Keep the focus on monetary policy

As we approach the OCR decision this afternoon and as some market economists are now talking about the possibility that the OCR could be below 1 per cent before too long, there has been more and more talk about whether fiscal policy should be brought to bear, to stimulate demand and (in some sense) assist monetary policy in its macroeconomic stabilisation role.  Just this morning there was an editorial in the Herald, a column on Stuff, and a comment from Bernard Hickey at Newsroom.   Some of the discussion is about what should be done now, and the rest is about contingency planning –  what happens when the next serious recession happens if the OCR is still constrained.

Much of the discussion seems to stem from people on the left who aren’t that happy with the government’s fiscal policy.  As someone not on the left, it has always seemed strange to me that Labour and the Greens pledged themselves to keep much the same size of government (and much the same debt) as National –  especially when, at the same time, you were running round the country talking about severe underspending on this, that, and the other thing.   I’m also of the view that structural budget surpluses are a bad thing, in principle, when net government debt is already acceptably low (on the OECD measure of net general government financial liabilities, New Zealand is now about 0 per cent of GDP, which seems like a nice round number – an anchor – to target).  There is an argument there –  whether from left or right – for some fiscal adjustment (taxes or spending), which might have the effect of a bit more of a boost to demand.

But those arguments really have almost nothing to do with the situation facing monetary policy.    They are fiscal and political arguments that should be made, and scrutinised, on their own merits: the arguments would be as good (or not) if the OCR was still 2.5 per cent as they are now, and you can be pretty sure that people on the left would have been making them then anyway?   The Governor of the Reserve Bank, for example, (a pretty staunch representative of the centre left) seemed keen on more infrastructure spending a year ago.  I guess he is a voter to so is entitled to his opinion, but it really doesn’t have much to do with monetary policy.

The general arguments that led countries around the world to adopt monetary policy more exclusively as the primary stabilisation policy tool have not changed.  Monetary policy can be adjusted quickly (to ease or tighten), operates pervasively (gets in all the cracks, without making specific distributional calls), is transparent, and so on.  If we had a fixed exchange rate –  as individual euro area countries largely do –  it would be a bit different (individual countries don’t have the monetary policy option any longer) but we have a floating exchange rate system which, mostly, works well for New Zealand.

To the extent that there is a monetary policy connection to the current calls for fiscal policy to be used (or the ground prepared to use it), it has to do with the looming floor on nominal interest rates.  International experience suggests that, on current laws and technologies, short-term nominal interest rates can’t be reduced below about -0.75 per cent without becoming ineffective (as more and more people shifted from other financial instruments into physical cash).  We don’t know quite where that floor is, as no central banks has been willing to take the risk of going further, but there is a fair degree of consensus (and it has long been my view too).

But that still means that in a New Zealand context there is 200 basis points of OCR cuts that could be used if required.    That isn’t enough for a typical New Zealand recession (rates have often been cut by 500bps), but is still quite a degree of leeway if what we are entering were to turn out to be a fairly mild slowdown in New Zealand.  It could (I’m not hedging here).   That capacity should be used energetically, not timorously.   So the issue –  monetary policy needing “mates” deployed now –  is not immediate.  It is about preparing the ground.

And there, the best macro stabilisation option remains the one the Reserve Bank –  and other central banks –  have done nothing active about, but really should.  Authorities (and it probably needs political support to do so) should be moving to make the effective floor on short-term nominal interest rates much less binding than it is.   It binds because the practice of central banks –  perhaps backed by law – has been to sell banknotes, in unlimited quantities, at par.   That practice can be changed.  It could be as simple as putting an (adjustable) cap on the volume of notes in circulation (quite a bit above the current level, but not at a level that would be transformative) and then, say, auctioning the right to buy additional tranches of bank notes from the Reserve Bank.  In normal times –  with the OCR at, say, current levels – the auction price would be at par.  If the OCR were cut to, say, -3 per cent (and be expected to stay there for some time) the auction price would move well above par, acting as a disincentive on people to attempt to make the switch from deposits to cash.  There is a variety of other ideas in the literature, as well (no doubt) as much less efficient regulatory interventions that could prevent really large-scale conversions happening.

