Implications of a new government for monetary policy

Whichever way New Zealand First decides to go, we’ll have a different government than we’ve had for the last few years.   Whatever form that government takes –  coalition, confidence and supply agreements, or just sitting on the cross-benches – New Zealand First’s votes will typically be vital for passing any legislation, and whichever party leads the government will constantly be needing to consult with New Zealand First to avoid inadvertently getting offside with them.

As issues around the Reserve Bank and the exchange rate have been a significant part of Winston Peters’ stated concerns over the years (including attempts to amend the Act through a private members’ bill, and repeated references to a Singaporean style of monetary policy), it is interesting to speculate on what difference his bloc of votes in Parliament might make to these issues over the next few years.  A journalist asked for my thoughts the other day, and this post fleshes out what I said in response to those questions.

There are probably at least three –  separable – areas worth touching on (simply as regards the Bank’s monetary policy roles):

  • the specification of the target for monetary policy, whether in the Act or the Policy Targets Agreement,
  • any changes to the legislated decisionmaking and accountability provisions for monetary policy, and
  • the type of person appointed as Governor.

I find it worthwhile to recall that Winston Peters has history in this area.  In 1996, New Zealand First was campaigning vigorously on bringing about change at the Reserve Bank.  At the time, the particular concern was that in focusing on price stability (0 to 2 per cent inflation at the time) we were encouraging/causing an overvalued exchange rate.  The proposed remedy was that we should instead target inflation around the average of our main trading partners (then a bit higher than New Zealand).    What actually happened was that as part of the horse-trading for the coalition agreement with National, Don Brash agreed to an amended Policy Targets Agreement, in which the target was raised from 0 to 2 per cent annual inflation, to 0 to 3 per cent annual inflation.  Actual inflation had been averaging about 1.5 per  cent anyway, so although the change made a small difference to policy for a short period, the difference was pretty minimal.  After that, Winston Peters –  as Treasurer – displayed little real interest in monetary policy and never bothered the Bank again.

So my starting point, in thinking about New Zealand First influence on Reserve Bank matters now, is that although I’m quite sure that the concerns Peters expresses –  including around overvalued real exchange rates –  are quite real (and in many respects valid –  shared as they’ve been by people spanning the range from Graeme Wheeler to me), in the end not much about the conduct of monetary policy is likely to change at his insistence.  And that is probably as it should be –  our real exchange rate problems are not primarily grounded in monetary policy problems.

We also know that although Peters has repeatedly talked of preferring a Singaporean model of monetary policy (a guided exchange rate, without an officially-set OCR), both Steven Joyce and Grant Robertson during the campaign flatly ruled out such a change.  They were right to do so.  I’ve explained why in a post earlier this year.    Even if such a system was desirable, it isn’t workable (at all) for New Zealand unless and until the structural demand factors behind our interest rates being persistently higher than those abroad are tackled –  and that isn’t a matter for monetary policy.

And the Singaporean model is not one of an absolutely fixed exchange rate.  It is a managed regime (historically, “managed” in all sorts of ways, including direct controls and strong moral suasion).  It produces a fairly high degree of short-term stability in the basket measure of the Singapore dollar.      But it works, to the extent it does, mostly because the SGD interest rates consistent with domestic medium-term price stability in Singapore are typically a bit lower than those in other advanced countries (in turn a reflection of the large current account surpluses Singapore now runs –  national savings rates far outstripping desired domestic investment).  As the Reserve Bank paper I linked to earlier noted

“From 1990 to 2011, the average short term Singapore government borrowing rate was 1.8 percent p.a. below returns on the US Treasury bill.”

Those are big differences (materially larger than the difference between the two countries’ average inflation rates).  And they mean that Singapore dollar fixed income assets are not particularly attractive to foreign investment funds.  By contrast, New Zealand’s short-term real and nominal interest rates are almost always materially higher than those in other advanced countries.   Partly as a result, even though Singapore’s economy is now materially larger than New Zealand’s, there is less international trade in the Singapore dollar than in the New Zealand dollar.

So a Singaporean model just is not going to be launched in New Zealand any time soon.

If Peters sides with National, what then might he secure in this area?

An obvious possibility would be a change to the Policy Targets Agreement.  There has to be a new one when a Governor is appointed, and (if they think the current interim one is lawful and binding –  which I don’t) they could also seek an immediate change.  Such changes immediately upon a change of government have been the norm rather than the exception (having happened, to a greater ot lesser extent, in 1990, 1996, 1999, and 2008).

At the start of each Policy Targets Agreement it has become customary (Peters began the pattern in 1996) to have a preamble about what the government is hoping to achieve.  The current government’s preamble reads this way:

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.

