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Labour's Parker on monetary policy; Says RBNZ should consider NZ$, employment & growth with inflation; RBNZ to decide appropriate mix; But monetary policy needs mates too
By Alex Tarrant
Last week I sat down with Labour Party finance spokesman David Parker to ask him about the changes Labour wants to make to the Reserve Bank's mandate if it wins the 2014 election, and why he thought those changes were necessary.
Labour mooted possible changes to the Reserve Bank Act in the run-up to the 2011 election, and since then Parker's time in the party's finance role has seen him questioning whether the central bank should just primarily target price stability.
Whether you agree or disagree with the policy, if Labour wins the 2014 election, Parker is set to be the next Minister of Finance. This is his current thinking on potential policy changes he will make.
A brief summary:
1) "We just don’t think that [inflation] should be given primacy over other aspects of economic management, like the exchange rate, particularly given how the world has changed in the last decade"..."But I don’t think that the Reserve Bank Act should say that the exchange rate for New Zealand should be X or Y."
2) There could be trade-offs between the mooted equal mandates of inflation, the level of the NZ$/exporters, employment and growth:
"And at the moment we always trade everything else for inflation targeting. If there’s ever a conflict between the objectives, the primacy given to control of inflation over other objectives – inflation trumps the other objectives.
"And we’re saying that’s wrong. We’re saying that there are times when you should give a wee bit in respect of your inflation target."
"There will be times when the importance of control of inflation trumps other matters of economic importance."
AT: Does the Reserve Bank just figure out those times itself? DP: Well, yes they do.
3) Monetary policy needs mates, especially to help narrow the current account deficit. Government can change settings influencing investment environment (ie tax settings - Labour wants a capital gains tax) and saving rates (Labour wants universal KiwiSaver)...
"But it’s notable that Australia has capital gains tax, plus [a form of] KiwiSaver, and they’ve still got...these similar problems. And I would say that what’s true of our monetary policy settings is also true of theirs."
4) Macro-prudential tools, like LVR ratios and capital ratios, should be used by the RBNZ for 'economic outcomes,' not just 'stability outcomes.'
5) Eyes enhanced role of RBNZ board in decision making processes around level of interest rate, use of macro-prudential tools. Also wants board members representing exporters and labour interests.
6) On moving from CPI target to nominal GDP target, or targeting the price of a basket of export goods:
"I’m willing to look at all those things. I don’t profess to be expert enough to say what’s the proper answer in respect to that, and I’d want to take advice on that. I’m open to those ideas."
7) Says NZ facing competitive currency devaluation abroad as major economies with very low interest rates engage in quantitative easing. But "not sure about" whether RBNZ should be cutting rates too:
"I think that Alan Bollard made a fair point at his final appearance in front of the finance and expenditure committee that lower interest rates would not necessarily flow through to a lower exchange rate, if people thought that those interest rates were unrealistically low.
"One of the problems that we have at the moment in the world, is that other interest rates are too low, rather than ours are too high.
8) AT: You’re also talking about this intervening in the currency markets every so often, just to try and scare people off...
DP: "Again, I haven’t gone quite that far. What I’ve said is that one of the criticisms that’s made [about] some of our monetary policy is, because it is so anodyne, and so predictable, we are a safe harbour for a proportion of the liquidity in the world that needs a short term place to stay."
"...the point these people are making is that one of the reasons why we have greater demand for our currency than would otherwise be the case, is that we have such predictable settings around monetary policy..."
So without any further ado, here is the transcript of our discussion on Thursday, September 27:
AT: So Labour wants to get away from just inflation targeting...
DP: Correct. Which is not to say that we think that inflation is good; [and not to say] that we don’t think that the Reserve Bank has a function in controlling inflation.
We just don’t think that it should be given primacy over other aspects of economic management, like the exchange rate, particularly given how the world has changed in the last decade.”
AT: So Labour’s going to tell the Reserve Bank it wants a set exchange rate? How do you figure that out then?
DP: We don’t say in the Reserve Bank Act that we favour a set inflation rate. We do have a policy targets agreement which sets out a range of what we want to achieve. But I don’t think that the Reserve Bank Act should say that the exchange rate for New Zealand should be X or Y.
