Reserve Bank’s dual mandate could backfire
New Government proposes focus on high employment as well as stable prices
On November 7, Finance Minister Grant Robertson announced a review of the Reserve Bank Act. The bank at present has a single mandate: stable prices. The review proposes shifting to a dual mandate: stable prices and high employment. Bloomberg News headlined the story “RBNZ reform could potentially lower rates, Finance Minister says”.
So what is the likely effect of these changes on mortgage interest rates? The answer may already lie in the “yield curve”. The yield curve plots rates on borrowed funds with maturity dates from now to many years ahead. Over the time of the formal announcement of the review, between November 6 and 8, the figure below suggests that rates reacted by going up.
The likely reason is that the market is predicting higher inflation will result from a shift away from the RBNZ’s current focus on price stability. More inflation means higher interest rates to compensate lenders for the loss of value of their money.
So what was behind the Finance Minister’s claim of lower rates? Proponents of the dual mandate argue it may better enable the RBNZ to cut rates to provide economic rocket fuel to get people back to work in times of recession. A great deal of eminent support can be found for this view, including the likes of Benjamin Friedman, the Harvard economist.
But applying rocket fuel requires lots of skill. Too much for too long and inflation can blow up. Yet sustainable growth and job creation rely on low and stable inflation. Consequently, a credible commitment must be made to raise rates as soon as inflation starts to pick up, once a recession abates.
What are the chances of a revamped RBNZ operating under a dual mandate treading this delicate path successfully? So far, the markets appear sceptical, given the upward shift in rates when the review was announced.
Robertson has defended his review for other reasons. He has pointed out that the US Federal Reserve operates under a dual mandate. Ironically, there is no assurance from the chairman of the RBNZ board “that any candidates he was interviewing would be ones who would be able to implement a change to policy along the lines we’re going”.
However applications for the job of governor closed long before the election. Maybe someone like Friedman didn’t apply then, since he did not support the single mandate. On the other hand if Taylor, who is one of its biggest fans, applied, would he now get a rejection letter? Perhaps the successful candidate will be the one with the fewest principles, happy to implement any mandate!