It would be easy enough to craft a form of words that talked about avoiding an overvalued and excessively volatile exchange rate and promoting the tradables sector of the New Zealand economy.

But it won’t make any difference –  one iota of difference –  to the way monetary policy is conducted.  It is a statement of political aspiration –  and can perhaps be sold to the base as such –  not a mandate for the Governor.

Recall too that the Policy Targets Agreements since 1999 have required the Bank, while pursuing price stability to” seek to avoid unnecessary instability in output, interest rates and the exchange rate”.  On occasion, that provision has (modestly) influenced monetary policy choices at the margin (one reason I’ve favoured removing it), at least with a Governor who was that way inclined anyway.  In principle, the exchange rate element could be singled out and given more prominence further up the document.

Winston Peters’ private members bill sought to amend the statutory goal of monetary policy (section 8 of the Act) this way (adding the bolded words)

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.

I simply cannot see the National Party agreeing to that specific formulation. I hope they wouldn’t.  It goes too far and asks the Reserve Bank to do something that is impossible (real exchange rates are real phenomena, not monetary ones).   But could they consider a formulation like this one?

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 promoting the highest levels of production, trade and employment that can be achieved by monetary policy.

It is very similar to the legislative provisions introduced by the National government in 1950, in providing a greater degree of (formal) independence for the Reserve Bank and a new focus on price stability.  But in that framing the caveat “the highest levels…that can be achieved by monetary policy” is vital.   Beyond the short to medium term, monetary policy can’t do much other than maintain stable prices.

Perhaps they could find, and agree on, some clever wording.   It would be a rhetorical victory for Peters, and since rhetoric and symbolism do matter not necessarily an insignificant one.

But, so I would argue, not one that would, on its own, make any practical difference to the conduct of monetary policy.  Reflecting back on the 25 years of advice I gave to successive Governors on the appropriate OCR, I can’t think of a single occasion when the advice would have been likely to be different under this formulation than under the current wording.

What about possible governance changes –  to the formal statutory provisions around monetary policy decisionmaking?  At present, all power is vested in the Governor personally, the Governor’s appointment is largely controlled by the Bank’s Board (unlike most countries where the Minister of Finance has the main power).

I can’t imagine that the National Party would be averse to some changes in this area.  After all, Steven Joyce commissioned the Rennie review and in doing so was presumably open to at least some modest changes (perhaps legislating something like the current internal advisory committee).   But equally, it is difficult to see why New Zealand First would regard it as any sort of win to hand power to more internal technocrats.  To the extent New Zealand First favours governance changes they probably prefer a decisionmaking Board dominated by outsiders, with a strong export sector orientation.  Perhaps it isn’t a die in the ditch issue for National, but it is harder to see the two parties reaching agreement on that sort of change, even if it did produce something that looked rather like the (generally highly-regarded) Reserve Bank of Australia.

But if Peters and New Zealand First care about making a difference to the actual conduct of monetary policy over the next few years, or even to how the Bank talks about monetary policy, the key consideration is who becomes Governor.   Whatever the formal specification of the target, whatever flowery words exist around goals, the personality, instincts, “models”, and preferences of whoever is appointed Governor matters a great deal.  Partly because it is a single decisionmaker system, and partly because as chief executive the Governor (inevitably and appropriately) has a big influence on how the institution evolves, where it focuses its analytical energies and advice etc.

But the Governor selection process has been underway for months, and the Bank’s Board – all appointed by the National government –  must be getting close to delivering an initial recommendation to whoever is appointed as Minister of Finance.   No doubt the Minister of Finance would consult New Zealand First –  whether through the Cabinet appointments process, or outside it –  and the Minister can reject a Board nomination.  But the Minister can’t impose his or her own candidate, they just have to consider the next person the Board puts forward.  Since the Board were (a) appointed under the current system, and (b) have had no concerns at all about the conduct of monetary policy or the leadership of the Bank in recent years, it seems reasonable to assume they’ll be putting forward a status quo candidate (there are no known exceptional candidates).  If so, my money is on Deputy Governor Geoff Bascand who –  as I’ve written about recently –  might be a safe pair of hands, but is unlikely to be more than that, and about whom there are some concerns (especially if, as Peters appears to, one cares about the interests of bank depositors.)

In short, if National leads the next government I wouldn’t expect any material differences on the monetary policy front, even if there are some symbolic wins for New Zealand First.  Even governance reform –  which most people think desirable –  might be hard to actually deliver (the status quo will avoid any conflicts).

And what if Labour leads the next government, requiring support of the Greens and New Zealand First for legislation?

In that case, legislative reforms are more certain, but somewhat similar questions remain about what difference they might make.