We’re not saying that, and to say that would be to misrepresent our policy. What we’re saying is that the Reserve Bank should have broader objectives than having to give primacy to inflation targeting. I don’t personally think that’s especially controversial, despite the fact that the National Party says it is.
Now, there are plenty of other countries [that] already have broader ranges. But even if they don’t have broader ranges, there are a lot of other countries that are actually now, in effect, not pursuing inflation targeting at the expense of exchange rate.
You’ve got to, I think, have a bit of a historical perspective in this. When I was overseas, Jeffery Frankel said something to me which I think resonates. He said: ‘No one system of monetary policy is right for all countries, and no one system of monetary policy is right for any one country all of the time.'
AT: But yet you want to copy other countries’ monetary policies.
DP: In part, yes, where there’s better practice, I do. But in part what I’m saying is – the second part of that – that no one system of monetary policy is right for any one country at all times – means you have to change with the times.
In the past New Zealand has, and the world has. We had the gold standard, then that stopped running, so we had Bretton Woods, and we had post-Bretton Woods arrangements which were largely fixed exchange rates. That ran out of rope and then we moved to new systems of monetary policy which focused on control of the money supply.
That stopped working, and we moved to inflation targeting. Inflation targeting has stopped working, and so we should move on.”
AT: So there’s other aspects you want the Reserve Bank to focus on. Is that like employment – the level of employment in the economy? The level of growth?
DP: We’ve said that the Reserve Bank should keep an eye on inflation, employment levels, and the exchange rate – well, the interests of exporters. There’s different ways you can express it, but essentially yes, a broader range of indicators other than inflation, or in addition to inflation.
AT: But do you accept some of these things could conflict with one another.
DP: Well that’s the very point.
AT: If the Reserve Bank cuts interest rates to foster economic growth, to foster employment, then that could be at the detriment of inflation.
DP: We’re not going to say that they should pursue full employment. We’re not saying that.
AT: Well, just more employment.
DP: Your question actually proves my point. That there are trade-offs involved here. And at the moment we always trade everything else for inflation targeting. If there’s ever a conflict between the objectives, the primacy given to control of inflation over other objectives – inflation trumps the other objectives.
And we’re saying that’s wrong. We’re saying that there are times when you should give a wee bit in respect of your inflation target.
AT: And who decides that?
DP: The Reserve Bank
AT: But you’ve told them to have stable inflation...
DP: Yes I have
AT: And you’re telling them you want more employment
DP: I’m saying that stable inflation is not an end in itself. There will be times when the importance of control of inflation trumps other matters of economic importance.
AT: Does the Reserve Bank just figure out those times itself?
DP: Well, yes they do. At the moment, we actually take a decision in advance, and we effectively say, there’s never a circumstance in which inflation targeting should not have primacy over other aspects of the economy. That’s very nice and it’s very simple, but how unreal is that?
For a country that has had a current account deficit that spans three [decades], and every year we have a current account deficit we plug that gap through more overseas borrowing and sale of assets to overseas, resulting in what we have now, which is net international liabilities of over 70% of GDP, predicted to go to over 80% of GDP, and the reason for our credit downgrades last year.
AT: So would the government perhaps do this through the Policy Targets Agreement, saying, 'for the next year, because unemployment’s so high, we want you to focus a bit more on the employment level than inflation?' It seems like it would have to have a bit more input from government though, than just leaving it to the Reserve Bank to decide.
DP: Well, I don’t know about that. I would be happy to look more carefully at policy targets agreements in other countries. But we’ve got many, many economists at the Reserve Bank who are able, in my opinion, to properly have a more nuanced approach to management of inflation and other aspects of monetary policy that are important to the growth of the economy.
At the moment we say, through statute, that they must give primacy to inflation targeting over all other aspects of economic management. And given that we face competitive devaluation abroad, and we are losing that battle in New Zealand, and it is costing us jobs and incomes and the New Zealand balance sheet inexorably every year gets worse – I think we had one or two years following the reinsurance proceeds from Christchurch and in recession where people put away their cheque books when net international liabilities didn’t get worse.
But the long-term trend is clear, and we’re back on that track now. We’ve got to change something.
AT: So right now the Reserve Bank should be cutting interest rates in line with everyone else?
