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FILE PHOTO: A security guard stands in the main entrance to the Reserve Bank of New Zealand located in central Wellington, New Zealand, July 3, 2017. REUTERS/David Gray/File Photo
October 12, 2017
By Ana Nicolaci da Costa and Charlotte Greenfield
WELLINGTON (Reuters) – The formation of a center-left government in New Zealand after an inconclusive election last month would likely spell big changes for its central bank, the pioneer of the inflation-targeting regime adopted across the world.
The Labour-Green bloc has an even chance with the ruling National Party to form a government, if it can agree to a deal with the nationalist New Zealand First Party after talks this week.
For 28 years, New Zealand’s central bank has had the single aim of keeping inflation between a set range. But Labour wants to add employment to the bank’s mandate, a goal shared by NZ First which also wants to broaden the Reserve Bank of New Zealand’s (RBNZ) focus to include greater management of the local dollar’s value against other currencies.
“It’s a huge change. We’ve had over 25 years of an extraordinarily successful monetary policy that has been copied around the world,” said Arthur Grimes, RBNZ’s chief economist in the early 1990s and Board Chair between 2003 and 2013. Any change without careful consideration and analysis would be “extraordinary”, he added.
New Zealand was first to formally grant its central bank independence and first, in 1989, to introduce an official inflation target after grappling with annual price rises as high as 18 percent during the 1980s.
Though its economy is only the world’s 53rd largest, New Zealand has earned a reputation for its economic experimentation and free market approach over the past three decades.
Its inflation targeting soon became the global economic orthodoxy.
“I don’t think people treated it terribly seriously (at first),” said Ted Truman, a former U.S. Federal Reserve official, who spent a month in New Zealand 16 years ago researching inflation targeting.
“Five or six years later it was much more respected and people flocked to New Zealand to find out how they were doing it… which is why I was there.”
Don Brash, who was governor when the inflation target was introduced, said the idea came from a TV interview with Roger Douglas, a Labour finance minister in the 1980s. Douglas was asked if he was happy with a drop in inflation to below 10 percent.
“He said: ‘No, I’m looking at price stability like zero to 1 percent’ and that was I think the first formulation of the target in numerical terms,” Brash told Reuters.
The initial 0-2 percent target was widened in 1996 and then lifted in 2002 to its current 1-3 percent.
New Zealand’s per capita income dropped during the radical reforms of the 1980s but has since stabilized. Its employment rate has consistently out-performed other developed countries for the past decade and inflation has remained in check.
Labour has said it is committed to the inflation target but wants to add the goal of full employment, bringing it in line with the likes of Australia and the United States.
Reserve Bank of Australia (RBA) Governor Philip Lowe is a fan of his broader mandate which comprises stable inflation, full employment and “economic prosperity”.
“It’s meant that we’ve been able to take our time in getting inflation back (to target),” he said recently. “We’re prepared to be patient.”
Grimes, however, argues that history proves monetary policy cannot have a sustained impact on employment.
“It would be like having someone who is running for health minister argue for a cancer drug to be used for heart issues,” said Grimes, who was in close contact with central bank officials from Britain as they moved to inflation targeting.
Analysts say the proposed change could lead to a higher bar for the central bank to raise rates as the RBNZ balances the need to keep inflation in check with that of securing employment growth – a trade off other central banks with dual mandates have had to grapple with.
“I had a conversation with Alan Greenspan once and he expressed envy for the fact that we had a single mandate,” Brash said. “He understands full well if the two are in conflict at some point, which one do you give priority to?”
Greenspan did not respond to requests for comment.
NZ First also favors greater intervention in the foreign exchange market, with leader Winston Peters even touting a Singapore-style system where a currency target path replaces official interest rates and the central bank intervenes to manage currency swings.
Paul Dales, chief Australia and New Zealand economist at Capital Economics in Sydney said this would represent “a complete shake-up” of New Zealand’s monetary policy and was unlikely to materialize.
He said greater central bank intervention was also unlikely given the RBNZ is bound by its “traffic light” system which guides any intervention and that any changes “would be tantamount to political interference in the central bank”.
Instead, Labour could agree to make a mention of the exchange rate in the central bank’s policy target agreement, along with price stability and full employment.
“If they put something like that in, it would be a rhetorical win for Winston … it wouldn’t necessarily change very much in substance at all,” said Michael Reddell, a former RBNZ official.
(Reporting by Ana Nicolaci da Costa and Charlotte Greenfield; Additional reporting by Wayne Cole in Sydney; Editing by Lincoln Feast)