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Monetary policy in New Zealand:
the OCR and other policy approaches
Aaron Drew, Reserve Bank of New Zealand
Presentation to High School Economics Teachers
Massey University
16 November 2007
1
Overview
1. Conventional view of monetary policy and how it
works through the economy.
2. New Zealand’s economic performance over recent
years.
3. Summary of RBNZ (and other) work on
supplementary policy approaches.
2
Key background papers
The RBNZ has published 3 key reports in 2006/7 broadly related
to macroeconomic policy in New Zealand
•
Supplementary Stabilisation Instruments
http://www.treasury.govt.nz/ssip/
•
Testing stabilisation policy limits in a small open economy: Proceedings
of a macroeconomic policy forum
http://www.rbnz.govt.nz/research/workshops/12jun06/2837468.html
•
RBNZ submission to the FEC Inquiry into the Future Monetary Policy
Framework
http://www.rbnz.govt.nz/monpol/about/3074316.html
3
Some conventional views…
• Monetary policy can only influence the general level of prices in the
long run - though substantive evidence that moderate to high inflation
impairs long run growth performances.
• The RBNZ’s pioneering “inflation targeting” approach is widely
regarded as international best-practice and has been adopted in many
countries.
• An independent monetary policy can not control the “mix” of monetary
conditions in an economy with free international capital flows (aka the
impossible trinity!)
• Pursuit of a single objective (the inflation target) is best accomplished
by sole use of a single instrument (e.g. in New Zealand’s case the
OCR).
 Last point is an ongoing source of debate in New Zealand and, to
a lesser extent, abroad.
4
The Transmission Mechanism
• Describes how a change in the OCR affects economic activity and
inflation.
• The mechanism is not mechanical – linkages are subject to
uncertainty over timing and impacts and are likely to differ over the
course of the business cycle.
• There is also evidence that the mechanism has altered in New
Zealand (and elsewhere) over the past decade or so; particularly with
regards exchange-rate pass-through.
• But NO evidence that the mechanism has made the conduct of
monetary policy in New Zealand ineffective.
Reference:
http://www.rbnz.govt.nz/research/bulletin/2007_2011/2007jun70_2drewsethi.pdf
5
Figure 1. The Transmission Mechanism of New Zealand Monetary Policy
OCR ↑
Inflation expectations↓
14
Effective mortgage rates ↑
1
3
Wholesale
short-term rate ↑
4
House prices ↓
2
Employment and wages ↓
Deposit rates ↑
Wholesale
long-term rate ↑
12
6
Savings ↑
4
8
Bond and
equity prices ↓
Business Investment and Activity ↓
10
3
8
6
11
11
7
Floating mortgage
and Variable loan
rates ↓
Household Consumption ↓
12
15
15
Imports ↑
Output ↓
Exchange rate ↑
5
9
Tradables Inflation ↓
16
15
Non-tradables Inflation ↓
Exports ↓
13
17
14
Inflation ↓
0
1
2
3
4
5
6
7
8 Time in quarters 9
6
Macroeconomic backdrop
• Despite unprecedented period of economic growth
“imbalances” in the growth pattern and persistent
inflationary pressure have lead to questioning whether…
• …in the “new world economic order” of open borders,
integrating financial markets, low inflation, flexible
exchange rates, new centres of high growth, etc…
• ….New Zealand’s macro-economic policy frameworks and
policy settings are adequate.
7
Growth recovery since early 1990s has been
impressive
•
NZ’s early 1990s growth recovery is now well documented.
•
Recovery from the 1998/99 recession has continued this
impressive growth into the new millennium
•
Professor Robert Shiller (summary of latest Penn World
Tables)….….
” China isn’t the only success story. Other big winners in terms of
real per capita GDP between 2000 and 2004 are
Lithuania (up 48%), Romania (up 41%),
Estonia (up 40%), Chile (up 33%),
Hungary (up 32%), Greece (up 31%),
New Zealand (up 28%), Australia (up 25%),
Korea (up 23%), Ireland (up 23%), ….”
•
http://www.project-syndicate.org/commentary/shiller42
8
Expansion since 1997 is longest on record
9
But macroeconomic adjustment processes
(or “imbalances”) have looked threatening
•
Strong domestic demand growth fuelled by rising house prices and
household incomes
•
Sustained by foreign funding of lending (e.g.Uridashi bonds)
•
More recently fiscal policy and rising commodity prices have added to
demand pressures
•
Pushing inflation and expectations beyond target band
•
And appreciating the exchange rate
•
Process has put pressure on the tradable goods sector, particularly
non-commodity exporters.
