Reserve Bank’s two roles are getting confused
LOOKING through the Reserve Bank’s latest monetary policy statement, I was left wondering what degree of separation there should be between the bank’s roles of monitoring financial stability and setting monetary policy.
The policy targets agreement between the Government and the Reserve Bank specifies that setting monetary policy is primarily about ensuring inflation is kept under control.
Yet the bank has become increasingly prone to bringing up financial stability issues when setting interest rates as the pressure on central banks to maintain market stability has intensified since the global financial crisis.
Apparent structural problems such as households’ lack of savings, over investment in housing, and excessive international debt levels are not short-term issues that can be affected by pushing interest rates up or down. They are more appropriately addressed in the bank’s financial stability reports. If problems are present, they will only be solved by a broader mix of financial regulation or fiscal policy measures.
The bank’s preoccupation with structural issues gives the impression it is trying to engineer a particular mix of economic growth with a strong export sector and a subdued domestic sector.
In its latest statement, the bank’s bias towards the external sector shows through in its belief that the New Zealand dollar is too high, which ‘‘is detrimental to the tradeable sector [and] undermines GDP growth’’.
Of course, firms in the export sector, or competing with imported product, will always be keen for a lower dollar. But those advocating a lower dollar ignore the fact a strong currency represents a real income lift for all consumers.
If the dollar was sitting at around US60C instead of US80C, there would be massive complaints about the cost of living. The local price of food commodities is determined by international demand and supply. Any drop in the exchange rate increases the revenue that could be generated by selling product overseas, thereby forcing domestic prices up commensurately.
How do you fancy paying another 10 per cent, 20 per cent, or even 30 per cent for milk and meat? What about a similar price rise for petrol or appliances? Yes, the stimulus for the export sector from the lower exchange rate would be massive, but the average worker would really struggle when faced with those price increases.
The dollar on balance reflects that. In mid-2011, the ratio of New Zealand’s export prices to import prices was at its highest level since 1974. Put simply, we need to sell fewer lambs to pay for a new ute. The high exchange rate ensures those income gains are more evenly spread around the country, rather than just being concentrated in the hands of a few exporters.
Tied up with the desire for more growth in the export sector is the belief that a period of ‘‘rebalancing’’ is necessary for the New Zealand economy. Over the past four years, this mantra has been based on a number of factors that mounted during the strong growth period of the mid-2000s.
Advocates of rebalancing have cited a housing bubble, excessive debt levels, strong growth in household spending, and a low saving rate. The bank still seems to believe that further rebalancing is required, even though, within the last year:
New Zealand’s net international debt, relative to GDP, has been at its lowest since 2003
The household saving rate has been at its highest since 2000
Housing has been at its least overvalued since 2003, when measured against the long-term trend in house prices
Household spending as a percentage of GDP has been at its lowest since 1987.
The shift in these ratios over the past few years in the economic cycle has already worked to moderate the excesses that had built up over the past decade. A lift in unemployment, weaker wage growth and a drop in house prices have led to more cautious spending behaviour. More restrictive credit conditions have also played their part.
The fact that historically low interest rates over the past three years have failed to rapidly turn around economic activity indicates consumers have learnt some lessons and modified their behaviour.
Perhaps the one ratio still causing some alarm is household debt to GDP, which is still well above historic norms. However, even this figure needs to be weighed up against a big lift in the value of households’ assets, so the increase in debt has not led to a massive deterioration in households’ net asset position.
Most of the increase in household assets has been concentrated in property, but house prices would need to fall about 30 per cent before households’ balance sheets would start to look shaky.
Given that house prices fell only 10 per cent immediately after the global financial crisis, a further decline of 30 per cent seems rather far-fetched.