I’m out of town today, so just something short.

I’ve noted in various posts recently that in past recessions in New Zealand since we liberalised in the 1980s the OCR (or prior to 1999, the 90-day bank bill rate) had fallen by around 500 basis points in a typical (median) recession.   Small sample and all that, but it was a reasonable stylised fact (and happened to around the same size adjustment as you see in the longer run of US data).

But, of course, the OCR isn’t a rate paid by anyone –  technically in fact it is the rate the Reserve Bank pays banks on their settlement account balances.   In thinking about the experience of firms and households one has to look at retail interest rate and how they changed.  In the 2008/09 recession, for example, there was quite a widening in the margin between the OCR and retail deposit and loan rates.

One can identify five reasonably material downturns in the interest rate data on the Reserve Bank’s website.  Here are the changes in floating first mortgage interest rates in each of them.

Not all of those events were particularly significant for the New Zealand economy, and the 2001 interest rate falls combined the effects of the northern hemisphere economic slowdown that year and the precautionary cuts the Reserve Bank implemented after 9/11.

But across this sample, the median reduction in both deposit and residential mortgage rates was 4.3 percentage points.  For the two deeper recessions, 1991 and 2008/09 the changes were larger still.

I’ve also shown the adjustments we’ve seen this year to date.   The main banks all lowered their floating mortgage rates on Tuesday by the full 75 basis points of the Reserve Bank’s OCR adjustment.  But retail deposit rates have only just begun to fall.

And in even The Treasury’s view, this recession “could” be bigger than the 2008/09 one (more realistic would be to view 2008/09 as tiddler by comparison, even if one allowed for nothing more than the elimination of our international tourism industry).

And then there are two problems to ponder:

• first, the MPC has pledged not to change –  raise or lower –  the OCR for at least a year.  So if one believes they will keep their word, what you see now is all you get.  Retail lending rates aren’t going any lower, and retail deposit rates will take a while to catch up but probably won’t fall more than 75 points either.  75 basis points is a great deal less than 430 points, and
• second, while it was probably good PR for the banks to cut point for point on Tuesday, actually it looks as though they’ve ended up with squeezed margins.  Here is a chart showing the 90 day bank bill rate less than floating first mortgage rate, up to yesterday

The 90 day bank bill rate is usually a bit above the OCR, and fluctuates mainly with shifts in sentiment re future OCR adjustments.  When the OCR is expected to be cut imminently the 90 day rate drops below the OCR.  That had happened recently. But note what happened after Tuesday’s cut: the margin between the bill rate and the OCR is now higher than at any time in the last two years.  That would usually only occur if the OCR was expected to be raised, but that clearly isn’t the story as the MPC just pledged not to change the OCR for at least a year.  In fact, it points to liquidity pressures in the local market (details not known to me).    The Reserve Bank’s liquidity operations would usually be able to ease such pressures, and it is a bit surprising they haven’t already done so.

But the key point remains: there is no prospect of further retail interest rate reductions in the middle of the most severe adverse shock of our lifetimes.  75 points is it.     It is a ridiculously small adjustment.  But that is what you get when (a) the Reserve Bank fails to do anything about removing/easing the effective lower bound, (b) fails to ensure banks’ systems were ready for negative interest rates, and (c) pledges not to cut the OCR any further anyway. It really is Alice-in-Wonderland stuff.

Even in circumstances like the present where we aren’t –  or shouldn’t be for now – trying to stimulate aggregate demand, low interest rates play an important role in managing economic downturns.  First, they help lower debt service costs, including for existing flexible rate borrowers (and most New Zealand debt reprices fairly frequently), and do so by transferring some prospective income from depositors to borrowers, consistent with the idea that time is temporarily less valuable.  Second, at a wholesale level they help to weaken the exchange rate, which also typically plays a significant part in buffering adverse shocks.  And third, the flexibility to adjust rate, actually exercised, helps to support and stabilise medium-term inflation expectations.

Did I mention the exchange rate?  In the 1991 recession, the TWI fell by about 10 per cent. In the 1998 recession, the TWI fell by 17 per cent, and in the 2008/09 episode the fall was in excess of 20 per cent.

And this time?  Well, the TWI yesterday morning was only 5 per cent lower than it had been at the end of December, despite the adverse shock being much greater than in any of those earlier events.    This week, we have had the extraordinary sight of the New Zealand dollar approaching parity with the Australian dollar.  I’m sure a variety of factors help explain that, but an unexpected commitment from the MPC not to lower the OCR further can’t have helped.  The TWI appears to have fallen overnight and perhaps before long panic and flights to cash/flights to home will mean the TWI will fall a long way, but monetary policy so far has been an obstacle in the road.

The economy is already in deep strife, and the problems are going to get a lot worse.  We shouldn’t settle for the complacency of central bankers talking up their adjustments, their alternative instruments etc, and all the while retail rates have barely moved, relative to the scale of change seen in most past (smaller) downturns.

The Minister of Finance should simply insist that the Bank sort it out, including getting bank systems fixed post-haste.  There is no conceivable way in which on OCR with a positive sign in front of it makes any sense in today’s New Zealand economy.  Retail deposit rates really should be negative, and retail lending rates probably should be too.