•
“Imbalances” manifest in a very large current account deficit, very low
levels of housing savings, strong non-tradables inflation….
10
%
-2
%
-2
Current account balance
-4
-4
-6
-6
-8
-8
-10
-10
1996
1998
2000
2002
2004
2006
2008
11
Inflation breakdown
%
6
%
6
Non-tradables
4
4
CPI
2
2
0
0
Tradables
-2
-2
-4
-4
1996
1998
2000
2002
2004
2006
2008
12
GDP growth breakdown
%
10
%
10
Domestic spending
GDP
6
6
1
1
Net Exports
-4
-8
1990
-4
-8
1994
1998
2002
2006
13
Have we had too much of “The Good Life”?
14
Policy questions
The fundamental question (Do these “imbalances” pose a risk to New
Zealand’s continuing prosperity?) can be broken down into (at least!) 7
other questions:
•
•
•
•
•
•
•
Has global financial integration reduced the potency of domestic monetary
policy?
Does the exchange rate “move too much” and does it damage long-run growth?
Is the current account deficit “too big” and is NZ at risk of a “sudden stop”?
What is the role of the housing market?
Should fiscal policy do more to assist monetary policy over the cycle?
Is there a cyclical role for prudential policies?
Do structural policies (e.g. features of the tax system and certain regulations)
amplify the cycle, “imbalances” and housing demand?
15
Has monetary policy lost potency?
•
International financial
integration has enabled
greater access to international
credit
•
Including for example Uridashi
bonds where the foreign
lender carries the exchange
rate risk.
16
Global financial integration
• Has seemingly caused
domestic interest rates to
be more tightly linked to
‘world’ rates, particularly
longer-term rates.
• Reducing the margin
between NZ and
international long-run
interest rates,
• and…
Source: BIS
17
..causing
…greater separation
between domestic short
and long rates
…and
18
inducing (mortgage) borrowers ….
…. to move out along the
yield curve
19
Around 2004-2006 reducing effectiveness of
increases in the OCR
• Raising of OCR affects
longer-term rates, but
impact was mitigated by
low world rates and low
bank lending margins…
• weakening the leverage
of the OCR over
effective borrowing
rates.
20
But this phase has now past and policy is
starting to gain traction….
%
9
%
9
Effective mortgage rate
8
8
7
7
OCR
6
6
5
5
4
4
1999
2001
2003
2005
2007
21
But this phase has now past and policy is
starting to gain traction….
Annual %
25
20
15
000s per month
12
QV house
price inflation
10
10
8
5
House sales (RHS)
0
6
-5
-10
1992
1997
2002
2007
4
22
Advice of “international experts”
•
“No obvious missing instrument that would deliver a home run.”
•
In this new world of open borders, integrated financial markets, low inflation,
flexible exchange rates, new centres of high growth, still widespread support for
the macroeconomic institutional arrangements.
•
In considering what could be adjusted to reduce imbalances, always a risk “such
adjustment could come at the risk of losing what NZ presently has.”
•
Maybe marginal improvements to be had in monetary and fiscal policy, but
greatest gains likely from improved structural (micro) policy settings.
http://www.rbnz.govt.nz/research/workshops/12jun06/2837468.html
23
Desirable properties of a monetary
policy instrument…
• Inside lags (recognition and approval) and outside lags
(implementation and affect) are as short as possible.
• Linkage from the instrument to output and inflation are fairly well
understood.
• Impacts are broad-based.
• Impacts are difficult to avoid.
• Usage of the instrument enjoys wide political support.
• The central bank has full instrument independence.
NO alternative instruments identified so far seems to fulfil the
criteria above as well as the OCR
24
The RBNZ’s recommendations to
the FEC inquiry included…
•
Encouraging further work by the relevant agencies to ensure that housing land
supply and the development of new subdivisions is not unduly restricted by
regulatory or administrative constraints.
•
Reviewing the taxation of investment income and the tax treatment of the
financing of the purchase of investment assets. This should include examining
the possibility of modifications to the existing provisions that allow any losses on
investment activities to be fully offset against a taxpayer’s other income at that
taxpayer’s marginal tax rate (“ring-fencing”).
•
Encouraging the development of a framework under which higher thresholds are
in place before substantial increases in government spending (or tax
reductions), especially those financed from unexpected revenue gains, occur at
times when demand pressures in the economy are intense.
•
Recommending the allocation of additional resources to improve the overall
range, quality, and timeliness of New Zealand’s macroeconomic statistics.
http://www.rbnz.govt.nz/monpol/about/3075586.pdf
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