Unusual as such options may sound, this is where the authorities –  here and abroad –  should really be concentrating their energies: giving monetary policy more leeway, in ways that will buttress market confidence that monetary policy will do the job when it is required.  At present, by contrast, when market participants contemplate a severe downturn they look into an abyss wondering what, if anything, will eventually be done, by whom, and for how long.  In a serious downturn that will just worsen the problem, driving down inflation expectations as economies slow (note that in the RB survey out yesterday, medium-term inflation expectations fell away quite noticeably –  and this while we still have conventional monetary policy to use).   And if there are objections that all this is somehow “unnatural”, bear in mind that had the inflation target been set at zero (rather than 2 per cent), as was the normal average inflation rate for centuries, we’d already have run into these practical limits, and been unable to get real interest rates even as low as they are now.

So there is plenty to be done with monetary policy, and the work programme to do it should be something open and active, drawing in the Bank, the Treasury, the Minister, and other interested parties.  The time to do preparation is now, not in the middle of a surprisingly severe downturn.

I have a few other reasons –  than “it shouldn’t be necessary” –  to be wary of calls for large scale fiscal stimulus now.  Just briefly:

  • there would be little agreement on what should be done –  these are inherently intensely political issues.  There is lots of talk of infrastructure gaps etc, but no agreement on what those are, let alone recognition of the twin facts that (a) the best projects, with the highest economic returns, have probably already been done, and (b) New Zealand government project evaluation is not such as to inspire confidence that new projects would add economic value.    And suppose there were attractive roading projects –  perhaps central Wellington and the second Mt Vic tunnel? – we know the attitude of the government’s support partner to new major roads.  Not a thing.  So what should we then spend on?  Uneconomic new railway lines?  Or what?  Perhaps some just favour more consumption or transfers spending – which might be fine if you are a lefty who believes in permanently bigger government, but if you aren’t the issue has to be addressed of how programmes once put in place are unwound later.
  • I don’t rule out the possible case for discretionary fiscal stimulus in the event of a new severe recession (especially if the authorities refuse to address the monetary policy issues above) but my prediction is that (in many ways fortunately) the political appetite for large deficits would not last very long, and that therefore we should preserve the option for when it might really be needed.  It isn’t now.   I take much of the rest of the world after 2008 as illustrations of my point: in late 2008 all the talk was of fiscal stimulus, but within two or three years all the political pressure was to pull deficits back again.  I don’t see why New Zealand would be any different (and that is to our credit, since low and stable debt has become established as a desirable baseline).
  • And thirdly, a point we don’t often hear from champions of more fiscal stimulus, relying more on fiscal policy and less on monetary policy to support economic activity and demand will, all else equal, put more upward pressure on the real exchange rate, further unbalancing an already severely-unbalanced economy (see yesterday’s long-term chart of the real exchange rate).  In a severe recession –  when the NZD tends to plummet –  that isn’t a particular problem, but it should be a worry now (when the TWI is still a bit higher than it was a year ago, let alone thinking about the longer-term imbalances.

Perhaps the Governor and the (experts-excluded) Monetary Policy Committee will proactively address some of these issues this afternoon. I do hope so. If not, I hope some journalists take the opportunity to push the Governor on why he (and the Minister and Treasury) aren’t actively pursuing work to make the lower bound on nominal interest rates much less binding, in turn instilling confidence in the capacity of New Zealand policy to cope conventionally with a severe downturn if/when it happens.

Oh, and I do hope some journalists might also ask the Governor this afternoon about the justification for ruling out from consideration for appointment to the Monetary Policy Committee

“any individuals who are engaged, or who are likely to engage in future, in active research on monetary policy or macroeconomics”

The Governor is, after all, a Board member and was one of the three person interview panel.    What was it that he –  or the Board generally –  were afraid of?    Expertise?  An independent cast of mind?  Of course, it isn’t only active researchers who have such qualities –  indeed, not all of them do either –  but it simply seems weird, and without precedent in serious central banks elsewhere in the advanced world, to simply disqualify from consideration for the (part-time) MPC anyone with the sort of background that many other central banks (Australia, the UK, the euro area, Sweden, the United States, and so on) have found useful, as one part of a diverse committee.

