Tomorrow sees the release of the latest Reserve Bank Monetary Policy Statement. My “rule” for making sense of the Governor’s monetary policy choices at present is that he really doesn’t want to cut the OCR – and hasn’t for the last year – as much because of the housing market as anything, and cuts only if reality mugs him, in the form of some key data that he just can’t escape the implications of. I haven’t seen that sort of data in the last month or two. Given the terms of the Policy Targets Agreement, it should have been an easy call to cut the OCR again, but it probably hasn’t been.
There is a nice, fairly trenchant, column from Hamish Rutherford in the Dominion-Post this morning on the Governor’s communications “challenges”. I’m very sympathetic to the line of argument Rutherford is running (including his use of some BNZ analysis of monetary policy surprises). My only caveat is that, in my view, getting policy roughly right is better than being predictable and wrong. There were no major monetary policy surprises or communications problems in 2014. But the repeated increases in the OCR were simply bad policy. Grudging as it may have been, and badly communicated as it undoubtedly was, the OCR has at least been moved in the right direction for the last year.
In this post, I wanted to highlight some issues that it would be good to see the Reserve Bank change its stance on in its statement tomorrow. If I really expected they would do so, I probably wouldn’t bother with the post, but perhaps there will be a surprise in store. Many of them have to do with countering that persistent sense, pervading Bank documents, that the economy is doing just fine. The Reserve Bank has an inflation target, not an economic performance one, but the argument that all is fine in the economic garden has been used repeatedly to justify keeping the OCR as high as it has been. As a reminder, even today, in real terms the OCR now is still higher than it was when the ill-judged 2014 tightenings began.
The first is the constantly repeated claim that monetary policy in New Zealand and in other countries is highly “stimulatory”. It appears in almost every Reserve Bank policy statement or speech, and appears to be based on nothing more than the undoubted fact that interest rates (real and nominal) are currently low by longer-term historical standards. That doesn’t make them stimulatory. It has now been more than seven years since the rate cuts during the 2008/09 recession came to an end. For most of the time since then the OCR has been at 2.5 per cent. Today it is at 2.25 per cent.
Adjust for the fall in inflation expectations (around 60 basis points over 7 years on the Bank’s two-year ahead measure), and if anything real interest rates are a bit higher than they’ve typically been since 2009.
The Reserve Bank appears to still believe that a normal (or ‘neutral’) short-term interest rate might be around 4.5 per cent. But there is nothing substantial to back that view. The fact that inflation has been persistently below target for several years, in a weak recovery with persistently high unemployment, argues against there being anything meaningful to a claim that 4.5 per cent is a “neutral” interest rate – a benchmark against which to measure whether monetary policy is “highly stimulatory” or not. Better, perhaps, to look out the window, and check the current data. That isn’t always a safe strategy, but it is better than clinging to old estimates of unobservable structural features of the economy. Having moved to a flat track in its interest rate projections, the Bank appears to be backing away from putting much practical weight on the high estimates of a neutral – or normal – interest rate. But the rhetoric still seems to matter to the Governor, and his reluctance to cut the OCR seems, in part, influenced by his sense that interest rates are already “too low”. He has – or at least has produced – nothing to support that sense – whether for New Zealand, or for most other advanced other countries. Better to put to one side for now any estimates of neutral interest rates, lose the rhetoric, and respond to the observable data as they are.
The second point I would like to see signs of the Reserve Bank taking seriously is the persistently high unemployment rate. At 5.7 per cent it has barely changed in the last year. I noticed that the OECD in its new forecasts seems to treat 5.8 per cent as the natural rate of unemployment (or NAIRU) for New Zealand. Few others do, and both the Treasury and the Reserve Bank have tended to work on the basis that our regulatory provisions (welfare system, labor market restrictions etc) are such that the unemployment rate should typically be able to settle nearer 4.5 per cent without creating any inflation problems. Someone forwarded me the other day a market economist’s preview of this MPS, noting with some surprise that the unemployment rate wasn’t mentioned at all. I sympathized with the person who sent it, but pointed out that it was the Reserve Bank the market economists were trying to make sense of, and the Reserve Bank gives hardly any attention to this key indicator of excess capacity in the labour market. Reluctance to cut the OCR might make more sense if the unemployment rate were already at or below the NAIRU. As things stand for the last few years, there is an inefficiently large number of people already unemployed, and the Governor’s reluctance to cut just condemns many of them to stay unemployed longer than necessary. The Governor should at least recognize that trade-off, and explain the basis for his judgements.
