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Grant Robertson on a Modern Monetary Policy Framework

Introduction

The year 1989 was a watershed for a host of reasons here in New Zealand and around the world. First and foremost, Seinfeld premiered on television. In all seriousness, the Berlin Wall fell as the implosion of the so-called Eastern Bloc moved apace. Ronald Reagan was finishing his eight years as President of the United States. Tim Berners-Lee produced the first design for a world wide web and the first internet connection in New Zealand came through the University of Waikato.

In New Zealand politics David Lange resigned as Prime Minister, our erstwhile Chair had just completed a report radically changing tertiary education in New Zealand, and I was completing high school in Dunedin. Protesting against our Chair’s plans. And of course in December that year the Reserve Bank Act was passed. 

An awful lot has changed in 28 years for all of us.   But the Reserve Bank Act has for all intents and purposes not altered at all.  I believe twenty eight years on it is right to examine its place in continuing to support the New Zealand economy, and delivering for New Zealanders the quality of life they desire and deserve.

It is true to say that at the time of its passing our Reserve Bank Act was a world leading piece of legislation. In particular its single objective of price stability and its single decision maker in the Reserve Bank Governor gave a sense of certainty that had been missing particularly in the early part of the decade.  

I don’t need to rehearse that period of political history for this audience, but suffice to say that the 7.6% inflation rate that was operating as the Act passed would have seemed like an oasis of calm to those used to volatile double digit inflation through the late 1970s and early 1980s, driven by the vice like grip of the accountant from Tāmaki on all aspects of the economy.

As such the Act was a creature of its time.  But now we live in different times.  In the wake of the Global Financial Crisis there has been a significant challenge to the effective operation of monetary policy globally.  The mandate and tools so necessary to control the rampant inflation of the 70s and 80s have struggled to help resuscitate economies hit by the crisis.

As Joseph Stiglitz has said

The crisis has brought home something that should have been recognised before the crisis: managing inflation is not an end in itself, but a means to an end. The end is a more stable economy - not just price stability but real stability and an economy that is growing faster in a sustainable way.”

The New Zealand Experience 

In New Zealand the failure to meet the Policy Target Agreement goal (CPI inflation 1 – 3%) for four years has raised questions about whether monetary policy can make a decisive difference in the operation of the economy.  Over the term of the current Governor inflation has averaged under 1% and even on the RBNZ preferred “core” inflation measure only just over 1%.  Meanwhile our currency has stayed at what the current Governor has described as too high and unsustainable levels, while hundreds of thousands of New Zealanders remain out of work.

I am not for a moment suggesting that any Central Bank is capable of dealing with all the ills of, or creating all the opportunities in, the economy.   What is needed in my view is the best possible alignment between monetary and fiscal policy.  The Reserve Bank itself has stated that monetary policy requires fiscal policy ‘friends’ in order to deliver its aims.  

The Secretary to the Treasury said this best recently when he stated that “relying on monetary policy alone to do that job risks the longer term growth potential of the economy, by leading to the misallocation of resources towards investments such as residential investment that are comparatively less productive in terms of generating wealth and well-paid jobs.”

An opportunity to reset

Given the length of time since the Reserve Bank Act, and the increasing questions about the effectiveness of monetary policy, I believe it is the right time for a review.  This is not only from a policy point of view, but also as the in-coming government will need to appoint a new Governor.

Let me be clear, we wish to undertake a review alongside the Bank, and to look at the measures and tools the Bank uses.  This would include looking at the way inflation is measured, and the adequacy and appropriateness of the tools that the Bank has at its disposal.  That level of review of operational matters can only be done in cooperation with the Bank.

But I think, in the interests of certainty and transparency, that I should outline our thinking on some core legislative matters in advance of any review. 

A review would represent an opportunity for a reset to a modern monetary policy.  From a Labour Party perspective, a refreshed approach would be founded on the view we must protect the independence of the Bank, while giving monetary policy the chance to play its fullest part in meeting the economic goals of the country. 

As a government it is our job to be clear on the goals we have for the economy, and to provide all parts of the economic apparatus, including decision-makers such as the Reserve Bank, the tools to focus on the delivery of these goals.