Thus, the Labour Party campaigned on amending section 8 of the Act to include some sort of full employment objective.   They haven’t provided specific suggested wording, and would no doubt want official advice on that.  The Greens have endorsed that proposal and there is no obvious reason why New Zealand First would oppose it. But they might want to try to get some reference to the exchange rate or the tradables sector included, whether in the Act itself or in the Policy Targets Agreement.  The sort of wording I floated earlier in this post might provide a basis for something workable.

I’ve also previously suggested that if Labour is serious about the full employment concern, it might make sense to amend section 15 of the Act (governing monetary policy statements) to require the Bank to periodically publish its estimates of a non-inflationary unemployment rate (a NAIRU), and explain deviations of the actual unemployment rate from that (moving) estimate.  In principle, something similar could be done for the real exchange rate, but the (theoretical) grounds for doing so are rather weaker.  Perhaps the political grounds are stronger, and such a change might encourage the Bank to devote more of its research efforts to real exchange rate and economic performance issues.

But –  and I deliberately use the same words I used above –  such legislative changes are not ones that would, on their own, make any practical difference to the conduct of monetary policy.  Reflecting back on the 25 years of advice I gave to successive Governors on the appropriate OCR, I can’t think of a single occasion when the advice would have been likely to be different under this formulation than under the current wording.

The Labour Party and the Greens also campaigned on legislative reforms to the monetary policy governance model (including a decisionmaking committee with a mix of insiders and relatively expert outsiders, and the timely publication of the minutes of such a committee.)   Although those proposals would represent a step in the right direction, they are rather weak. In particular, since Labour proposed that all the committee members would be appointed by the Governor, the change would largely just cement-in the undue dominance of the Governor.    But I’d be surprised if they were wedded to those details, and it shouldn’t be too hard to reach a tri-party agreement on a decisionmaking structure for monetary policy –  probably one that put more of the appointment powers in the hands of the Minister of Finance (as elsewhere) and allowed for non-expert members (as is quite common on Crown boards –  or, indeed, in Cabinet).

So legislative change in that area –  probably quite significant change –  seems like something we could count on under a Labour-led government.

But whether it would make much difference to the actual conduct of policy over the next few years still depends considerably on who is appointed as Governor.   Not only will whoever is appointed as Governor going to be the sole decisionmaker until new legislation is passed and implemented –  which could easily be 12 to 18 months away –  but that individual will be an important part of the design of the new legislation and the sort of culture that is built (or rebuilt) at the Reserve Bank.

As I noted earlier, the appointment process for the Governor has been underway for months.  Applications closed at a time –  early July –  when few people would have given the left much chance of forming a government.  And the Board, all appointed by the current government and strong public backers of the conduct of policy in recent years, have the lead role in the appointment.   Perhaps a new Labour-led government would reject a Bascand nomination.  But even if they did so, they have no idea which name would be wheeled up next.

There are alternatives, if the parties to a left-led government actually wanted things done differently at the Bank.   First, they could insist that the Bank’s Board reopen the selection process, working within the sorts of priorities such a new government would be legislating for.  Or they could simply pass a very simple and short amending Act to give the appointment power to the Minister of Finance (which is how things work almost everywhere else).  Of course, there is still the question of who would be the right candidate, but at least they would establish alignment of vision from the start –  a reasonable aspiration, given that the Reserve Bank Governor has more influence on short-term macro outcomes than the Minister of Finance, and yet the Minister of Finance has to live with the electoral consequences.

Over time, governance changes are important as part of putting things at the Reserve Bank on a more conventional footing (relative to other central banks, and to the rest of the New Zealand public sector).   I think some legislative respecification of the statutory goal for monetary policy  –  along the lines Labour has suggested –  is probably appropriate: if nothing else, it reminds people why we do active monetary policy at all.   But on their own, those changes won’t make any material difference to the conduct of monetary policy  –  or even to the way the Bank communicates –  in the shorter-term (next couple of years) unless the right person is chosen as Governor.  Perhaps so much shouldn’t hang on one unelected individual, but in our system at present it does.

Symbols matter, but so does substance.  It will be interesting to see which turns out to matter more to a new government with New Zealand First support.

In closing, there is a long and interesting article in today’s Financial Times on some of the challenges – technical and political –  facing central bankers.  As the author notes, in many countries authorities are grappling with a mix that includes very low unemployment and little wage inflation.  In appointing a Governor for the Reserve Bank of New Zealand, it would be highly desirable to find someone who recognises, and internalises, that the challenges here are rather different.  Unlike the US, UK, or Japan (for example) New Zealand’s unemployment rate is still well above pre-recessionary levels –  when demographic factors are probably lowering the NAIRU –  and real wage inflation, while quite low in absolute terms, is running well ahead of (non-existent) productivity growth.    There are some other countries – the UK and Finland notably –  that also have non-existent productivity growth, but it is far from a universal story.  Productivity growth carries on in the US and Australia and (according to a commentary I read last night) in Japan real output per hour worked is up 8.5 per cent in the last five years (comparable number for New Zealand, zero).

