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Rodney Dickens makes a public plea to Governor Wheeler to keep the OCR more stable in the future, avoiding unnecessary and costly volatility in the OCR
By Rodney Dickens*
Since the first governor was appointed on 1 January 1934 the Reserve Bank has had 11 governors of which seven have been misters, two have been doctors and two have been sirs.
There have also been two periods when acting governors were in charge, which included the period between Don departing and Alan taking over in 2002 during which Dr Rod Carr was acting governor.
The adjacent chart shows the recent history of Reserve Bank governors.
A half tribute to Alan Bollard
In the last three years and five months of Alan Bollard's term as governor he only changed the OCR three times: two 0.25% hikes in 2010 and one 0.5% cut in 2011.
This was a remarkable achievement in the context of the volatile history of the OCR shown in the chart below.
And, more generally, in the context of the volatility in interest rates shown in the chart above since the Reserve Bank was given independence in the operation of monetary policy via the Reserve Bank Act of 1989 (although the Reserve Bank was effectively given independence some time before 1989).
In a number of past Ravings I have highlighted the cost of volatile interest rates and made a case for much more stable interest rates (visit our website to see these).
The massive volatility in interest rates experienced in the past has needlessly kicked around industries sensitive to interest rates like residential building (see the adjacent chart).
The Reserve Bank could have achieved its inflation objective without marching interest rates up the hill just to march them back down again.
So I applaud Alan for keeping the OCR more stable since 2009.
There have still been cycles in mortgage interest rates and residential building consents during the recent period of a much more stable OCR. But it is no coincidence that these cycles have been much less severe than most past cycles.
The volatility of new dwelling consents in the recent period of a more stable OCR has been almost one third of the previous volatility based on the relevant mathematical calculations (i.e. standard deviations).
The more stable OCR has contributed to a more stable economic environment, which is something the Reserve Bank put far too little emphasis on in the past.
In the past the Reserve Bank was a major contributor to volatility in the economy.
But it was more coincidence than intent that the OCR and 90- day bank bill yield have been much more stable recently.
The bottom chart shows that the Reserve Bank has consistently predicted significant increases in the 90-day bank bill yield during the period Alan kept the OCR stable (i.e. Alan intended to deliver a large cyclical increase, but events prevented this).
Most notably, economic growth failed to experience the normal strong recovery after the recession in 2009.
The adjacent chart shows that economic growth has been not far from the historical average rate since early 2010. A range of factors contributed to economic growth being weaker than predicted by the Reserve Bank over the last few years, as discussed in our monthly economic reports.
Over the last couple of years we have warned clients that economic growth would be weaker than the Reserve Bank predicted and that the predictions of significant interest rate increases were misplaced. For info on these reports visit http://www.sra.co.nz/index.php/interesting-times.
It was more a coincidence than intent that Alan didn't change the OCR much over the last few years. But maybe Alan was partly motivated in the last few years by a desire to keep the OCR more stable rather than the stable OCR being just a reaction to economic growth failing to rebound to above average levels (i.e. maybe he deserves more than a half tribute).
But Alan deserves credit because he resisted hiking the OCR in the last couple of years despite regular calls the bank economists for hikes.
In a 7 August 2011 Raving I highlighted why OCR hikes were not warranted despite calls for hikes.
Graeme, please focus on the neutral OCR rather than be the next Grand Old Duke of York
This Raving is a public plea to Governor Wheeler to keep the OCR more stable in the future (i.e. avoid marching it up the hill, just to march it back down).
This doesn't mean the OCR shouldn't change. When the financial crisis eventually heals there will be a case for a reasonably significant increase in the OCR, although this shouldn't mean a major increase in the interest rates faced by borrowers.
The main feature should be the gap between the OCR and the likes of the average mortgage interest narrowing towards precrisis levels (see the top chart on page two to see how much the financial crisis resulted in this gap increasing).
My plea is that Graeme focuses on assessing the appropriate level of the OCR for achieving the medium term target of keeping inflation in the 1-3% range (i.e. he focuses on assessing the "neutral" level of the OCR) and avoids unnecessary and costly volatility in the OCR.
This means he needs to depart from the path of his predecessors who far too frequently marched the OCR (and 90-day bank bill yield) up the hill, just to reasonably soon thereafter march it back down again. To view the report I wrote in June 2011 that reviewed the experience with an independent central bank since 1989 use this link ».
This report concluded that the Reserve Bank has more often been the disease rather than the cure. To view the report I wrote in June 2011 that exposed the fundamental flaw in the way OCR decisions are made use this link ».
The flawed approach used to make OCR decisions meant monetary policy has been a major source of volatility in economic activity and especially housing market activity, in the incomes of retired people who often have a sizeable portion of their wealth in interest bearing investments and probably also in the NZD. To view the final of the three reports on monetary policy I released in June 2011 use this link ».
This report proposed a superior approach to making OCR decisions that would result in significantly less volatility in interest rates and a more stable economic environment than has been the case on average since 1989.
*Rodney Dickens is the managing director and chief research officer of Strategic Risk Analysis Limited.