The third point it would be good to see the Reserve Bank explicitly addressing is the mistakes it has made in monetary policy over the last few years. Depending on the precise measure one uses, inflation has been below the target midpoint – a reference point explicitly added to the PTA in 2012 – for many years now. Some of that might not have been easily foreseeable. Some of it might even have been desirable in terms of the PTA (if the one-off price shocks were all one-sided, which they weren’t). Humans – and human institutions – make mistakes, and one test of a person or institution is their willingness to recognize, respond to, and learn from their mistakes. Since the Governor is unwilling even to acknowledge that there were any mistakes, it is difficult to be confident that he or the institution has learned the appropriate lessons and adapted their behavior.
The fourth point it would be good to see the Reserve Bank acknowledge is how poor New Zealand’s productivity and per capita real GDP performance has been. For example, here is real GDP per hour worked for New Zealand and Australia since the end of last boom.
Maybe data revisions will eventually close the gap, but that is the data as it stands now.
And here is per capita real GDP growth rates.
A pretty dismal recovery phase, by comparison with past cycles.
My point is not that monetary policy can or should target medium-term productivity growth or real GDP growth, but simply to illustrate the climate in which the Governor has been making his monetary policy calls, holding the OCR consistently higher than the inflation target required. He likes to convey a sense – akin to the tone of the government’s own “glee club” – that everything is fine here but actually it is pretty disappointing. Perhaps holding interest rates higher than was really necessary might make a little sense if the per capita GDP growth or productivity growth had been really strong – leaning a little against the wind – but they’ve been persistently weak. Again, the Governor should explain the basis for his trade-offs, not pretend they don’t exist. We’d have had a better cyclical performance if the OCR had not been kept so high.
I could go on. The Governor could usefully highlight that, although he is uncomfortable – as everyone should be – with current house prices, there is nothing in the turnover or mortgage approvals data (per capita) to suggest an excessively active market (high turnover is often associated with excessive optimism, and unjustifiably loose credit conditions). And there is nothing in the consumption or savings data to suggest that high or rising house prices have spilled over into unwarranted additional consumption, putting upward pressure on inflation more generally. I showed the chart of private consumption to GDP in a post yesterday – stable over almoat 30 years, despite really large increases in house prices and credit. This chart shows the national savings rate, since 1980. There is a little year to year variability, but again no trend over 35 years now.
House prices are a national scandal, but there is no reason to think they should be treated as a monetary policy problem.
I do think the OCR should be lower – perhaps 50 or 75 basis points lower than it is now. In time, the Reserve Bank is likely to recognize that. But my point here is really that when he makes his choices – and they are personal choices, not those of a Committee – the Governor should, and should be seen to, engage with world as it is, not as he might wish that it would be. In that world, the unemployment rate lingers high, productivity and income growth have been persistently weak, inflation has been persistently below target, wage inflation is weak, house price inflation isn’t splling into generalized inflation pressures, and historical reference points around normal or neutral interest rates seem increasingly unhelpful. Perhaps there is a good case for keeping the OCR at current levels, but a good case can’t simply pretend everything is rosy in the garden or that – finally – everything is just about to come right.
(And all that without even mentioning the exchange rate which is not only high by historical standards – again raising doubts about those “stimulatory” claims for monetary policy – but this morning is at almost exactly the same level it was at a year ago. The fall in the exchange rate from the 2014 highs was supposed to help get inflation back to target. It was a half-plausible story when the fall first happened. It is less even than that now.)