In my post the other day, I outlined one way in which the unemployment concerns that appear to be behind the Labour Party’s desire to amend the statutory objective for monetary policy could be implemented in a new Policy Targets Agreement, even before the Reserve Bank Act itself is amended.
We still have no specifics as to how the Labour Party (and now the Labour-led government) envisages changing the Act. But in an interview on Radio New Zealand this morning I heard the Minister of Finance talking about looking to the specifics of the Australian and US legislation. I didn’t find that very enlightening or reassuring.
The Reserve Bank of Australia was set up in 1959, and the section of its legislation relating to monetary policy goals and objectives was in the original.
It is the duty of the Reserve Bank Board, within the limits of its powers, to ensure that the monetary and banking policy of the Bank is directed to the greatest advantage of the people of Australia and that the powers of the Bank … are exercised in such a manner as, in the opinion of the Reserve Bank Board, will best contribute to:
a. the stability of the currency of Australia;
b. the maintenance of full employment in Australia; and
c. the economic prosperity and welfare of the people of Australia.
In 1959, Australia – like most countries – had a fixed exchange rate, so that “the stability of the currency of Australia” meant the external value of the currency. The provision has since been re-interpreted, and as is now taken as meaning the domestic value of the currency (ie domestic price stability), but no one would write the provision that way today.
This wording is also legitimately subject to the criticism made by those who disagree with what Labour is proposing. It makes no attempt to distinguish between the short and long run, and thus does not recognise that monetary policy cannot affect the longer-term rate of unemployment at all. The Australian legislation also has nothing like a Policy Targets Agreement (the document that resembles a PTA is informal and non-binding) and provides far too much discretion to the Reserve Bank. That discretion has not been blatantly misused in recent decades – a period when the actual conduct of monetary policy in New Zealand and Australia have mostly been quite similar – but the legislation should not provide any sort of model for New Zealand as to how best to specify the goals of monetary policy.
What of the United States? Much is made of the “dual mandate” that has guided the Federal Reserve over the decades. But even that, mostly quite sensible, conduct of policy rests on a rather slender and unreliable legislative footing. The statutory objectives in the Federal Reserve Act were set out in 1977, around the high tide of monetarism, and read as follows:
Section 2A. Monetary policy objectives
The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.
In other words, the Fed is actually mandated to pursue long-term money and credit growth targets, in the belief that doing so will promote (a) maximum employment, (b) stable prices, and (c) moderate long-term interest rates. Again, no one would write the statutory objectives that way today, and the formulation should offer little or no guide to anyone looking to overhaul the objectives of our own central bank. In practice, of course, the Federal Reserve works around the statutory formulation, rarely citing it directly. I think they way they run monetary policy in practice is quite sensible – and typically not that different to the way the Reserve Bank here has often run policy – but I bet they wish Congress had written the goal a bit differently in 1977.
In an ideal world, both the Australian and US statutory provisions would be updated and amended. It isn’t desirable to have powerful autonomous agencies working under the mandates that don’t reflect today’s understandings of policy, leading those agencies to creatively reinvent their own mandates. Those reinventions probably lead to better policy in the short-run, but the process of doing so undermines confidence in the role of legislatures in mandating, and holding to account, such agencies.
If one looks around the advanced world, there are lots of different ways of specifying central bank objectives. In most cases, the wording is considerably more recent than either the US and Australian examples. A few years ago a colleague and I did a Reserve Bank Bulletin article reviewing those formulations – the work initially prompted by the approach of the 2014 election, when Labour was also proposing changes. As we noted,
Despite the similarities in how monetary policy is operated, there is a wide range of ways in which legislation and supplementary documents specify the medium- and longer-run aims societies have for monetary policy. In some countries the focus is more on the economic outcomes that a successful monetary policy could contribute to over the longer-term. In others it is more on what monetary policy can more directly achieve. These differences do not seem to primarily reflect very different views of what monetary policy could reasonably accomplish. Specific national circumstances influence how formal documents are written. And older legislation often looks different than legislation adopted in the past 10-20 years, with the latter typically having a more explicit focus on domestic price stability. In some countries, formal documents say relatively little about what monetary policy is expected to achieve, while in other countries the formal documentation is more extensive.
As I’ve noted here previously, I think the sort of statutory change Labour seems to be talking about makes some sense. In part, that is because monetary policy has – ever since the late 80s – been a divisive political issue here in a way that it hasn’t been in other countries. In part, it is because of the failings of the Reserve Bank – with many fewer constraints than their peers in many other advanced countries – over the Wheeler years in particular. But I’m not sure that the way other countries have worded their legislation is going to be of very much assistance to Treasury and the Minister of Finance as they attempt to come up with some specific proposals. If I was to offer them specific suggestions, they would involve changes to the purpose clauses , to the clause governing the primary function of monetary policy, to clause 10, and to the clause governing Monetary Policy Statements.
It is perhaps worth remembering that over the life of the Reserve Bank – now 83 years – there have been various different formulations of the statutory goals of monetary policy. Those changing goals were also discussed in a Bulletin article a few years ago. When the first legislation was enacted in 1933, the statutory goal was simple, if not specific
It shall be the primary duty of the Reserve Bank to exercise control […] over monetary circulation and credit in New Zealand, to the end that the economic welfare of the Dominion may be promoted and maintained (1933, s12).
It is worth remembering that it simply isn’t possible to write down, whether in statute or in a PTA, all that one wants a good central bank to do in conducting monetary policy. Or, at least, it hasn’t been since we went off the Gold Standard in 1914. There is no perfect formulation, and good people – sound judgement and a good understanding of the issues and constraints – matter as much as precise wording. Each generation faces differing shocks, differing sets of circumstances, and different things that aren’t well understood. It is easy, and tempting, simply to set out simple wording like what is in the Reserve Bank Act now. So long as it is understood not to capture everything – and successive Governors and Ministers have recognised that – it may not do much harm, and it keeps a focus on the long-term limitations of monetary policy. But, equally, we have active discretionary monetary policy because we believe that monetary policy can do other useful stuff in the short to medium term. Finding ways that reflect that understanding and translating them into legislative wording has its risks – as not doing so does – and can’t be done perfectly, but that isn’t a reason for not doing it at all.
And finally, it is worth remembering that, whatever the precise statutory wording, past research has found that, on average, the Federal Reserve, the Reserve Bank of Australia, and the Reserve Bank of New Zealand have tended to conduct monetary policy in much the same way, faced with similar shocks.