Towards a new Policy Targets Agreement

In 20 days time, 27 March, Adrian Orr is scheduled to take office as Governor of the Reserve Bank.  I say “scheduled” because he can’t be appointed until he and the Minister of Finance have signed a Policy Targets Agreement consistent with the statutory objective for monetary policy set out in section 8 of the Reserve Bank Act.

We can assume there will such a Policy Targets Agreement.  After all, the current (unlawful) acting appointment of Grant Spencer ends on 26 March, and all the powers of the Reserve Bank are vested in the Governor personally.

But given that (a) Orr’s appointment was announced three months ago, and (b) the changes in focus for monetary policy that the new government has foreshadowed, it isn’t very satisfactory that we still have no Policy Targets Agreement, and that whatever is being cooked up is being done in secret.   Perhaps I get repetitive in making the point, but as I’ve noted previously the Policy Targets Agreement is the main instrument of macroeconomic management, signed up for five years at a time, and then with all the powers delegated to a single individual (who hasn’t even been inside the Reserve Bank before signing up to his new mandate). against whose decisions there are no rights of appeal.

There is also a review of the Reserve Bank Act underway at present.  When the Terms of Reference were announced  –  four months ago today – we were told that as regards the first part of the review, dealing with monetary policy goals and governance,

A Bill to progress the policy elements of the review, including on the details necessary to introduce a potential committee for monetary policy decisions, will be introduced as soon as possible in 2018. This will give greater certainty on the direction of reform in advance of the appointment of the next Reserve Bank Governor, currently scheduled in March 2018.

The clear suggestion was not just that a report might have been provided to the Minister of Finance, but that a bill would have been introduced to Parliament before the new Governor took office.   The decisions in that legislation would, it was implied, inform PTA negotiations.   That phrasing was repeated when the Independent Expert Advisory Panel was appointed in December.

At the time we were also told that

The Panel will also be responsible for a report to the Minister that sets out their views on the Treasury’s policy conclusions and recommendations for phase 1. This will be delivered to the Minister at the same time as the Treasury’s recommendations for phase 1, which is planned for the second half of February.

Treasury’s dates seem to have been slipping.  The web page for the review now says

For Phase 1, please provide any submission to us by 19 February 2018 if you would like your input to be considered before initial advice is provided to the Minister.

If submissions were only due by 19 February, it didn’t give much time for (a) Treasury to reach its conclusions, and (b) for the independent panel to reach and write up their views on the conclusions, all by “the second half of February”.

When this review was initially announced the dates seemed tight but, if observed, ones that might allow some external discussion before the new Policy Targets Agreement was set, especially around the proposed wording of any change to the statutory objective of monetary policy.   As things stand now, we seem most likely to be shortly presented with some sort of fait accompli.

It isn’t a good way to make policy.  The details of the legislation will, in time, be subject to select committee review (and the publication of associated submissions) but the Policy Targets Agreement itself –  including the extent to which it aligns with the proposed new legislation – will have legal force almost right away.   There is no good reason why a more open process could not have been adopted.  At very least, I hope that the Minister of Finance will instruct the Reserve Bank and Treasury to pro-actively release all the papers relating to the forthcoming PTA (it took several years after the event to extract those relating to the 2012 PTA).

And when the Minister sits down to decide what he wants in the Policy Targets Agreement, I would urge him to take much more seriously –  than there is any sign his predecessors, or officials, did over the last few years –  the next serious recession.  As a reminder, in typical recessions short-term interest rates fall (or are cut)  by 500 basis points or more, and at present –  with inflation below target midpoint –  the OCR is at only 1.75 per cent.   I talked yesterday to a journalist who asked how this might be done.   I don’t think it is a matter of changing the inflation target itself at present – that might be appropriate at some point but should be a last resort –  but there are at least three items which could be included either in the Policy Targets Agreement (preferably, since it is an agreement) or in the Minister’s non-binding letter of expectation to the Governor.

  • The Reserve Bank should be required to prepare and provide to the Minister (preferably disclosing the bulk of such a report) a report on practical options that could be put in place early to alleviate or remove the near-zero lower bound on nominal interest rates.  The Reserve Bank’s forthcoming Bulletin article on digital money –  now apparently delayed –  (which they told me about when they refused to release any of their work in this area) may be one input to such work,
  • In conducting monetary policy, and without derogating from its obligation to act to keep inflation within the target, the Reserve Bank should be required to have regard to the desirability of there being as much effective policy capacity (or at least rather more than at present) as possible to respond to the next serious recession, and
  • consistent with that, the Minister could indicate that he would be more comfortable if core inflation over the next few years fluctuated in, say, the 2.0 to 2.5 per cent part of the target range, than if core inflation continued to fluctuate around 1.4 per cent as it has now for a number of years.

It might also be desirable to require the Governor to publish a substantive statement, perhaps within a month of taking office (or at the next MPS), outlining his interpretation of the new Policy Targets Agreement.  We should not have to rely on discovering the meaning of a major instrument of macro policy  solely by revealed preference.

