Looking to the MPS

I was tempted to write a post about the new head of the Irish central bank, perhaps offering some pointers to my (handful of) Irish readers about the propensity of their new British Governor to speak openly, and typically not in a very robust or convincing manner, about all manner of things, all while the foundations of New Zealand’s economic prosperity –  our dismal productivity record –  were neglected.  No doubt he will be a solid administrator and is a nice guy, but it seems like quite a step down from Governors such as Philip Lane and Patrick Honohan.   That said – and unlike the New Zealand situation – at least the appointment  of the Governor was made by someone (an elected minister) with a democratic mandate.  As for the vacancy in the position of New Zealand Secretary to the Treasury, one can only hope that between the Minister and the State Services Commissioner they come up with a better appointment this time round.  But as I noted earlier in the year after the advert appeared, it is hard to be optimistic.      After all, it isn’t obvious that either the Minister or SSC sees a problem.

But to revert to more-mundane central banking, next Wednesday will see the release of Reserve Bank’s Monetary Policy Statement, the first (and first OCR decision) for which the new statutory Monetary Policy Committee is responsible (rather than the Governor personally).  There will be more interest than usual in this MPS.  In part that is because for the first time in a couple of years or more there is some genuine uncertainty as to what the OCR decision itself (as distinct from the language around it) will be.  But it will also be because of the new Committee and the uncertainty over how it will communicate (we know the minutes will be published at the same time, but don’t know what they will look like, we don’t know whether the MPS itself will look any different (probably not), and we don’t know whether some or all of the external members might start to avail themselves of the opportunity to speak openly (eg that thing called accountability)).

I’m pretty clear that the OCR should be a bit lower.  My reasons for that are straightforward:

  • core inflation is still below the focus of the target (the 2 per cent midpoint) –  has been for years, and any progress back towards 2 per cent seems to have petered out again,
  • market-based measures of medium to longer term inflation expectations are very low (close to 1 per cent),
  • that forces that added to demand growth this decade have more or less exhausted themselves and so there is little reason to expect (as a central view) higher inflation over the next year or two on current monetary policy settings,
  • confidence indicators are weak, output and employment growth have been slowing, and there is little sign of over-full employment, and
  • the global situation offers much the same set of messages (weak inflation, subdued output growth etc, albeit –  at least in some major economies –  with a better unemployment position than we have in New Zealand).

(And all this, even though New Zealand wage inflation –  often characterised as weak –  continues to outstrip growth in productivity and the terms of trade.)

But the focus here is on what the new Monetary Policy Committee might choose to do.

In his final statement as sole monetary policy decisionmaker, the Governor shifted his stance, expressing it this way

The balance of risks to this outlook has shifted to the downside. The risk of a more pronounced global downturn has increased and low business sentiment continues to weigh on domestic spending. On the upside, inflation could rise faster if firms pass on cost increases to prices to a greater extent.

The shift to an explicit statement of a (net) downside risk –  and thus more likelihood of an OCR cut than an increase in the period ahead – took quite a few by surprise in late March.

My reading of the data is that not much has changed since then. In other words, we have had another month or more of pretty subdued data and no fresh signs that (core) inflation is likely to get back to target.  Against that sort of backdrop, it would be quite easily justifiable to cut the OCR next week –  not necessarily foreshadowing a succession of future cuts, but just to provide a bit more of an underpinning for demand, and a bit more support for getting core inflation back to 2 per cent.

But, equally, it would be mechancially easy enough for the Bank –  having come only lately to recognise the need for a downside risk at all – to simply stand pat.   And, if anything, the Governor was sounding quite unbothered about the “recent slowdown in growth” in an interview with NBR last week.

What the Committee finally chooses to do has to be, more than might usually be the case, anyone’s guess.

For a start, the economic forecasts (that influence and are shaped by) the Committee’s policy preferences must be more of a wild card.  The forecasts will, presumably, be owned by the MPC itself –  not just treated as staff forecasts –  but four of the seven MPC members weren’t involved in the previous MPS and associated full forecast round.  One of the other members will have been, but he is now in a quite different (and vitally important) role as the Bank’s Chief Economist.

And we know almost nothing about the policy preferences, or mental models, of any of the new external members (or some of the internals).  How do they interpret the mandate?  How do they think about the relevance of overseas risks?  How much confidence do they have in the value of economic forecasting at all?   We don’t even know much about the Governor’s own views on such matters because (endlessly repeated point) he has not given a single public speech on monetary policy in his time in office.  Glib one-liners aren’t the same thing at all.

One thing I think we can count on is that there will be no vote, and thus no disclosure in the minutes of any difference of view among the MPC members.  Even if some members aren’t fully happy with where the majority is heading, the Governor is likely to put pressure on the externals not to explicitly dissent –  after all, he and the Minister have championed the “consensus” model, one which strengthens the relative hand of the Governor.  If there was a dissent first time up, that might establish a pattern or precedent that management really wouldn’t want.  As it is, it is hard to believe that any of the externals –  none with a significant background in monetary policy or forecasting –  would be wanting to buck the internal majority anyway, lest of all first time up.

The Governor has spent some time pushing back against suggests that his monetary policy communications has not been good.  In that NBR interview, he claimed again that it it isn’t his job not to surprise markets, and went on to suggest that picking the next OCR call was “barely necessary” and that energy devoted to it might be better devoted to lifting productivity, improving the health system or whatever.  I don’t suppose those comments –  typically glib –  will have endeared him to his critics in the market (eg those reported in the recent Reuters story).     For all his bluster, however, it would be a bit surprising if he wasn’t being advised to avoid further unnecessary controversy over his communications (especially now that, at least in principle, he represents the MPC not just himself).   That doesn’t necessarily determine which way the Bank will go, but perhaps there might be fewer comms risks from cutting now, than risking some sort of whipsaw reaction if they get the messaging wrong around holding fire for now?

One other consideration that may be relevant is the RBA interest rate decision next week.   Markets had swung to the view that the cash rate would be cut when the RBA Board meets on Tuesday –  core inflation is now badly undershooting the midpoint of the RBA target –  and I gather market opinion is now fairly evenly balanced.   (Ten days out from a general election is always an awkward time for monetary policymakers.)  The Reserve Bank of New Zealand MPC will almost certainly make their decision (more or less finally) before the RBA decision is known, but given that the Governor noted in March an unease that other countries easing while we didn’t could put upward pressure on the exchange rate, it might be appealing to him to move now.     If the RBA cuts and he doesn’t, there will be press conference questioning about “why wait?”, and if he cuts and the RBA hasn’t done so, the Governor could look pro-active and responsive.

I mostly don’t do MPS preview posts, and did so this time mainly because I’m interested in the legislative change and the impact/implications of the new system, and the uncertainty the transition generates.  In a poll earlier this week, I predicted a cut but, asked about the strength of my view, described it as a 51/49 call.  I see one of the big banks has just put out a note taking a similar view (55/45). It is easy to say that individual OCR decisions don’t matter that much –  and there is some truth in that, but they set the scene for the next one.  Probably no one can really claim they will be too surprised which way the OCR call goes on Wednesday, and the bigger challenge –  opportunity for getting things wrong –  is probably around the rest of communications (both the wording of the policy statement itself and the credibility of the forecasts, all shaped by new leadership).

There are now seven holders of statutory MPC positions. Not one of whom has made any serious speeches or paper on monetary policy (we know nothing of the views of most them), the Bank needs to be looking to improve its medium-term monetary policy communications quite materially.  It would be an inconceivable situation for most other advanced country central banks –  and those monitoring them –  to find themselves in.



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