A month ago there were no commentators suggesting the OCR should be raised at the next review. Since then we’ve watched day-by-day as the news about the coronavirus (now named “SARS-CoV-2” and the disease it causes “COVID-19.”) has got relentlessly worse. Against that backdrop, the case for an OCR cut today looks pretty unanswerable. Not because an OCR cut will make any material difference to March quarter GDP – it won’t – but because the job of discretionary monetary policy is to lean against demand shocks, positive or negative, so long as inflation is well in check.
As I noted the other day, core inflation hasn’t got as high as the target midpoint for the whole of the last decade. In that context, when there is a clear-cut (if not readily calculable) adverse demand shock, the Monetary Policy Committee would be remiss if it simply sat on the sidelines today, suggesting that they would merely be “watching closely” and be ready to act down the track. In the current macro climate – quiescent inflation, flat or falling inflation expectations – there is simply no downside to acting now. There is no particular virtue in instrument stability: the instrument exists to lean against macroeconomic instability (doing what it can to maintain “maximum sustainable employment”, in the current jargon).
Even a couple of weeks ago one might perhaps reasonably have reached a different view. But now we have Chinese inbound tourism cut to almost nothing overnight (first as a result of Chinese restrictions and then our own), and confirmation from the universities that perhaps 60 per cent of their PRC students are still out of the country and unable to travel here. We have much the same situation in Australia, a key economy for us, and in China itself – one of the world’s largest economies – huge economic disruption, and a spreading range of restrictions on movement, social gathering etc etc. We see photos of largely empty streets or public transports in big Chinese cities that aren’t locked down, quite limited returns to work after earlier shutdowns, and so on. From Hong Kong there are reports of more cases, but again the bigger impact is probably people staying home, avoiding social gatherings etc. Investment banks doing business in China – ie quite severely constrained in their freedom to run negative lines – have been marking down their 2020 Chinese and global economic forecasts. Even the WHO – which previously presented as relatively complacent – is now talking of this as
WHO chief Tedros Adhanom Ghebreyesus told reporters in Geneva the vaccine lag meant “we have to do everything today using available weapons” and said the epidemic posed a “very grave threat”.
“To be honest, a virus is more powerful in creating political, economic and social upheaval than any terrorist attack,” Dr Ghebreyesus said.
“A virus can have more powerful consequences than any terrorist action.
I’ll leave the florid rhetoric to him, but if there was a good case for cutting the OCR after the 9/11 attacks and after the February 2011 earthquake (and I think there was) that case is at least as persuasive – compelling in my view – now.
It isn’t really clear to me why, faced with a decision to make today (not, say, a week ago as with the RBA), anyone would favour not cutting the OCR. The OCR (monetary policy more generally) is designed to be flexible and responsive (easing and, if warranted later, reversing such easing). The OCR isn’t about support for individual adversely affected sectors – if that is really needed in some areas it is a fiscal policy/government matter – but about stabilising the overall economy faced with (in this case) clear negative shocks. The tool is fit for purpose.
One argument sometimes heard is that we shouldn’t do anything because things are so uncertain. But that argument should run exactly the other way round. The high degree of uncertainty, which is probably now rising by the day, is exactly the conditions in which people put off spending, put off travel, are a bit warier about eating out, and so on. It represents a likely material adverse demand effect on top of the specific channels (tourists, students) we already knew about. Think of travel. You might have been planning a business trip into Asia. You might be happy enough to go today, and yet you look ahead and wonder what things might be like when you want to get home again, let alone what conditions might be like if somehow you got sick. I reckon we’ll see an increasingly number of non-essential trips postponed, whether business or leisure. And that won’t be so just in New Zealand. With each passing week, we’ll also see more spillover effects into spending elsewhere in the economy and the confidence surveys – whatever we make of them – are likely to take a hit.
There is also the argument that things will snap back once the virus is behind us. No doubt that is the most sensible assumption, but an increasing number of commentaries are noting that a full snap back isn’t likely to be a matter of a few weeks: it seems increasingly likely that the level of economic activity over much of this year, in much of the world, will be weaker than otherwise – perhaps not a lot by the end of the year, but that is still 10-11 months away. And assuming things will simply snap back risks being a recipe for doing nothing with monetary policy when it was actually needed (there are plenty of things forecasters think will be shortlived, but turn out to drag on rather longer).
I’ve also heard a story that the Reserve Bank cutting the OCR by 50 basis points last August may have instilled in some a sense of unjustified worry, becoming a bit of an own goal. Is there a risk of something similar now? First, the August cut wasn’t well-handled. It may have been substantively justified, but was poorly communicated and was not clearly tied to specific and very visible adverse developments here and abroad. As it happens, I don’t think the “own goal” effects, if they existed at all, lasted for long at all (little sustained evidence in eg confidence surveys). What about a move now? Sure it would be unexpected, in that surveys of economists were all picking no change. But (a) those surveys were often done a week or more ago, (b) economists generally aren’t asked what they think the Bank should do, and (c) there is a very clearly identified adverse event, which every commentator will be focusing on. It would be quite easy for the Bank to credibly justify a cut today, specifically tagged to the coronavirus (and referring to 9/11 and 2011). And if in doing so the Bank raised a bit more public consciousness of the mounting economic issues, it would probably be no bad thing anyway.
Perhaps the final caveat I’ve seen is that global equity markets seem quite surprisingly sanguine. If they aren’t pricing something quite bad – or even high risk – why should central banks react? It is a fair question. One answer is a matter of different time-horizons. Equity markets are pricing earnings prospects over the life of the firm, while central banks are (by design) supposed to be focused more on the short-term. A few bad months might not rationally affect the value of most firms much, but might still warrant lower policy interest rates. It is just a different game. But it is also worth noting that New Zealand markets are pricing an OCR cut by the end of this year. If it is needed, and likely to be useful, in a coronavirus context, it is much more useful – and more likely – frontloaded.
Time (not long now) will tell what the Monetary Policy Committee decides to do. I am encouraged by two things: first, was the MPC’s willingness to act decisively last August (even if the accompanying communications etc were hamfisted) on much less clear-cut evidence, and second by the fact that one of the external members of the MPC (retired economics professor, Bob Buckle) was heavily involved in The Treasury’s early work on pandemic economic effects last decade.
Whatever the MPC chooses to do, the Reserve Bank has introduced an interesting new exercise in transparency. If you are on Twitter you can ask the Bank directly a question during the press conference this afternoon.