last year, Amy Wood and I looked at the wide variety of ways legislation is written in 18 advanced countries (or regions in the case of the euro) that now use inflation targets as the day-to-day centrepiece of monetary policy.

There are big differences across countries. Some of those differences are about the age of the legislation. Old legislation looks quite different from newer legislation. Some is probably about the preferences of legislative drafters in different countries. And one important difference that became apparent is that in some countries they have written a limited statement of what a central bank can directly achieve, while in others they have written more about the longer-term desired outcomes that might flow from good monetary policy. And while acts of Parliament are one part of the mix, they often aren’t the only place in which society’s aspirations for monetary policy are set down.

At one extreme, in Sweden the only formal document – the central bank act – simply states that the goal of the Riksbank’s monetary policy is “price stability”. There are no other formal or binding documents (although there are plenty of Riksbank texts on what current governors interpret the Act as meaning).

The US legislation, by contrast, is a mix of medium-term objectives (things the central bank might more directly affectl) and desired outcomes from good policy. The Federal Reserve Act requires the Fed to “maintain long-run growth in the monetary and credit aggregates commensurate with the economy’s long-run potential to increase production”. Stable money growth was the thing the Fed could directly influence. But the Act goes on to state that this is to be done “so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates”. Congress didn’t care about money supply growth for its own sake, but for the things that are thought to flow from it.

The Bank of Canada operates under very old legislation. The Bank is required to “regulate credit and currency to control and protect the external value of the national monetary unit” (this dates back to before the era of floating exchange rates), but again it does not do this simply for its own sake. Rather, Parliament goes on to explain that the desired outcome of monetary policy is “to promote the economic and financial welfare of Canada”

I could go on. Even the ECB, established by treaty rather than by national legislation, operates under provisions which state that while the primary objective is “price stability” a variety of good things that should flow from the work of the ECB specifically and the EU more generally (eg “…stable prices, sound public finances and monetary conditions and a sustainable balance of payments”).  When I first stumbled on that last clause, about a sustainable balance of payments, I wondered if the Labour Party people were aware of it.

In many countries, even with quite recent legislation, there is an explicit obligation on the central bank to work together with, or support, other government economic policies, at least so long as doing so does not threaten the primary price stability goal,

What about the New Zealand situation?

Section 8 of the Act is pretty clear and succinct about what monetary policy is for, but nature tends to abhor a vacuum. Trace through the evolution of the Policy Targets Agreements since 1990 and you will more and more stuff written down, that was previously unwritten and somewhat taken for granted. But political pressures and criticisms of the Bank saw more and more details added in.  The 1992 PTA was perhaps the most cut-down approach.

Price Stability Target Consistent with section 8 of the Act and with the provisions of this agreement, the Reserve Bank shall formulate and implement monetary policy with the intention of maintaining a stable general level of prices

But in late 1996, a revised PTA was signed as part of the National-New Zealand First deal. It moved beyond just writing down the direct stuff the Bank could manage, to articulating what the point of pursuing price stability was.   The ‘so that” language that Winston Peters introduced here paralleled the “so as to” in the Federal Reserve Act.

Price Stability Target

Consistent with section 8 of the Act and with the provisions of this agreement, the Reserve Bank shall formulate and implement monetary policy with the intention of maintaining a stable general level of prices, so that monetary policy can make its maximum contribution to sustainable economic growth, employment and development opportunities within the New Zealand economy.

In 1999, in the wake of the MCI debacle, Michael Cullen added this provision.

In pursuing its price stability objective, the Bank shall implement monetary policy in a sustainable, consistent and transparent manner and shall seek to avoid unnecessary instability in output, interest rates and the exchange rate

It isn’t in the Act, but it is no less binding on the Governor (and successive Governors who have signed it). Unfortunately, as I noted last week, it is a somewhat troublesome clause, in that no one has ever been sure quite what the practical import was. At one level it was uncontroversial – avoid “unnecessary instability” – but quite what is “necessary”?

In 2002, Michael Cullen and Alan Bollard reformulated clause 1, restoring a clean focus on price stability in a), which just mirrors section 8 of the Act, while adding a separate sub-clause outlining what the government’s economic policy was looking for, and a sense of how price stability contributes.

Price stability

a) Under Section 8 of the Act the Reserve Bank is required to conduct monetary policy with the goal of maintaining a stable general level of prices

b) The objective of the Government’s economic policy is to promote sustainable and balanced economic development in order to create full employment, higher real incomes and a more equitable distribution of incomes. Price stability plays an important part in supporting the achievement of wider economic and social objectives.

With a change of government in 2008 there was a change in economic policy goal

The Government’s economic objective is to promote a growing, open and competitive economy as the best means of delivering permanently higher incomes and living standards for New Zealanders.  Price stability plays an important part in supporting this objective.