31 thoughts on “Keep the focus on monetary policy

  1. The government could increase fiscal spending – best via transfers, wages and tax cuts – as infrastructure spending will become bogged down, but not clear how much stimulatory effect it will have. The government could run a deficit and get the bank to finance it directly, allowing the money supply to expand, but we aren’t there yet. As a small open economy the government could ramp up funding to Guardians of NZ – again debt financed by the RBNZ – to buy foreign assets and drive down the NZD (we aren’t parties to the G-20 accord on currency) and a weaker NZD could be very stimulatory.

    We have options.

    We aren’t there yet, monetary policy and fiscal spending from surpluses provides us some room to move. But my advice on unconventional measures would be to avoid QE like the plague, try to avoid negative rates if possible, and use monetised deficit spending and direct FX purchases to provide stimulus.

    As a small open economy, we inflict a recession on ourselves when we have options, if we don’t use the currency.

    Liked by 1 person

      • In the US, QE is mainly a swap of US treasury bonds with a 10% US cash deposit reserve that requires every bank to hold 10% cash reserves with the US Federal Reserve of savers deposits collected.

        In NZ our Reserve Bank does not hold any cash deposits and therefore has no ability to swap out NZ treasury bonds with a Reserve bank cash deposit. It does not exist in NZ.


      • That simply isn’t correct. The RB can buy bonds, and proceeds would be credited to banks’ exchange settlement accounts at the RB, the level of which would rise commensurately. Reserve requirements (or absence of them) are irrelevant in this context.


      • The NZ Reserve Bank has no cash other than a small $10 billion Foreign Currency intervention fund. What will it use to buy NZ treasury bonds? Create NZ dollars out of thin air is just an ill disciplined approach.


      • The US Federal Reserve was far more disciplined in its QE approach than what you are suggesting with our NZ, 8 wire approach.


    • Interesting ideas Peter. I’m more sceptical than you appear to be on fx intervention. It probably won’t be needed if the OCR is -0.75% (yield gaps to the rest of the world will have closed) and if the OCR is still around current levels probably won’t be effective (just some cheaper entry levels).

      In the current climate I would be wary of one option that would lower the RER quite a lot – cutting medium-term immigration – because, whatever the longer-term issues, the short-run demand effects of immigration really outweigh the short-run supply effects.


      • When tourists and international students demand NZ$17 billion every 12 months for their spending and entertainment activities, immigration other than international students have little or no effect.


    • The “Infrastructure spending” we typically funded looking at the last recession is pretty low value. The added value of paying someone to build a new road is currently pretty small. Building focused research & development infrastructure and then funding programs (sort of like NASA’s X planes) that use said infrastructure to develop a core capacity while higher risk offers magnitudes greater returns (how to close the carbon loop profitably or autonomous maritime mining systems & the like would be high value capacities to develop).

      Many of the fiscal stimulus methods considered ignore the value of critical mass, is giving everyone a $1000 dollars really more effective than using a lottery to give one in a hundred $100,000. Would it still be more effective than if it was used to subsidise the domestic production of something which the government brought overseas (the Ozzies can spend~25% more on locally built warships before it would have been cheaper to bought from overseas). The effect of quantitative easing on US companies was in many was negative causing them to drastically reduce R&D spending as well as quitely likely contributing to the management cultures that give Boeing the 737 Max problem. Maybe we need to look to more traditional forms of government involvement in the economy


  2. I am not a fan of really low interest rates.
    What happens to savers, increase their risk by gong to shares?
    What are the effects ob retail rates.

    Put the emphasis on infrastructure spending. One problem here is governments spend for political purposes not economic.

    Here in OZ the government ( and Opposition ) only support 2 of the 34 projects Infrastructure Australia has on their priority list.


    • Lower interest rates are not going to work if the RBNZ continues to demand for higher capital retention which is equivalent to holding cash underutilised in the bank and not available for investment or consumption.

      Also equity LVR controls are still in place at 30% which limits investors from enjoying the wealth effect of higher property prices and banks have been forced to incorporate responsible lending rules and disband commission targets for employees.

