Bank’s credibility is a fragile thing

Grant Robertson gave a speech. He could be finance minister by the end of the year so we need to pay attention to what he’s thinking.

The Reserve Bank Act is 28 years old, he declared. It is time for a review. Helpfully, he knows what the review needs to find: the Reserve Bank needs to focus on inflation and employment, not just inflation.

Full employment is a worthy goal; shouldn’t the Reserve Bank care about it? Perhaps it should also focus on inequality or pay equity.

Back in the 1950’s, New Zealand economist Bill Phillips found high inflation was associated with low unemployment. In response, governments generated inflation in order to lower unemployment, and this worked, for a while.

Prices rise fast, wages don’t. Real wages fell and when labour is cheap employers hire more. Inflation cuts unemployment by increasing poverty.

However, once people anticipate inflation they index their wages. Only if inflation was higher than expected would unemployment fall. This created an incentive for governments to lie; promise that they would behave and not print money, while secretly printing money.

We solved this problem in 1989 by handing the money supply over to the Reserve Bank and Dr Brash. The Reserve Bank Act removes government control over the money supply and Brash made it clear he didn’t care about unemployment, pay equity or the Warriors. He only cared about inflation. At first not everyone believed him but he stood firm as unemployment rose and the inflation rate fell.

The cost of the Reserve Bank’s credibility was expensive to obtain, but will be cheap to lose.

Robertson is unlikely to believe anything I have to say. I understand that. Not even my wife believes me most of the time. Still, Robertson might find it useful to know that when Cullen became finance minister he commissioned a review of the Reserve Act by Swedish economist Lars Svensson who concluded ’’it is beyond the capacity of any central bank to increase the average level or the growth rate of real variables such as GDP and employment.’’

The understanding that monetary policy can only influence the value of money and nothing else is one of the few untarnished successes of modern economic thought. It is disturbing Robertson does not seem to appreciate this

Malaysian businessman Adrian Lim is about to make his fifth trip to New Zealand. Tourism New Zealand estimates that in a five-year period from 2010, about a third of tourists were repeat visitors.