Reserve Bank comes under historic scrutiny
The Reserve Bank got somewhat lost in the biggest Budget week in recent memory. It’s fairly understandable. If a complete media blackout had a price, adding $140 billion to net Crown debt would probably be it.
But across the road from the Treasury, the Reserve Bank (Treasury’s traditional rivals) had an equally busy week. Governor Adrian Orr published the bank’s Monetary Policy Statement, or MPS, the first since the lockdown. It was sobering reading.
A month earlier, the bank began large-scale asset purchases (LSAP) of up to $33b, meaning it essentially invented money to buy the Government’s debt. The bank, which has an obligation to make sure the financial markets run smoothly, calmed the waters by announcing it would begin to buy bonds from the organisations who held them. Buying such a vast amount of debt immediately calmed the markets, and forced borrowing costs down.
It was the beginning of a round of what is known as alternative monetary policy – tools the Reserve Bank uses to control inflation and boost employment when the OCR stops working. Last week, it doubled the LSAP programme to $60b.
At the beginning of the month, deputy governor Geoff Bascand also wrote to bank chief executives to get ready for a negative OCR: banks would be charged for leaving their money with the Reserve Bank overnight. The effect is to encourage banks to lend, pumping the economy full of money.
The Reserve Bank has told retail banks they should get ready to implement negative rates, although they promised to hold the OCR of 0.25 for 12 months. The Reserve Bank is, of course, highly independent. The finance minister sets a general target, and then leaves the bank to it. But in a time of crisis, the implications of these decisions inevitably land at the feet of politicians.
Finance Minister Grant Robertson is loath to venture any comment on the actions of the Reserve Bank that could leave him in a difficult position, as the bank’s decisions weigh on the Government. The most obvious area of concern is what happens when the bank decides to slow the LSAP problem. Robertson has drawn a line in the sand: the Government will indemnify the bank purchasing only up to 50 per cent of all Government debt on issue up to $60b. Given it’s expected to lift net debt to $200b (and gross debt to $218b) this means the bank needs to make sure the private market gets back to functioning normally.
While no-one is predicting a return to crippling borrowing costs seen in the past, even a small rise in borrowing costs could be painful for the Government balance sheet with such high borrowing.
The Reserve Bank’s job is to ensure financial stability, not keep borrowing costs low for the Government. There are, however, two looming issues that do concern the finance minister.
One is the suggestion from former senior Reserve Bank staffer Michael Reddell that the Government should trigger a provision under the Reserve Bank Act to force the bank to pursue a different policy. He’d like to see the New Zealand dollar fall to a more competitive exchange rate, helping out exporters.
The politics of this are difficult, and it’s hard to see Robertson ever intervening in the Reserve Bank’s affairs, but Reddell makes the strong point that the exchange rate is still high by historic standards. This makes it difficult for our exporters to drive the economic recovery.
The other point of difficulty is between the Reserve Bank and the retail banks over strict new regulatory standards. Last year, the Reserve Bank announced it would require the big banks to hold vastly more capital, costing them $20b (although not all in cash) over seven years.
The banks were less than pleased, not least because the changes would be paid for mainly by reducing payouts to their Australian parents. The Reserve Bank put the reforms on ice for a year, allowing the banks to focus their attention, and their balance sheets, on helping businesses and households through the current crisis.
There’s no suggestion that the Reserve Bank will go back on the reforms, but it will raise some political questions for the banks, who will grumble about having added costs foisted upon them during a deep crisis.
It’s also a potential problem for the Government, which has so far avoided wading into the issue, citing the Reserve Bank’s independence. If recalcitrant banks cut back on lending to pay for the regulatory changes, a problem that began with the Reserve Bank would swifltly become an issue for the Beehive.
No-one wants politicians talking about central bank decisions, but as the economic crisis deepens, politicians may not have any choice.
The Reserve Bank’s job is to ensure financial stability, not keep borrowing costs low for the Government.
Adrian Orr, Reserve Bank Governor