Meddling with OCR carries risks

One of most important policies underpinning the stability of the New Zealand economy seldom enters election debates. The Reserve Bank’s mandate to control inflation is treated delicately by both major parties. But when one of them proposes to change the bank’s targets or procedures, the implications can be serious.

Yesterday we carried a report from the international Bloomberg service that said, “New Zealand’s central bank may be facing the biggest shake-up to the way interest rates are decided since it pioneered inflation targeting three decades ago.” It was referring to the Labour Party’s intention to give the bank a statutory target of full employment in addition to its long-standing goal of price stability.

Back in April when this policy was posted on the party website, polls were giving Labour little chance of becoming the next government and not much notice was taken of it. Now, notice should be taken. Its finance spokesman, Grant Robertson, said: “We’re doing this because in the wake of the global financial crisis there has been a significant challenge to the effective operation of monetary policy, in particular in dealing with a low or no inflation environment.” He said Labour was “fully committed to low inflation and will seek to continue the Reserve Bank’s inflation target of 1-3 per cent” but added the goal of full employment would, “bring us into line with other countries such as Australia and the United States”.

This country has no need to copy any country’s conduct of monetary policy. New Zealand pioneered inflation targeting by an independent central bank and it served this country well through the global financial crisis whatever mistakes others may have made. The divergent targets of the US Federal Reserve possibly contributed to the crisis.

A target of “full employment” sounds fine in principle but how practical is it? Monetary policy has proven capable of keeping inflation within a fairly narrow band but it may not be able to influence employment as precisely. And what target does Labour have in mind? Economists define “full employment” as up to 4 per cent unemployment, since at the best of times there are always some people between jobs. Could a Labour Party bear a target of 0-4 per cent unemployment?

In practice, the Reserve Bank already takes employment into account when setting interest rates to keep the economy on a low inflationary growth track. It believes low inflation is necessary for sustaining full employment in any case. A formal target might not change the bank’s primary focus but it is a risk that needs to be considered.

Labour’s proposed changes to the way the bank operates may be more damaging. The Governor would no longer be solely answerable for the key interest rate, the official cash rate (OCR), set eight times a year. Labour would give the decision to a committee with some appointees from outside the bank. Already the Governor consults widely. But sole accountability can produce better decisions. A committee allows blame to be dispersed.

Our system of monetary management is working well. Labour should hesitate to meddle with it.