Reserve Bank: we’re ready to cut
A top Reserve Bank official has dismissed criticism from bank economists about his forecasts as ‘‘nonsense’’, saying the bank is ready to cut interest rates if growth lags.
On Thursday both Westpac and ASB accused the Reserve Bank of being too optimistic in its forecasts for economic growth.
But Dr John McDermott, the Reserve Bank’s chief economist for the past decade, said the bank economists appeared to misunderstand the process involved in creating Reserve Bank forecasts.
Rather than predicting what the economy will do, the bank worked out what kind of growth was needed to generate sufficient inflation. The variable in the equation is interest rates, which the bank can change.
In an interview at the Reserve Bank’s headquarters in Wellington, McDermott repeatedly said that if the economy was not growing fast enough to generate inflation, the bank would cut the official cash rate.
‘‘It’s not about being optimistic or hopeful, it’s actually, if we don’t get that growth rate, we are going to lower interest rates because otherwise we won’t get the inflation rate.’’
The Reserve Bank is tasked with keeping inflation as close as possible to the middle of a 1-3 per cent band. While it aims to hit the target over the medium term, inflation has spent almost all of the past five years below 2 per cent, and for much of the period below 1 per cent.
As well as chief economist, McDermott is an assistant governor and chairs the informal committee which assists the governor to make interest rate decisions.
‘‘Our inflation forecasts are always 2 per cent, it’s always 2 per cent,’’ he said.
‘‘It is because we plan to succeed, and then you go, ‘well, how do you do this’. And so, the monetary policy statement’s objective isn’t an unadulterated forecast about what we think will happen, it’s what do we need the plan to look like to make it happen.’’
McDermott said many bank economists did not appear to understand the process.
‘‘They sit outside, they don’t get to influence policy. We get to move [interest rates]. Inflation has to be 2 per cent, and engineer backwards, what do you need growth to be, to engineer 2 per cent [inflation].’’
So if growth starts lagging, you’re going to cut the OCR?
‘‘Yes. That’s the game,’’ McDermott said. ‘‘So the fact that they think we’re being optimistic is a nonsense, because if it doesn’t eventuate, we get to alter interest rates.’’
Although economists have slowly come around to the Reserve Bank’s view that the OCR will stay at its current low for at least a year, none give a significant chance that the Reserve Bank will cut.
McDermott suggested were wrong to do so.
‘‘The market thinks ‘you guys are never gonna [cut]. They’ve been through almost a whole year of ‘there’ll be no chance you guys are going to cut interest rates’. Well, that’s not true.
‘‘We kept saying there’s an equal probability that the next move could be up, or the next move could be down.’’
He would ‘‘remind’’ several chief economists of the process.
McDermott said it would be a different situation if the banks were saying that the forecasts were too optimistic based on the OCR remaining at the current level.