A couple of weeks ago, the Herald ran their annual Mood of the Boardroom survey, capturing the views of 101 (mostly) chief executives on a wide range of business, political and policy issues.  It is a slightly frustrating survey because, despite the heavy coverage the Herald gives it, they don’t report the exact questions, and as everyone surely recognizes, how one frames a question influences –  intentionally or otherwise –  the answers one gets.

Often enough the answers are pretty predictable.  Sometimes predictably depressing.  Daft and detached from reality as I’ve argued that the Prime Minister’s line about New Zealand as a haven for the rich, the “Switzerland of the South Pacific” is, the CEOs (79 per cent of them) seem to like it.

But the question that caught my eye was one about monetary policy.  Asked whether the government should “rewrite its agreement with the Reserve Bank”, so as to “consider wider economic factors beyond inflation” the answers reported were:

Yes                                    48 per cent

No                                      38 per cent

Unsure                              14 per cent

It is now less than 12 months until a new Policy Targets Agreement is required, and the Minister of Finance has poured cold water on the idea of major changes in the PTA.  But on this occasion, business leaders –  often important defenders of the status quo around monetary policy – seem to be calling for change.  As the Herald notes, it is “a marked change from previous surveys”.

It would be interesting to know quite what these CEOs had in mind, as there isn’t much hint in the supporting article.  One CEO is quoted as suggesting that the Reserve Bank needs to think about economic growth too, and that is about all.  There is no reference in the article to the exchange rate, unemployment, asset prices, credit or any of the considerations that people sometimes argue that the Bank should pay more attention to.  But since these respondents aren’t monetary policy experts, we can assume they don’t just have in mind minor technical rephrasing on some clause or other in the PTA.  There must be some genuine angst in CEO-land about how monetary policy is being run.

Without more follow-up questions, it is hard to know what the balance of thinking among respondents was.  Some will probably will favouring lowering the inflation target, to bring the target into closer alignment with actual inflation outcomes in recent years.  Perhaps some favour linking monetary policy and the Bank’s regulatory powers more closely.  Some might be channeling stuff they read from abroad suggesting a new approach to monetary policy is needed, with little real sense of what a different approach might look like (no other country having changed its framework).  But others might be reflecting more of a Labour/New Zealand First unease about the framework, emphasizing perhaps international competitiveness, or more of a focus on full employment.  Perhaps some are just reacting to the failings of the current Governor in conducting policy?

We don’t know what the balance is, but the survey result does feel rather like a straw in the wind, something for the powers that be to focus on as the negotiation of the new PTA next year approaches.  The latent unease among business leaders –  whatever motivates it –  reinforces the argument I’ve made here several times in the past that the process leading to negotiating a Policy Targets  Agreement really should be a much more open one.  The PTA is the principal guide to short-term macroeconomic management in New Zealand, for five years at a time, and yet it is a process shrouded in secrecy from beginning to (well after the) end.   There was no public consultation on the changes to the PTA in 2012 (or those in 2002), and even after the event the Reserve Bank has refused to release background papers relating to the PTA negotiation.

Perhaps none of this matters very much if there is a strong consensus in favour of the status quo –  although even then it is as well to have to articulate the case from time to time, and deal with the challenges, even if they come from only a small minority of voices.  But this time, according to this survey, a plurality of business leaders favours changing the PTA.  Regulatory agencies have to publish consultative documents on proposed changes. New legislation has to be worked through a select committee. The government publishes a Budget Policy Statement setting out in advance the key considerations that will shape its subsequent Budget.  But there is nothing remotely similar around the key policy guide to short-term macroeconomic management, the PTA.  Democratic deficits abound in matters relating to the Reserve Bank, but this is one that could be quite easily fixed.    As part of the lead-up to next year’s PTA, the Minister of Finance should announce that the Treasury will be hosting a workshop/conference, perhaps around six months from now, to consider papers on the appropriate content and structure of the Policy Targets Agreement.  Several background papers could be commissioned, the Reserve Bank and Treasury themselves might submit papers (with some caution about those from the Reserve Bank, given that it is the institution whose conduct the PTA is supposed to shape, and hold to account), and outside experts (academic and otherwise) and interested parties could be invited to contribute.