And finally in 2012, the words –  already present in section 10 of the Reserve Bank Act since 1989 – about having regard to the efficiency and soundness of the financial system in conducting monetary policy were added.  Quite what these words mean in practice is also less than clear –  even after 26 years.

No other countries have a binding legal arrangement akin to the Policy Targets Agreement.

There is a wide variety of ways in which countries, with very similar practical monetary policies, write down what they want from their central banks.  So the current wording of section 8 should not be sacrosanct –  the only possible way sound money could be preserved.  Personally, I would have no great objection if the wording introduced to the PTA in 1996 were to be translated in an amended section 8 of the Act.    I’d probably have slightly more problem with the Labour Party’s version from the manifesto last year, but ultimately it is for politicians to lay out higher level objectives for the Reserve Bank, and monetary policy.

But, and in a sense this is the point of the Bulletin article, those sorts of alternative formulations would not, on their own, be likely to make any material difference to the way monetary policy was run.  Practical differences flow from different Governors and different Policy Targets Agreements.  If political parties want actual practical differences in how monetary policy is run, they need to look to what they are negotiating in the PTA, and with whom.  As it stands, although the Reserve Bank has made more than its fair share of policy mistakes, evidence suggests that in normal times it has responded to incoming data in much the same way as central banks in Australia, the US, or Canada do.  And legislatures in each of those countries have written things down in rather different ways, to each other and to New Zealand.

There is no harm in amendments that may have little practical impact.  Symbolism matters, and since few would argue that  price stability should be sought for its own sake, there should be no strong objection to writing down in statute what it is hoped that good monetary policy will help contribute to.  Indeed, I would argue that it is better to write it down in statute than to keep fiddling with the Policy Targets Agreement. PTAs can be signed in the dead of night, perhaps involving two people only, as part of bundles of post-election negotiations.  The first the public know about the new terms is when the parties publish the signed document.  By contrast, even in New Zealand, the legislative process is usually much more open and transparent. Bills typically go to select committees, which invite submissions and review the arguments from outsiders before making recommendations.  And the hurdle of making changes in law is higher than for the PTA –  which has become something each change of government feels obliged to change.

I would favour amending section 8.  We need to face the fact that New Zealand is probably the only advanced country in which monetary policy has been repeatedly an election issue.  There has not been an election since 1987 in which one or other party was not campaigning on changes to the Act or the PTA.  That is no passing discontent.

Changing section 8 isn’t the biggest issue to address is reforming the Reserve Bank, but it shouldn’t be treated as of no importance either.

Since I’m not a die-hard inflation targeter either, I would favour something along these lines

Monetary policy shall be formulated and implemented towards the economic objective of maintaining medium-term stability in the purchasing power of the New Zealand dollar, so as to  maximise the medium-term contribution monetary policy makes to full employment and to the economic and social welfare of the people of New Zealand.

With such a clause, clause 4b –  the troublesome clause about avoiding unnecessary variability – should be able to be junked.  Parliament will have made clear that the whole point of the Bank is to promote good economic outcomes, and the longer-term interests of New Zealanders.  But don’t lose sight of the fact that New Zealand’s real medium-term economic failures have little or nothing to do with the conduct of monetary policy, or the way the Reserve Bank Act is written.

Of course, there still will –  and should  –  be vigorous debates about what intermediate targets the Bank should be required to pursue.  Many will favour the status quo, others might favour NGDP targets, and some might come to favour wage growth targets.  Some might favour a more active role in exchange rate smoothing. But those debates too should be carried on openly.  As I’ve argued before, the Minister of Finance and the Treasury (with or without the cooperation of the Bank) should already be planning an open process for consideration of issues before the next PTA will be due in 2017.  As 2017 is election year, the earlier the better really.

Of course, there is probably another debate to be had, before the Act is next comprehensively reviewed, as to whether there should be a single overarching objective for monetary policy and financial regulatory policy.  I think that would be a step in the wrong direction.  They are two quite different functions, just as monetary policy and fiscal policy are quite different.  But perhaps that is a topic for another day.

12 thoughts on “Should the statutory objective for monetary policy be changed?

  1. The inflation targeting regime was the latest thing when NZ took it on board and I thought it a really good thing at the time. It is not at all clear to me now that it has been that good, more muddle along than anything else. The problem seems to be that action is derived from forecasts. The result is the classic inventory problems of either too much or too little of whatever you need.

    Has there been a satisfactory case made for the pros and cons of the alternatives, such as the currency board that Hong Kong uses? Has Hong Kong been more successful than New Zealand and if so, in what ways?


  2. Richard

    I’m pretty confident that a currency board or fixed exchange rate would have been a disaster for NZ (something akin to Ireland or Spain). The RB has covered this option in various material, and the 2025 Taskforce’s report also dealt with it pretty forcefully.

    Other alternatives – such as NGDP targets or wage targets – could be better in some circumstances, but probably need more rigorous evaluation.