      Inflation and the economy ran hot in 2002 to 2007 due to loose bank controls. Low Documentation loans was common for self employed buyers. I am not suggesting the bad old days but certainly some looser bank controls would allow the wealth effect to filter through to the economy.


  3. As here, infrastructure has become quite political (more so now the Greens in govt oppose roads in principle).

    I suppose my take is that ever-lower interest rates aren’t a first-best, but neither are overvalued exchange rates or underutilised resources.


  4. The Government is typically a poor judge of aded value when it comes to increased spending, but deficits can be increased and spending stimulated through tax cuts – then people get to chose where they spend their money and make better decisions on its use. Why is that not an option?

    Liked by 1 person

    • The standard counter is that tax cuts don’t do much to stimulate demand directly because the people who pay lots of tax tend to be relatively high income earners and thus less likely to spend any new after tax income quickly.

      So purely from a short term demand stimulus perspective, direct govt purchases of goods and services tend to do more more quickly.


      • Actually monetary policy also does not do much to NZ household spending because the amount of NZ cash savings deposits closely equal the amount of NZ Household house borrowings. In fact there are more savers in numbers than there are borrowers so you could argue that lower interest rates result in less spending by more people.

        Lower interest rates however do help businesses that do rely on loans to run their businesses. However, residential overdraft interest rates which most of our small businesses rely on continue to run at the high end of 5.3% which means businesses are no better off under this OCR drop to 1%. On commercial interest rates, the interest rates would be still around 7%.


  5. For the past two weeks the currency cowboys have been aggressively selling the NZD/AUD pair. Today, post 2:00 pm they are covering short positions. NZD down 1200 pips


  6. Attending a Government led auction on the right to acquire currency: on a continuum of public confidence to public angst, I’d predict the latter.


  7. Anyway regardless what is happening here in Oz or back in NZ with low interest rates or the stupid tax cuts here in Oz as my tax cuts if do get them are going on the mortgage repayments (note I’m on a service pension after my med discharge from the ADF) As I prefer to see some form of QE and spending on infrastructure on either side of the ditch, but I think the real ticking time bomb is China atm if this article is anything to go bye which would blow any low interest rates, QE, a run on the markets or any form of stimulus out of the water.

    Anyone want to go on two way range (war) atm? As history will tell us that any single one party state/ country will advert to some form of conflict to keep the masses occupied where the economy sinks faster than the Titanic and a good old two range is one way of stimulating the economy.


  8. Helicopter Money or putting money in people’s accounts won’t work now people will just pay down debt or save it.

    Prezzy cards would actually be more effective.

    On Central Banks and the banking system. They had a chance in 2009 to create credit for two purposes. They could create create for productive purposes or they could create credit to invest in fine art. They choose that latter. Chinese money was our QE as it limited the private household debt of kiwis in fine art.


    • The problem with our recessions is that it has been mostly engineered by the RBNZ trying to contain inflation. The end result is almost complete decimation of our manufacturing industrial companies. We are now relegated to milking cows and entertaining tourists.


  9. I don’t think there is any danger of completely averting recessions once in a while – all mon pol can usually do is lean against the worst effects. But remember that recessions involve people being tossed out of jobs, and serious recessions have been shown to adversely affect those starting out for the whole of their lives.


    • Point taken Michael but just how much does one lean, at what level of intervention does one declare that’s all we can do. We now have talk of printing cash etc the problem with all of the ideas is they become almost impossible to reverse large parts of the economy become dependant upon “the new norm”


      • I guess this is one of those areas where I end up agreeing with the Governor: central bankers have to take the world as they find it and do what they can to stabilise macro outcomes. There are really big structural challenges for the world economy (and indiv countries) – in some way to better balance desired savings and investment in ways that are consistent with full employment and more-normal interest rates. I have some ideas on how, but certainly don’t claim an integrated or compelling story.


  10. The property market (housing) is disconnected from the national economy (incomes)? The only argument in favour of that is that the seller invests in something more productive? That is an example of acting as though we have globalised?


    • The property market may be disconnected from National wage incomes but is totally connected to foreign cash that flow through Air BnB that has boosted property based incomes.


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