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Memo to Graeme and Bill: Insanity is doing the same thing over and over again and expecting different results
By Bernard Hickey
Leadership changes at the Reserve Bank are once-in-a-decade events so the arrival of a new Governor and the writing of a new Policy Targets Agreement (PTA) with Finance Minister Bill English offers a rare opportunity to change the way monetary policy is managed.
Former World Bank Managing Director and Treasury Deputy Secretary Graeme Wheeler is due to take over from two-term Governor Alan Bollard on September 25.
Ahead of his arrival, English and Wheeler will negotiate a new PTA and the current indications are it's unlikely to be changed much from the existing one signed in December 2008, which gives the central bank the mandate to target inflation at between 1 to 3% on average over the medium term.
That's a pity.
The current monetary policy framework is working with the government's fiscal policies, our floating exchange rate and a housing shortage to reinforce all the same old imbalances in our economy.
Government borrowing, safe haven demand from foreign investors for bonds and property, and a surge of reinsurance funds for earthquake claims has boosted demand for the New Zealand dollar. This has pushed our currency well above 80 USc and out of whack with a 30% fall in commodity prices in the last year.
Exporters are struggling and five years after the beginning of the Global Financial Crisis we have yet to see hardly any of the rebalancing towards exports and production everyone expected from 2008 on.
Bollard acknowledged as much in an excellent speech he gave this week that emphasised how little deleveraging of debt had actually happened and how little rebalancing had happened.
The tragedy for Bollard and the economy is the very reason there has been little rebalancing is the same reason he can more easily hit his 1-3% inflation target.
The high New Zealand dollar is proving very effective at doing the Reserve Bank's dirty work of slowing down the economy and keeping inflation low. Exporters face a double whammy of lower commodity prices magnified by a higher dollar. Meanwhile consumers and importers benefit from downward pressure on import prices.
As a result, New Zealand's current account deficit position is forecast to worsen towards 7% of GDP and we do little to pay down our still-high foreign debts.
It's a case of 'plus ca change, plus c'est la meme chose'. The more things change, the more things stay the same.
Yet again we see house prices rising (up 9.4% in Auckland in July from a year ago), household debt rising (up NZ$5.335 billion to NZ$NZ$187.951 billion in the last two years) and the New Zealand dollar rising at the same time as the economy slows down and unemployment rises (up to 6.8% from 6.7%).
There is the potential that the situation could be made even worse if the Reserve Bank uses its blunt instrument of a rate cut to offset the effects of a 'Euro-geddon' type meltdown in Europe. Safe-haven capital inflows and even lower interest rates for longer could see Auckland house inflation skyrocket and the New Zealand dollar strengthen.
Bill and Graeme must nut out some strategy to break this self-destructive nexus.
Before Wheeler's appointment, the Reserve Bank said it was looking at loan to value ratio limits and other 'macro-prudential tools' to reduce the risks of housing bubbles distorting the economy.
These are tools used in Hong Kong, Singapore and more recently in Canada to try to slow the housing sector without an economically damaging interest rate hike.
Wheeler and English should look hard at using these tools.
Otherwise they risk proving Einstein right: "Insanity is doing the same thing over and over again and expecting different results."