Was huge rate cut a colossal blunder?

This Government changed Reserve Bank Act so buck now stops in a committee. That may be the problem

The first thing National will need to do when it returns to government is repair the Reserve Bank. I’m confident it will.

Someone highly respected in the party remarked to me last week that it was hard to imagine any previous governor of the bank cutting interest rates drastically in our present circumstances. The economic outlook does not seem that dire.

No National figure will say this out loud of course because it is in the party’s political interest to pretend the economic outlook is every bit as bad as the Reserve Bank’s monetary policy committee thinks.

But few real bankers think so, which is why the dollar dropped suddenly and trading banks dropped their lending rates as soon as Governor Adrian Orr announced the central bank’s second cut of the year last Wednesday, this one twice as big as expected.

The bank has reduced its official cash rate to just 1 per cent and there is talk of another cut before the year end, leaving the bank with little room to move if recession really looms. Orr is contemplating negative interest rates in that event, a charge for saving.

He thinks the latest cut will boost

business confidence. It is likely to do the reverse. Business has effectively been told the picture is worse than they can see. Or, if they don’t believe this, they must doubt the competence of those now in charge of their financial lifeblood.

Either way, it is not a recipe for confidence.

The Reserve Bank has been one of the foundations of the stability and sustained growth we have enjoyed since interest rates were taken out of governments’ control and given to a bank with statutory independence.

Statutory responsibility resided in the Governor until this Government changed the Reserve Bank Act so the buck now stops in a committee. That may be the problem.

It’s not that the committee is led by an unusual character and includes two academics and a former trade union economist, it’s the dynamics of committee decisions.

Collective thinking tends to be mechanical rather than astute. The published summary of this committee’s discussions show it has been guided mainly by the mid-point of its inflation target, 1 to 3 per cent. Twice now it has cut interest rates because inflation remains slightly below 2 per cent. But the art of monetary management is not that precise. If it was, the stated target would be the mid-point not a band. Yet the committee seems determined to keep cutting rates until inflation rises. Committees are also prone to herd thinking. This one is acting in line with central banks of larger economies, which might sound like a good and necessary herd to follow. But it is not always.

This year central bankers and economists around the world have talked themselves into a funk, which happens from time to time. It’s human nature to think good times are too good to last and after a few years of growth economists look for reasons it might not last. Almost the only reason they can find at present is Donald Trump’s trade war with China.

Trump’s use of tariffs as a weapon of his political and geopolitical will is doing enormous damage to the American and international economies but it is not the sort of damage that triggers a recession. It’s worse. Recessions tend to be shortlived, nasty while they last but cured when industries need to build up their inventories. Trump is doing the sort of damage that cannot be as readily repaired.

He has set back decades of progress towards a more open trading world. Progress was politically difficult to achieve, by small, incremental steps in global and regional agreements, and it is fanciful to assume it will be readily resumed when Trump has gone. He has put the US on a path of slow decline as its production becomes more protected, more costly and less competitive, China develops the products the US won’t sell it and the world has less trade, less cross-border investment, more government direction of business and economic resources.

A small economy needs its monetary authority to be smarter than most, not run with the herd at every turn. Previous Reserve Bank governors would be more cautious at times like this. They were probably acting on instinct as much as data. Instinct is harder to assert when a committee is making the decision.

The committee’s pessimism could be contagious. The big interest rate cut last week could precipitate a slump with big consequences, which means National could be in a position to fix the bank before too long.