DP: I’m not sure about that. I think that Alan Bollard made a fair point at his final appearance in front of the finance and expenditure committee that lower interest rates would not necessarily flow through to a lower exchange rate, if people thought that those interest rates were unrealistically low.
One of the problems that we have at the moment in the world, is that other interest rates are too low, rather than ours are too high. But maybe they should. And that’s certainly, I think, something that should be looked at in the Reserve Bank in the context of effects on exchange rate, rather than giving primacy to merely the inflation targeting.
AT: You’re also talking about this intervening in the currency markets every so often, just to try and scare people off...
DP: Again, I haven’t gone quite that far. What I’ve said is that one of the criticisms that’s made [about] some of our monetary policy is, because it is so anodyne, and so predictable, we are a safe harbour for a proportion of the liquidity in the world that needs a short term place to stay.
AT: But that’s because we demand that liquidity. We want those overseas funds in order to...
DP: There’s two issues here. I don’t think that’s necessarily right in respect to the whole of the problem. Yes of course we want money because we’ve got a current account deficit to fund. There’s a chicken and egg argument there that I’ll come back to.
But the point these people are making is that one of the reasons why we have greater demand for our currency than would otherwise be the case, is that we have such predictable settings around monetary policy that if you want a safe place to put some of your money, if you’re taking a portfolio approach to investing, then you’ll whack more of it in New Zealand than you might otherwise do, because our settings are just so predictable.
It’s virtually a one-way bet. You’ll know that you’re not going to lose it...
AT: So even though we’re a net capital importer, you’d want less of that.
DP: Actually I want to be less of a net capital importer.
AT: So how do you do that? Is that up to the Reserve Bank, or is that up to...
DP: No, you overcome your current account deficit. That’s how you get over that.
AT: Is that up to the Reserve Bank though? It’s up to fiscal policy surely...
DP: It’s partly up to fiscal policy. We ran fantastic fiscal policy in the thousands, which is the point that I made earlier, and we still had a current account deficit.
Is it up to the Reserve Bank to fix that problem? Not alone. But do current Reserve Bank settings make it harder for our exporters? Yes they do.
And as a consequence of that, our current account deficit is worse than it would otherwise be.
AT: If the Reserve Bank settings are detrimental to exporters, that’s surely because the interest rate is too high at the moment – the OCR.
DP: I think you need to be a bit careful that you view things in a prism, other than just in the instant. And over time, there is no doubt that New Zealand’s exchange rate is higher than the fundamentals of our economy, and I think that’s evidenced by the fact that we’ve run a thirty year current account deficit.
Stand back and say, has our currency been too high? Well, we’ve come through the best terms of trade in a generation. We never had a current account surplus.
People say, ‘well Australia do the same thing.’ Stand back and ask yourself, how does it make sense that following ten years of a resources boom, Australia’s still in a current account deficit. Their currency’s overvalued relative to the fundamentals of their economy.
AT: Like us, they’re sucking in funds to go into their housing market...
DP: In part. But in part the reality is they’re not earning enough from their exports, despite record volumes of exports in Australia, and record prices for minerals, because their exchange rate is too high, relative to what other countries are doing in the world.
We’ve got China having the world’s largest trade surplus ever, successfully managing their exchange rate at a peg – low. We’ve got other countries around the world doing something similar, like Singapore, managing within a range.
The Americans – and you read the literature around quantitative easing - one of the reasons they’re doing it is to lower their exchange rate to improve the competitiveness of their export economy against Japan and China and others. And that’s narrowing at the rate of twelve percent per annum in part, because of their quantitative easing.
You’ve had Germany profiting for years off a euro held low by problems in other parts of Europe relative to the German export economy, and now Europe’s going into quantitative easing – effectively printing money.
You’ve had Switzerland, not taking real money and spending it to defend their exchange rate, but printing money in order to defend a cap. You’ve got the British having done something similar.
You’ve got countries like Brazil intervening when their currency goes too high. It’s happening all around the world, and our currency is being inflated as a consequence. We should not ignore that.
AT: So in response to that people would say countries like Singapore, China, have huge reserves, China can export a lot because of their economic settings – perhaps labour laws and stuff like that, the US is trying to ward of deflation.