Some of these issues are relevant to monetary policy (eg unemployment gaps) and some are relevant to medium-term competitiveness (wages rising ahead of productivity growth).  We should expect a Governor who can recognise the similarities between New Zealand’s experiences and those abroad, but also the significant differences, and who can talk authoritatively about what monetary policy can, and cannot, do to help.  Perhaps even, as a bonus, one who might even be able to provide some research and advice to governments on the nature of the economic issues that only governments can act to fix.





7 thoughts on “Implications of a new government for monetary policy

  1. Michael Graeme Wheeler from my layman’s perspective seemed to be very concerned about the housing market. His interventions with Macroprudential Tools to my mind did have an effect on the market. In particular increasing the LVR requirement to 40% for investors last year.

    Michael do you think the next RB governor will be as interventionalist wrt the housing market?


    • Depends – almost wholly – who it is. It isn’t an area where there is any decent accountability framework or the like, so the instincts, preferences, “models”, of the individual appointed will matter even more than for monetary policy.


  2. Hi Michael. I was struck by your line that “Whatever the formal specification of the target, whatever flowery words exist around goals, the personality, instincts, “models”, and preferences of whoever is appointed Governor matters a great deal.” If the target for the RBNZ doesn’t change – and the individual is reasonably competent – I’m not sure the choice of Governor matters much for the “eventual” monetary policy path. Right now there is also plenty of noise around who Trump might choose as next Fed Chair. While there may be immediate market movements on whether the candidate is seen as a hawk or dove my take is that this would be short-lived. The goals of the Fed (and all central banks) are a fairly well-established consensus – at least for now – so data is the key driver of monetary policy. As an example, too much is made of the differences in the Fed dots which I suspect are almost entirely differences in the contributors forecasts for inflation/unemployment and much less differences in how they would respond to the same set of economic data. Coming back to the RBNZ, the 2014 tightening that had to be subsequently unwound – and which you correctly railed against at the time- was in the main a forecasting error. I get the point that a different RBNZ Governor (perhaps with the help of a few sensible outside Board members) may have put less weight on an uncertain forecast and waited for more information. But the eventual endpoint for the OCR would have been similar. To finish, where I think the next Fed Chair (and perhaps the RBNZ Governor) may have a larger impact is around financial regulation. peter


    • Peter

      I entirely agree with your final sentence. As I noted to an earlier commenter, the absence of any real accountability framework or well-specified goals around the financial stability functions means that, absent governance changes, the new Governor will have a great deal of influence, with little firm guidance to go on. (This post of course wasn’t dealing with the financial regulation side.)

      On monetary policy, I guess I’m not so convinced (although of course agree to the extent that the inflation target itself isn’t going to change and that ultimately will anchor policy whoever the individual is). Re 2014, yes GW eventually unwound the tightening, but probably had to cut further partly because the unnecessary tightenings lowered inflation expectations. But perhaps a bigger point is that we still ended up, with no ZLB problems, with an inflation outcome over 5 years well below the target midpoint. That was a choice – including about which risks to run. A different Governor could, in principle, have cut more aggressively earlier, totally avoided 2014 and the aftermath, determined to ensure that inflation (core) was averaging at least 2% for as long as U was above (reasonable estimates of) NAIRU. Here I’m not focused on arguing that the outcomes would have been better – who knows – but they would have been different, and those differences wouldn’t just have been the odd tenth of a percentage point on inflation. In addition, the rhetoric would have been materially different.

      I don’t want to overstate how much difference mon pol can/does make – ultimately I’m totally orthodox on mon pol neutrality in the long run – but i do think individuals matter (esp in our system). I agree with you about the US dot plots, but I also suspect that the US regime is a bit more entrenched/individual-resistant than our own system – altho if Trump were to appoint Kevin Warsh as chair, even that proposition might be put to the test.

      Bottom line for us: flowery words won’t change very anything. An individual may not change very much either, but if you just accept the status quo candidate wheeled up by the Board, you’ll most probably just get more status quo. Some are happy with what they’ve had: Winston, and Lab/Greens, suggest they aren’t.


    • Thanks Jim

      And just to be clear, when I’m talking of exchange rate overvaluation (and I pretty sure that applied for Graeme Wheeler too) I’m not talking of a Dornbusch overshoot relating to monetary policy adjustments, but to longer-term structural considerations, not materially amenable to monetary policy. Graeme often used a macrobalance approach, while my thinking is more akin to a Balassa-Samuelson model.


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