Towards Modern Monetary Policy

There are many areas to cover in terms of what constitutes a modern monetary policy approach, but I want to focus today on two proposed changes to the Reserve Bank Act. 

The first is a broadening of the objective of the Bank from just price stability to include also a commitment to full employment

It is important for New Zealand that we control inflation. We have seen the damage that out of control inflation can do to our economy and to our citizens. It is our most vulnerable who are the most affected by rising prices. The most recent data from Stats NZ shows that our senior citizens have faced a 50% higher inflation rate than average in the last nine years.  The lowest income quintile has seen inflation nearly a third higher than average, and yet the highest income quintile has seen inflation increase nearly 25% less than average. 

It is therefore right that we should continue to have price stability as a focus of monetary policy.  It is our intention that the current inflation target band in the Policy Targets Agreement would be maintained. 

But the next Labour government is also determined to focus on the creation of decent work with high wages. This should be no surprise to anyone - it is in the very DNA of our Party. Our policy platform calls for us to work towards full employment.  One of Andrew Little’s first commitments as Labour Leader was to reduce unemployment to 4% in our first term. Having 140,000 people unemployed – 44,000 of whom have been for more than six months – will never be acceptable to a Labour Finance Minister nor should it be acceptable for New Zealanders. 

There are of course a range of policy measures that we will take to support this goal.  

I should mention at this point that only a couple of weeks ago Labour and the Green parties released a set of Budget Responsibility Rules that represent a fiscal bookend to this monetary policy speech.   On fiscal matters we will be responsible and deliver transformative policies.  As the most recent Labour government showed we can run surpluses, pay down debt, invest in long term and achieve far reaching social change. 

These will be driven by a substantial focus on regional development, skills and training, investment in research and development and changing the rules of government procurement to name just some.  But monetary policy can play its part too.

The idea of including a reference to employment outcomes in the objectives of a central bank is not unusual.  A number of countries such as the United States and Australia have either a dual or mixed mandate for their Central Bank. 

Nor should it be assumed that it degrades the other objective of controlling inflation.  Eric Rosengren, Chief Executive of the Federal Reserve Bank of Boston has undertaken a study to compare the inflation outcomes of the US as a dual mandate country and a range of single mandate countries.  His research shows that over the past 15-20 years the US performing better or as well in controlling inflation than the single mandate countries.

The current Governor of the Reserve Bank has made clear that employment outcomes and other measures of the health of the economy are considered by him when making decisions.  If that is so there is little to fear by changing the objective.  My view is that by legislating into the mandate of the Bank a focus on full employment this will give the labour market an appropriate weighting in decision making.

It also means that the Bank can be held accountable for keeping interest rates artificially high during periods of low inflation and high unemployment – as we have seen recently in New Zealand.  As Peter Redward has recently noted that had a mandate to maintain full employment been in operation in New Zealand it is likely that it would have constrained the bank’s aborted tightening of the Official Cash Rate in 2009 and 2014. This would have in turn would likely have seen a faster return to target inflation and faster economic growth.

Placing full employment in the mandate also not about ‘virtue signalling’ – as Michael has catchily termed it. We are serious about setting objectives for the Bank that are long term, and providing the right signals and incentives to the Reserve Bank.

In the UK during the 1990’s the then Chancellor of the Exchequer stated that that rising unemployment was “the price that we have had to pay to get inflation down. That price is well worth paying”. Unemployment at the time was rising towards 2.5 million and retail price inflation was 4.5%. 

The ECB in 2012- with a single price stability mandate – increased interest rates. Inflation in the area was rising – and was 2.7%. Unemployment in the ECB area was 10% in the general population, rose to 12% after the announcement of the rate change. As the Wall Street Journal Editorial said at the time “The European Central Bank’s single mandate to achieve price stability and to focus on nothing else is often criticised for being a handcuff that prevents the ECB from being proactive during swings in the economic cycle. A look back at the last six years of business conditions data clearly shows these critics are onto something”.

In the words of Paul Krugman, “Central Banks and Policy Makers will be making a terrible mistake if they look at low, stable inflation rates and pat themselves on the back for a job well done. Low, stable inflation can be entirely consistent with catastrophic economic mismanagement” – a dual mandate provides a means by which government can signal that low inflation alone does not signal a job well done – an economy characterised by both low inflation and full employment is the goal of any responsible government.

