A step backwards
The Reserve Bank got a new Governor on March 26, and a set of rather different riding instructions from those of his predecessors.
After nearly 30 years of having the sole objective of maintaining price stability, it will henceforth have to ‘contribute to supporting maximum sustainable employment’. This change is set out in the new policy targets agreement between the Governor and the Minister of Finance, with the so-called ‘dual mandate’ to be formally codified through a Bill to amend the Reserve Bank Act.
Federated Farmers is disappointed and concerned. Rather than innovative and new, the change is a step backwards to the 1970s and 80s, when the bank had a number of objectives, and failed either to control inflation or to promote employment.
Since 1989, when the current Act was passed, New Zealand’s monetary policy has operated at world’s best practice. Reviews in 2001 and 2007 confirmed this. More recently, it worked well in helping get New Zealand through the Global Financial Crisis and various other economic shocks over the past decade.
Employment has grown rapidly under current policy settings, by 93,000 in the year to December. The labour force participation rate is a near record 71 per cent, and the rate of unemployment has fallen to 4.5 per cent. If there is concern about future prospects for employment, say around workforce skills, other policy tools are likely to be more effective. There is no compelling reason why this change had to be made.
Not only is the change unnecessary, but putting an employment mandate into the Act is risky. It adds a potentially contradictory measure that could cause confusion as to what the bank’s focus actually is, and would result in overly loose monetary policy if employment wins out when inflation is rising.
There is much uncertainty as to what ‘maximum sustainable employment’ is. Is it zero unemployment, 2 per cent, 4 per cent? With uncertainty comes the opportunity for political interference, as politicians weigh in on what they think is the ‘right’ level of unemployment. It will never be too low.
The US and Australia have been cited as operating under dual mandates, but their mandates are relics from the past. The US in particular is not a good example to follow, as the imbalances that led to the GFC were caused by overly loose monetary policy, influenced in part by too much prominence of employment in its decision-making.
Many economists seem quite relaxed, probably because they think it’s window dressing, and they don’t see things changing much in practice. If so, why make the change? While the sky won’t fall immediately, the real test will be when unemployment and inflation are both rising and the Reserve Bank is forced to choose. Will the politicians really leave the Reserve Bank to exercise its judgment?
The Reserve Bank Act is a crucial cornerstone of economic policy that has served New Zealand well. It is a pity to see it being undermined.
"While the sky won’t fall immediately, the real test will be when unemployment and inflation are both rising and the Reserve Bank is forced to choose. "