DP: Well let’s do them one at a time, because the grand question’s hard for me to answer here. Ask the China one first, for example.
AT: OK, China. Huge foreign exchange reserves, they can manage their currency with a peg...
DP: Born of a current account surplus.
AT: Yes, so again it comes back to current account surpluses doesn’t it.
DP: That’s right. Born of a current account surplus because they manage their exchange rate in way that doesn’t happen in New Zealand. Now I’m not saying that we should go to the extremes of China, but I’m saying that we should be further away from the extreme where the primacy of inflation targeting trumps exchange rate.
AT: You can say Singapore has those reserves.
DP: Again. This is a chicken and egg argument. When you have a current account deficit for 30 years, of course you’ve got no reserves. Of course you’ve got no reserves. But you’ve got to do something serious about overcoming that, otherwise the country’s balance sheet gets worse every year, as it is in New Zealand.
And one of the things that you’ve got to be willing to change is giving [away] the primacy [of inflation targeting] for the people who can influence this in some way, which is the Reserve Bank, and at the moment we tell them, ‘no, don’t do that’.
AT: It’s also surely due to the settings that influence capital allocation in the economy though as well...
DP: I’ve already acknowledged that, I don’t deny that – it is influenced by that. That’s why we also favour a capital gains tax, so that there’s fair allocation of capital in society – in productive enterprise rather than speculative investment.
That’s one of the reasons why we also favour expanding KiwiSaver.
But it’s notable that Australia has capital gains tax, plus [a form of] KiwiSaver, and they’ve still got...these similar problems. And I would say that what’s true of our monetary policy settings is also true of theirs. They’re no longer working.
AT: With Frankel you talked about nominal GDP targeting. Is this something you’re seriously looking at?
DP: What he says is, even if you’re inflation targeting, he doesn’t think that the Consumer Price Index is the appropriate index to monitor, and he prefers nominal GDP.
He also thinks that for some countries that have a resource weighting – have a commodity basis of their exports – that they should be monitoring a basket of those commodities that they export, rather than nominal GDP or CPI.
I’m willing to look at all those things. I don’t profess to be expert enough to say what’s the proper answer in respect to that, and I’d want to take advice on that. I’m open to those ideas.
But I am sure that giving primacy to inflation targeting over other aspects of economic management is no longer necessary in New Zealand, and is no longer right.
AT: So we’ll see some details soon perhaps, from Labour.
DP: Well you’ve already seen some. We said we’d amend the Reserve Bank Act to extend the objectives in the way that we’ve said; We’ve said that the membership of the board should be changed so that it’s less dominated by bankers, and there are other aspects of the economy better represented, namely exporters and the interests of labour.
We think, whatever the rules are, you’ll get different outcomes if the board is of a slightly different make-up.
We’ve said that prudential tools, like loan-to-valuation ratios, or capital adequacy ratios, should be able to be used for economic outcomes, not just financial stability outcomes, which is the limitation under the current Act.
And we’ve said that the decision as to interest rates and those macro-prudential tools should be integrated and taken by the board, rather than by the Governor of the Reserve Bank. If you’re going to be using both of these tools it’s a nonsense that you’ve got separate decision makers for them. They should be integrated.
AT: So the board would tell the Governor, ‘look, there’s an asset price bubble going on in the housing market, we reckon...
DP: The Governor would effectively be the chief executive of the Reserve Bank. The board would be in receipt of all of the advice that the Reserve Bank provides to it, and the board would take decisions as is the normal decision making process, whether it’s for cabinet, for major corporations, or school boards of trustees.
AT: Now you’re having the board making more operational sorts of decisions?
DP: No, I don’t think so. No more so than is the case for the Cabinet, or for the board of any corporate body. It’s actually the normal decision making process, rather than having a Presidential model, which is effectively what we’ve got with the Governor.
Then we’ve also said that we need complimentary measures that work alongside Reserve Bank policy, including sound fiscal policy by the government, and we stood for that in the last government, and we stand for that going forward.
And we think that we need complimentary tools in the form of capital gains tax, to take the heat out of asset price bubbles.
AT: So mates for monetary policy.
DP: Yeah, we do. We agree with that. We’ve long agreed with that. The Reserve Bank said monetary policy needs mates, and we agree with that.
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