Full employment is the manifestation of sustainable economic growth in the economy and therefore it is appropriate for it to be an objective for the Reserve Bank as core actor in the economy. 

There are of course a variety of definitions of full employment, and a number of variables that impact on it such as labour force participation.  The exact operation of this objective would be subject to the negotiation of a new Policy Targets Agreement, but it is not our intention to seek a specific numerical target.   

The second area I want to focus on today are the decision making processes of the Bank – particularly around the Official Cash Rate.

I am proposing a change to the decision making process of the Bank so that a Committee, including external appointees, will have responsibility for setting the Official Cash Rate. The Committee will publish the minutes of its decision within three weeks, including noting any dissenting views 

While the single decision maker role for the Governor could be seen as an effective accountability mechanism, it is out of step with international practice. Also, with the expansion of the objectives highlighted above and the increasing complexity of financial markets, the role is not one that I am comfortable vesting in one person. 

This is no reflection on the current Governor or indeed any previous one.  As the Bank itself has said ‘ a group of individuals with a diverse and different set of useful information should make generally more informed decisions than an individual’. 

In 2012 at the time of the appointment of the current Governor the Treasury told the Minister of Finance that they saw benefits in pursuing a committee structure and noted that discussions with private economists favoured it as well. 

In some senses this has already been recognised by the current Governor. In 2013 he formed a Governing Committee including the two Deputy Governors and the Assistant Governor. He has made clear that while he maintains statutory responsibility for decision making, the Committee has in effect taken on the role of setting the Official Cash Rate.

This proposal seeks to build on that approach.  We propose that the four governing committee members be joined by three independent experts.  The appointment of the experts would be in the hands of the Governor, after consultation with the Minister of Finance. The appointments would also would be subject to Select Committee scrutiny through the Finance and Expenditure Committee.   A Treasury official would attend the Committee, without voting rights to provide a link to fiscal policy matters.

Again, this approach is not unusual around the world.  It is closest in operation to the United Kingdom model, but in Australia, and Europe similar models are in operation. 

I do not intend to name individuals who I believe could fulfil these roles, largely to protect the innocent.  However I am more than comfortable that there are capable people with the expertise required in academia, the public and private and non-governmental sector, including former Board members, to undertake this work. We would be seeking to have a range of perspectives represented reflective of both the importance of the decisions the Bank makes, and indeed the broadened objective we have proposed.

We will be asking those who undertake these roles to make a significant time commitment.  To give an indication of this, in the current process used by the Bank there is effectively a nine day programme every setting cycle.  I would expect anyone involved in the Committee to make a full time commitment over that period, in addition to other regular discussions and meetings.

We will also be asking members of the Committee to sign a non-disclosure agreement meaning that they could not talk publicly about their decisions or make public comment about future decisions without the express permission of the Governor. 

We believe adding outside expertise and perspectives will enhance public confidence in the decision making process. In addition to help sustain confidence in the system, greater transparency would accompany a change to the decision making arrangements.

We are proposing putting the minutes of each meeting of the Committee on-line within three weeks, including the result of any vote.  This is done in a number of other jurisdictions including the United Kingdom and Australia.  This would give greater certainty to markets about the trajectory of decision making by the Bank.  It is also important for a public institution making as important decisions as the Reserve Bank does, but that do not answer to any elected official to have this level of transparency.

Reserve Bank Staff would continue to prepare projections and financial information for the Committee. The RBNZ Board would still have retrospective oversight of Committee decisions, and would hold the Committee and the Governor to account for any systematic errors or omissions. The Minister of Finance would retain all the powers reserved for them under the Reserve Bank Act 1989. 

Conclusion

Monetary Policy is a complex topic, and one where certainty and consistency are virtues.  But it is also not written by Moses on a stone tablet.   Like all areas of policy it needs to be reconsidered from time to time to reflect the principles and practices of good economic management, the changing environment in which we live and work and the way it relates other parts of the economy.

Now is the right time to do that, for both policy and practical reasons.  I look forward to engaging with all those who are interested to shape our modern monetary policy so that it can play its part in the development of a New Zealand economy that delivers sustainable and shared prosperity.

Thank you.

 

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