Nothing radical, we’re the RBNZ
Reserve Bank doesn’t expect review to drive major change in what it does
The Reserve Bank seems to expect that the review of the Reserve Bank Act will be more an exercise in aligning the legislation with its current practice, than driving any major change in the way it does things.
The first phase of the review is intended to work out the details of implementing the policy Labour campaigned on: widening the objectives of monetary policy so that decision-makers “give due consideration to maximising employment” alongside the existing objective of price stability, and replacing the existing single decisionmaker model with a monetary policy committee, as is the norm in other central banks.
The review is to be conducted by the Treasury, the Reserve Bank and an independent expert advisory panel, yet to be appointed. The aim, Finance Minister Grant Robertson said, is for the first phase to be completed in time to inform the negotiation of a new policy targets agreement (PTA) with the new governor, who will take over from Grant Spencer next March.
The minister has said he does not want to change the current definition of price stability — consumer price inflation of 1 to 3 per cent. He has indicated that, in the interests of greater flexibility, he is open to dropping the language about a focus on the 2 per cent mid-point which was introduced into the PTA when Graeme Wheeler became governor, following a period when the CPI had wobbled around the top of the target band.
Robertson has also made it clear that he does not expect a quantified target for unemployment.
Right now, an employment objective looks like a solution in search of a problem. Over the past four years the number of people employed has risen by 15.6 per cent — enough to absorb exceptionally rapid growth in the working-age population and still raise the employment rate by more than 3 percentage points to a record high and the fourth highest level in the OECD. Labour force participation is also at a record high.
This suggests that in recent years, neither the wording of the Reserve Bank Act nor the conduct of monetary policy has been hobbling jobs growth.
And if the unemployment rate, at 4.6 per cent, is higher than it was during the mid-2000s boom, it is worth remembering that that was accompanied by 3 per cent inflation and an official cash rate ultimately 6.5 percentage points higher than it is today.
Give us a break, however, is not the argument Spencer runs.
Instead, he says the bank calls itself a flexible inflation targeter for a reason. The flexibility concerns how patient it is prepared to be about how long it might take for inflation to return to the mid-point of its
target band, and the economy to return to balance more generally.
In pursuing its objective of price stability, the policy targets agreement already requires the bank to “seek to avoid unnecessary instability in output, interest rates and the exchange rate.”
Central banks are in the business of trying to close the output gap — the difference between potential and actual output. Potential output is what the economy could produce if its resources, including crucially its workforce, were fully employed, without inflation taking off.
And estimating potential output requires taking a view on “NAIRU”, the unemployment rate below which inflation will accelerate. It cannot be observed directly and is liable to change over time.
Right now, the bank thinks NAIRU — it stands for the “non-accelerating inflation rate of unemployment”, also known as the natural or equilibrium rate of unemployment — sits somewhere between 4 and 5 per cent. However it is reluctant to be too dogmatic or precise about the right-hand side of the decimal point.
So when might having a dual mandate make a difference to the bank’s interest rate calls?
Two years ago, the unemployment rate was 5.6 per cent. “Say we were under a dual mandate, we would have had unemployment clearly above NAIRU and that would have had more weight. It would be a bias towards easing. Whereas now at 4.6 per cent it is in that territory where we know NAIRU is, between 4 and 5 per cent, so there would be less of an obvious case,” Spencer said.
What matters is not just deviation from some equilibrium rate, but where it is heading. “With a dual mandate, it may be our approach will be
more flexible, in the sense of allowing greater volatility in inflation in order to promote more stability in employment,” he said.
“Usually, we are away from the target and thinking about how quickly to get back to it. The mandate will influence whether you try to get back quickly or are happy to take a bit longer. We can make a dual mandate work.”
But what the Reserve Bank cannot do, Spencer emphasised, is influence where the equilibrium rate of unemployment is. That depends on structural factors in the economy like a mismatch in skills between the demand and supply sides of the labour market.
If the government wants to see unemployment below 4 per cent, it will have to adopt policies, for example in education and training, to address that. “I think the minister recognises that.”
As for the other major change to the monetary policy regime — the move to a committee — the bank was also happy with Robertson’s “careful thinking around the committee structure” outlined in his speech in April, Spencer said.
But it seems to be a wary kind of happiness.
Although the statute places sole responsibility for monetary policy decisions on the governor, in practice Graeme Wheeler moved to a model of decision-making by the “governing committee” made up of himself, his two deputy governors Grant Spencer and Geoff Bascand, and assistant governor/chief economist John McDermott.
Robertson proposes formalising that and adding three external members, plus a non-voting representative of the Treasury.
Spencer’s view seems to be that while it is desirable to have a diversity of views and perspectives around the table when arriving at monetary policy decisions, it is important that differences of opinion are not aired in public, as that could cloud and complicate communication of the bank’s view to the financial markets and the wider world.
Because it is not all about setting an overnight interest rate. Presenting a single clear and credible view of the outlook, mainly through monetary policy statements but also through speeches, is how the bank acts on the world.
“I’m not saying [speeches] have to be vetted by the governor. But there should be a principle of collective responsibility, just as there is in the Cabinet.”
Right now, an employment objective looks like a solution in search of a problem