Our Reserve Bank isn’t the only one facing a change in the way its objective is specified.  Just recently, a new objective was set down for the Norwegian central bank, the Norges Bank.   It was the culmination of a two-year process, of which the Ministry of Finance observed

The Ministry has placed emphasis on ensuring a transparent process

The new specification lowers the inflation target –  from 2.5 per cent to 2 per cent.  The initial 2.5 per cent target, adopted in 2001, had been justified on the basis of Balassa-Samuelson types of effects –  as the oil wealth flowed, Norway might have expected to see high non-tradables inflation rates.  Norway is now, on their own reckoning, past that phase.

Here is the bulk of the (notably short) new mandate

Section 1 Monetary policy shall maintain monetary stability by keeping inflation low and stable.

Section 2 Norges Bank is responsible for the implementation of monetary policy.

Section 3 The operational target of monetary policy shall be annual consumer price inflation of close to 2 percent over time. Inflation targeting shall be forward-looking and flexible so that it can contribute to high and stable output and employment and to counteracting the build-up of financial imbalances.

Section 4 Norges Bank shall regularly publish the assessments that form the basis of the implementation of monetary policy.

The second sentence of section 3 is new –  explicit references to “high and stable output and employment” and also to ‘counteracting the build-up of financial imbalances’.  The latter provision is completely new, while the output and employment reference replaces the current objective of “contributing to stable developments in output and employment”.

What I liked was two things:

  • firstly, the deliberate and transparent process used to make the change, and
  • secondly, the public exchange of letters betweeen the Ministry of Finance and the Norges Bank explaining the change and (from the central bank’s side) explaining how the Bank envisages implementing the mandate.  Thus, on the financial imbalances point they note:

The regulation and supervision of financial institutions are the primary means of addressing shocks to the financial system. To some extent, monetary policy can contribute to counteracting the build-up of financial imbalances and thereby reduce the risk of sharp economic downturns further ahead. How much weight this consideration will be given in the conduct of monetary policy will be situation-dependent and must be based on an overall assessment of the outlook for inflation, output and employment.

I don’t think the Norges Bank specification is the appropriate one for New Zealand.  If it were adopted it would be a sign that the government wasn’t really serious about a greater focus on employment outcomes and minimising deviations of unemployment from an (unobservable) NAIRU.   But the open and deliberate process looks like a good example to follow.

In the New Zealand context, one legislative change that should be made is that future Policy Targets Agreements (or mandates from the government, if that were the chosen model) shouldn’t be developed before a new Governor takes office.  (Among other reasons, because no new Governor appointed since the early 1980s has had any recent practical experience with monetary policy).  The target should instead be set, say, every five years (with potential for changes more frequently than that  – eg in the event of a change of government), with a requirement that prior to any new PTA there should be a period of public consultation.  The Reserve Bank has to do that when, eg, it wants to impose new LVR limits.  Governments typically have to do that when they want to legislate (select committees).  For such a major instrument of macroeconomic policy, it seems fitting that a similar sort of process should apply.


5 thoughts on “Towards a new Policy Targets Agreement

  1. Hypothetical question. Let’s say the government implements a suite of reforms to increase saving across the government, business and household sector. The central bank must offset that to meet its target. How do you propose they would do that? I assume they would lower interest rates, but I would also expect to buy foreign currency sovereign bonds, in order to ensure enough demand came through the X-M channel. Do you agree, or only if interest rates have hit the ZLB?


    • The Labour Government is not about savings but one of spending. So the current 100 day plan is all about spending and not savings. The suite of savings you have already seen the impact under the National government. They did this to get into a surplus position putting in a suite of savings across all government departments while footing the bill for a disaster recovery. The end result is, well you have already seen the end result. A change in government due to the health system underfunded, welfare system underfunded, infrastructure spending – non existent, social housing underfunded, increase in homeless, EQC underfunded and under-resourced leading to poor Christchurch disaster repairs.

      The Central Bank should have taken a larger leadership role in the recognition of the size of the disaster which was a $20 billion to $30 billion recovery. Instead they touted that disaster as a boon to the NZ economy and started to increase interest rates in the face of a disaster recovery with many economists trumpeting the NZ rockstar economy. They should have instituted a $50 billion QE so that the disaster recovery would be fixed pronto rather than dragged out forever from the governments operational budget. Ridiculous.


      • Would you have targeted Christchurch with the QE, or, instead opted for helicopter money for ChCh residents alone, or gone for National QE for the lot


      • Central Bank QE tends to be of a National QE nature but it does not guarantee that the funds available are used for a specific purpose. The intent being to lower the cost of funds and to allow the banking system to be flush with cash and therefore make that liquidity available to the general public.

        In our Christchurch example, you would want that lower cost of funds and liquidity available to people, businesses, builders, insurers and EQC and to the government Earthquake Recovery Ministry to speed up recovery. Not too sure of the specific mechanism that a Central Bank could undertake to make that liquidity more available in Christchurch. Perhaps a segmented LVR macroprudential tool to prevent that additional liqudityity floating into Sharemarket investments and property values.


  2. I don’t think fx intervention would make any material difference to anything, notably the exchange rate, unless we got to the ZLB and any such intervention was unsterilised. Even then, I suspect the unsterilised purchases would make the difference, not the currency of the asset purchased.

    But recall my view that if we got near the general level of foreign interest rates, the exchange rate would be a great deal lower. The 2000 experience remains salutary for me – NZD/USD was about 39cents.


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