Should the PTA be changed? Business leaders seem to think so

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.







5 thoughts on “Should the PTA be changed? Business leaders seem to think so

  1. The PTA is a target range between 1 and 3. This target seems consistent with most other economies around the world. What our Reserve Bank needs to be reminded is the ultimate intent is the general welfare of the NZ economy and we do want that to be moving in the positive direction. Not too far and not to fast as it creates market distortions and similarly we do not want deflation.

    Even though inflation is sitting at 0.4% officially and below the band, the economy is humming along very well. Clearly there is inflationary forces in the building industry not entirely reflected in the CPI index.

    Property prices are definitely moving ahead too fast especially in the apartment market therefore it does pose banking risks. In standalone houses there is fundamental reasons largely driven by the Unitary Plan rezoning land into multi units and multi level sites and in Metropolitan cities 18 levels of highrise. land prices are therefore being repriced for the future opportunity.

    Apartments have little or no land which means price rises to the level we have seen in recent years are not justified. One of the reasons is that it becomes simple commercial mathematics to a developer. A development that has say 100 apartments that have increased by $100k a apartment equates to $10 million dollars. It makes complete commercial sense to cancel the existing sales contracts, return the buyers their deposits and to resell the apartments at $100k higher making $10 million pure profit. Yes there is some escalation of costs but it is quite minimal in the context of the property price increases that we have seen thus far.

    It is convenient for a developer to blame the bank and pull the plug and to then resell the project. Commercial contracts do not consider loss of future opportunity as a loss therefore there is no compensation for loss opportunity.


    • There are therefore clear market distortions in the apartment market and the RB needed to act. The 40% LVR rules should have been applied to the rest of NZ and to the apartment market off the plans excluding Auckland and excluding first home buyers. Higher prices in Auckland needed to occur in the agglomeration of properties in order to build high rise and more of them.


  2. If our inflation rate is successfully pushed higher, above the currently low rates of our trading partners, all else equal, wouldn’t that make us less competitive? It would seem in such a situation that a sensible response to a global phenomenon of muted inflation would be a lower mid-point. Like Don Brash I’m struggling to see why low inflation is something bad.

    Falling and low interest rates for years to come is plausibly a factor inflaming the property market, drawing savers and investors in greater number as they seek to cash in on low interest rates and high capital returns, I would think. Even if it is not strictly the RBNZ’s concern, I imagine they would be mindful that a rampant property market is not helpful either.

    Is there a more constructive way of tackling unemployment rather than through interest rates? I was wondering if a lower immigration level would help.


    • Fair question. In general, if our inflation rate is a bit higher one would expect our exchange rate to be depreciating a bit, to maintain competitiveness. In the current circumstances, actions to raise the inflation rate back to around target would tend to lower the exchange rate – part of how the inflation rate would rise.

      My argument isn’t that very low inflation is bad per se. In an ideal world, I’d support a target centred on 1 per cent inflation, or perhaps even a bit lower. The problem/risk relates to the inability to cut the OCR much below zero. If everyone comes to expect that inflation will be around 1%, or even less, so-called inflation expectations will drop further and the OCR will have to be cut further just to keep real interest rates unchanged. And the risk then is that when the next recession comes – and on a historical time series you’d have to think that would be in the next few years – there wouldn’t be much room left to cut the OCR. In those circumstances, monetary policy wouldn’t be able to do as much of what we expect from it in stabilizing demand. Many other countries ran into this problem following the 08/09 recession, and I think we should be doing everything possible to avoid the problem ourselves.

      Re immigration, in the short-run if anything immigration tends to lower the unemployment rate and in the longer-term probably makes no real difference to the unemployment rate. Typically you see the RB raising the OCR when immigration is high – consistent with the idea that immigration boosts demand more than supply in the short-term. Things are a bit different this time, but mostly because the RB mistaken raised interest rates in 2014 and has since been dealing with the aftermath of that mistake.


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