    Altho I’m less wedded to inflation targeting than most at the RB probably still are, the common ground between us is that NZ’s real problems don’t have much to do with mon pol (forecast mistakes notwithstanding). That is why I’ve been driving towards recognising that whatever holds up our real interest rates and real exchange rates (not just this year, but 20 year averages) is more likely to be the issue. My argument: high rates of targeted inward migration clashing with quite a low savings rate



    • Thanks for that Michael. Why do we want the RBNZ to manipulate interest rates at all? I can see an argument for crisis intervention but is rate setting in normal times just a case of mission creep? Seriously, is this the classic sort of risk concentration that increases vulnerability without you knowing it that Telab talks about?


      • Expanding on that line of thought:

        Does the RBNZ merely enable bad policy (eg on immigration) by reducing interest costs for the government of the day and by bailing out over-indebted mortgagees?

        Is the RBNZ merely another captured regulator forced to adjust interest rates in the interests of the holders of household debt?


      • Richard

        I suspect I’m much too conventional/mainstream for you. But the way I see the role of the RB is broadly to mimic what a free market would do with interest rates, while intervening strongly if and when crises occur. In a slowing economy, with sharply falling commodity prices and rising unemployment, I think there is little doubt purely market-determined interest rates would be falling too.

        Advocates of so-called “free banking” argue that we don’t need a central bank in the picture- they note for example that NZ or Canada got along fine without one until the 30s. But if central banks broadly mimic what markets would do – raising interest rates when demand for funds is strong, and lowering them when it is weak – that I’m reasonably content with something like current arrangements (be it inflation targeting, or NGDP targeting, or even credit targeting – at many times they all have much the same implications.



  3. This blog has educated many of us on some of the limitations of the present system. For those of us in the private sector, I think some kind of nominal incomes level targeting (e.g. a level target built around a 5% nominal incomes target) would be better than what we have now. There are legitimate concerns about how such a system would work during a terms of trade shock, but I think it would place greater accountability on the RB for making continuous mistakes in one direction.


  4. Bear in mind that an NGDP rule would have strongly supported OCR increases in 2013 and into 2014. I might post later in the week some discussant comments I did at a conference last year in the process of preparing which I talked myself back away from support for NGDP in a NZ context (so volatile are commodity prices now).

    I genuinely don’t think there are easy fixes. After all, as I pointed a couple of weeks ago all the domestic market (incl the Shadow Board) were on board with the Bank’s mon pol strategy over recent years. If anything they were more hawkish. If too many people misread what is going on, bad outcomes are going to happen. Rebuilding the capability of the RB is probably the most important change that could be made, since the Bank will always have far more analytical resource than market players, and market commentators usually don’t have much incentive to deviate much from the RB.

    Finding the right next Governor is going to be the big challenge.


  5. I take your point that NGDP is quite volatile in a small economy. But would you accept that labour income is less volatile than NGDP, and that level targeting puts the focus on the longer term picture?


    • Yes, level targeting for NGDP is certainly yes problematic for NZ than growth rates. Re the labour income yes, which is why I have been toying with wage targeting. I think it has appealing properties, both for macro conditions and financial stability, but it does have some rather large and asymmetric PR problems: “we are raising interest rates directly to slow wages growth”…..

      But I know I promised you something more on wages targeting and need to find time to develop my intuitions

      And I still reckon inflation targeting actually would have done ok -not ideal – over the last five years if the forecasts had been right. It is not that the RB has consciously and actively been targeting 1.3% inflation


  6. Surely the objective for both bank and Government is to build a country of wealth and prosperity for its owners. i.e. those of us who are the citizens and live here.

    Presently the only organization that seems to serve that view is the Super fund.

    How about we start thinking of monetary policy as an aid to making NZ genuinely wealthy and independent.
    Inflation targeting has denied that all along and in my view when Brash came along inflation was already beginning to be tackled by the market. Nothing any Gov has done since has actually had any effect except to beat the C—P out of the monetary system to the distress of those who have to access the system.

    In NZ inflation is beyond our control because we buy and sell on a world market, the sum of which determines what happens to us. Chins has given us a long break, that is beginning to change upwards with price increases from their cost increases. A pattern seen before with Japan.
    There will always be these nation swings that contribute to our economics.

    The current TPP is a good example of what’s not in our control as well. Failed over sugar, cars and last dairy. Diary being of no consequence to others.

    Money is a commodity market like others and trying to interfere in that huge market is like peeing into a Wellington Southerly. A waste of effort.

    Better thinking needed.


    • Thanks

      Not sure I could share your enthusiasm for the Super Fund. A leveraged punt on world markets seems, well, risky. It looks good when asset markets are booming, and really bad in the slumps (such as 09). My presumption is that they will produce a no better than mediocre result in the long run, and all the while our taxes have been kept a bit higher than otherwise. That is quite a cost to, for example, people struggling to buy a first home in Auckland.


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