No doubt some would worry about “upsetting the markets” but (a) this is a democracy, and one that often espouses the importance of open government and (b), as importantly, markets can read too.  The Mood of the Boardroom results are no secret, and nor is the unease that most Opposition parties feel about the New Zealand monetary policy framework.  Nor, for that matter, is the ongoing international debate about how best ot run monetary policy in future a secret.

To be clear, I am not myself advocating material change.  If I were starting from scratch, I would rewrite the PTA at about half its current length, but would not change any of the central features of the current document.  That isn’t because the current system is perfect, or likely to be the end of monetary history (the system we still have 100 years hence), but because the case for any real-world alternative has not yet been made compellingly.  And because I think getting the forecasts more accurate, and reforming the governance of the Reserve Bank –  including getting the right people running the place – are more important than tweaking the target.

I was, however, interested in one of the Herald survey’s advocates of changing the PTA.  Don Brash, former Governor of the Reserve Bank, was included in the survey as chair of ICBC, one of the Chinese banks operating in New Zealand.  Don is quite clear in his view that

over the longer term monetary policy can’t significantly effect an improvement in real economic growth or employment.

But, he argues,

And the Government should probably either reduce or widen the inflation target band. It’s not obvious to me that an average movement in the price of goods and services (as measured by the CPI) of say 0.5 per cent a year should be regarded as a serious problem to be solved.

“There’s not much evidence of people holding off spending because the CPI is at current levels,” said Brash

I think Don Brash is just wrong on this one.

First, he ignores the extent to which the unemployment rate (just over 5 per cent) is still above the natural or sustainable rate in New Zealand –  estimated by Treasury at around 4 per cent.  Very low inflation is not necessarily a problem in itself, but it can point to an extent of unused capacity in the economy.  That is most obvious in the unemployment numbers, but is also reflected in just how weak per capita GDP growth has been in the current upswing.  We simply could have done better.

But my bigger concern is about what lowering the inflation target would do to our capacity to cope with future severe economic downturns.  I’d be happy, in an ideal world, to lower the inflation target, back to perhaps 0 to 2 per cent per annum (there are some modest upwards biases in the CPI measure of inflation).  Apart from anything else, the closer to price stability the economy averages the less distortionary the tax system is.

But…the rest of the advanced world has spent the last decade discovering the limitations of conventional monetary policy.  With current technologies, laws, and central bank practices, no one thinks that nominal policy interest rates can be cut much below zero (something around -0.75 per cent seems to be accepted as near a practical floor).  Fortunately, New Zealand hasn’t faced those constraints yet.  We had to cut the OCR as much as almost anyone in the advanced world, but since our interest rates have averaged so much higher than those in other countries, the OCR hasn’t yet fallen below 2 per cent (and even the doves don’t think it needs to go below 1 per cent).

As the Reserve Bank has noted, weak inflation over recent years has been accompanied by falling inflation expectations.  But those inflation expectations have typically fallen quite sluggishly, partly because people still seem to think that eventually inflation will get back to something around 2 per cent.  If the target was changed, to say 0 to 2 per cent, they would have no reason to expect inflation to average anywhere near 2 per cent, and their expectations (explicit and subconscious) would be revised down towards 1 per cent.  All else equal, that would amount to an increase in real interest rates –  and to prevent inflation falling further, nominal interest rates would have to be cut even more.

In typical downturns in New Zealand, the OCR (or the 90 day bill rate pre 1999) have been cut by hundreds of basis points (500 basis point falls haven’t been unusual).  Even with an inflation target centred on 2 per cent, we don’t have anything like that sort of leeway when next a recession hits New Zealand.  We would simply be foolish to give away any of the capacity we do have by cutting the inflation target now.  Of course, if the government, the Treasury and the Reserve Bank were finally going to get serious about taking the sort of steps that would largely remove the near-zero bound on nominal interest rates it would be a quite different matter.  But this issue need to be taken seriously in any discussion of future PTA options.