Download Comments prepared by Peter Neilson*, CEO of the Financial

Comments prepared by Peter Neilson*, CEO of the Financial Services Council, for a
response to Dr John McDermott’s address to the FINSIA/ANZ Luncheon “What does 2013
hold for us?” held on 15 March 2013
[*These are personal reflections from Peter Neilson, a former Associate Minister of Finance with the
responsibility for monetary policy, and do not represent the views of either the FSC or any of its
members]
Savings and Monetary Policy: Unfinished Business
Back in 1987 Roger Douglas asked me, as his Associate Finance Minister, to take day to day
responsibility for monetary policy, the Government-owned financial institutions and to oversee the
policy and legislative process that culminated in the Reserve Bank Act of 1989 and the start of
flexible inflation targeting in New Zealand.
1. The Reserve Bank Act 1989 regime has brought low and stable inflation. You can quibble that
the performance was almost always closer to the upper than the lower band but it is a much
better inflation performance than what came before. (Table 1)
2. We now know how to use monetary policy to reduce inflation by lifting interest rates. Inflation
targeting was adopted around the world and helped bring about the Great Moderation in
inflation. Unfortunately the new “masters of the universe”, the central bankers, then decided
they could fine-tune monetary policy. We now know they can’t.
3. Unfortunately soft monetary policy seems much more effective in creating asset bubbles rather
than producing a strong real economic recovery.
4. We already have an overpriced housing and share market even before the arrival of a strong
recovery in either the economy or employment. (Table 2)
5. Current monetary policy settings are a mixed blessing for financial markets. Monetary policy
since 2008 has been a massive put option on the NZ housing market. By cutting mortgage
interest rates anyone who used their home as an ATM machine in the 2000’s has now had the
benefit of sustained, artificially low mortgage interest rates. Provided they stayed in
employment, over-geared home owners have been able to avoid selling their homes or rental
properties when there was the possibility of negative equity. So the mortgage portfolio of the
banks has been underwritten by this loose monetary policy. On the other side, the cost has
been very low interest rates for savers. In effect we have rewarded the spenders and punished
the savers.
6. When the legislation for the Reserve Bank Act 1989 was introduced, in part it was because we
had found the limitations of activist fiscal policy in a small open economy. A fiscal expansion
from tax cuts or spending increases quickly brought with it a Balance of Payments problem. It
was always easy to relax the fiscal stance to boost the economy but much harder to contract
fiscal policy when the economy showed signs of overheating. It was also always very difficult to
get the policy timing right. In effect fiscal policy in practice was pro-cyclical not anti-cyclical and
discretionary “fine tuning” fiscal policy fell out of favour.
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7. We now face all those difficulties with monetary policy. As Alan Bollard found, little New
Zealand cannot soak up the world’s liquidity if most central banks have monetary policy stances
so loose that they are creating asset bubbles. It is in practice much easier to loosen monetary
policy rather than tighten it. Between June 2008 and April 2009, the Official Cash Rate was cut
from 8.25% to 2.5%, a 5.75% cut in only 10 months. If inflationary expectations start lifting, as
eventually they will, does anyone believe the Reserve Bank would raise the OCR by 5.75% over
10 months anywhere close to an election? Such a situation in the future will severely test the
Reserve Bank Governor’s inflation fighting credentials.
8. When the current monetary policy regime was introduced it was often stated that, while
monetary policy using flexible inflation targeting was highly appropriate, monetary policy
needed mates. That has not changed. Since the Global Financial Crisis (GFC) New Zealand has
not used fiscal policy as much as it could have. We have left economic stimulus mainly to the
Reserve Bank when it does not have most of the tools needed to effect such a policy. We have
of course benefited from the much larger Australian and Chinese stimulatory interventions since
the GFC. If we want to address the issue of a persistently overvalued exchange rate we need a
lot more than just monetary policy changes.
When New Zealand could not achieve a positive current account balance even during a time
when we had a domestic recession, very good terms of trade and a USA drought, then I think
there is strong prima facie evidence we have an overvalued currency. Graeme Wheeler, based
on recent comments, appears to agree. The sustained level of our currency seems more
influenced by our love affair with investing in real estate than the stage of the dairy price cycle.
Unless we address the bias in our tax and lending policies which favour buying land rather than
investing in productive assets we will persist with an overvalued currency and our CAB will
remain in permanent deficit.
The missing economic instrument in New Zealand is a savings policy. If we find it too difficult
politically to address our general bias in favour of investing in land we will need to address the
relative overtaxing of savings, particularly those invested in assets held long enough to earn
compounding returns.
We also need more automatic stabilizers for both monetary and fiscal policy. Despite thirty
years of over investment in econometricians and with the continuing underinvestment in
improving the statistics used for forecasting, our ability to pick turning points for the economy
appears no better. Discretionary tools are almost always used too late and too little to work
effectively and end up as destabilizing interventions that make the peaks higher and the troughs
lower.
In the current environment we probably could use monetary policy in the short term to
accommodate a lowering of the currency because inflationary expectations are likely to remain
low for the next few years until the real economy recovers. Once inflation expectations start
rising again however, monetary policy will need to get back to its day job of being used to
restrain inflation. In the meantime we need to get to work on improving the automatic
stabilizers in fiscal and monetary policy and removing or reducing the tax and other biases
against both saving and investment in assets that will increase our future incomes.
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Table 1
RBNZ inflation target band and annual CPI inflation (%)
9.0
8.0
7.0
6.0
5.0
Lower Bound
4.0
Upper Bound
CPI
3.0
2.0
1.0
0.0
Mar-90
Mar-92
Mar-94
Mar-96
Mar-98
Mar-00
Mar-02
Mar-04
Mar-06
Mar-08
Mar-10
Mar-12
-1.0
Source RBNZ 2013
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Table 2
Ratio of average house price to average household disposable
income
7
6
Value of ratio
5
4
3
2
1
0
1962 1965 1968 1971 1974 1977 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010
Source Briggs and Ng RBNZ (2009) updated to 2013
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