A closer look at the 'regret analysis' and view that low interest rates are the new norm that underpinned the Reserve Bank's decision to cut the OCR to 1%

A closer look at the 'regret analysis' and view that low interest rates are the new norm that underpinned the Reserve Bank's decision to cut the OCR to 1%
Reserve Bank Governor Adrian Orr

Reserve Bank (RBNZ) Governor Adrian Orr says the Monetary Policy Committee (MPC) was mindful of “regret analysis” as it made its shock decision to cut interest rates by 50 basis points.

The New Zealand dollar plummeted on Wednesday on news the Committee cut the Official Cash Rate (OCR) to a new record low of 1%.

Speaking at a press conference, Orr said the MPC members “tossed and turned” but decided it was best to get ahead of the curve - make it much cheaper for households, businesses and the government to “wake up and go and spend” to prevent the economy nose-diving.

“Over recent days the Committee became increasingly convinced that more [monetary policy stimulus] sooner is a safer strategy to achieve our targets than slower for longer,” Orr said.  

“And in a sense, it’s around the regret analysis. In a year’s time I would far prefer to be sitting here… thinking, ‘Wow, inflation expectations might be getting away on us’…

“That’s a much nicer challenge to have in monetary policy than doing too little, too late.”

While Orr admitted the final OCR decision was made on Wednesday, he said there wasn’t a particular event that tipped the MPC in favour of making such a drastic move.

Low interest rates were clearly needed, and for the MPC it was “simply more of a strategic discussion around regret analysis”.

“Holding an interest rate [cut] back in case you need it to add more in the future just makes no sense whatsoever, so we’re comfortable with it,” Orr said.

Monetary policy still effective

Having previously disregarded the argument of diminishing returns, or the view that you get less bang for your buck with each cut, the lower the OCR is, Orr said: “Monetary policy is still just as effective at lower rates. It just means that you are operating around a lower neutral interest rate.”

Orr was firmly of the view that low rates were the new norm and the RBNZ needed to keep abreast with what its counterparts around the world were doing.

“We’re sitting in our waka here as Aotearoa-New Zealand, but we are on a global ocean and that tide has gone out in terms of the nominal interest rate levels.

“Monetary policy is as effective, but it’s still relative to some sense of a global neutral interest rate, and that has certainly declined. When you look at the long-end of the US 10-year bond yield significantly below 2%, these are really, really interesting times.”

Zero in the realms of possibility

“It’s easily within the realms of possibility that we might have to use negative interest rates,” Orr said.  

“The important thing to remember today is that by doing more sooner, probably reduces the probability (I don’t know by how much) of having to do that.”

He said the RBNZ was looking at how to use its “full tool suite” should the OCR keep falling.

While the RBNZ was working with local and international experts, as well as talking to Treasury, Orr said details were confidential due to being market sensitive.  

Asked whether there was a role for broader consultation with the public and government on the matter, Orr said: “No, but we would certainly operate with no surprises…

“If you chose negative interest rates, it’s business as usual - you’ve just got a negative in front of the number.

“Quantitative easing - it’s about shortening the duration of a government yield curve.

“All of these things would have to be done with the full understanding of the whole of government, but it remains within the remit of monetary policy to do whatever it takes to meet our mandate with our toolset.”

Medium-term outlook key

Coming back to Wednesday’s Monetary Policy Statement, it noted the US-China trade war, slowing growth in New Zealand’s export markets, and dampened business investment off the back of low confidence were among the headwinds facing the economy.

RBNZ Chief Economist Yuong Ha couldn’t pinpoint how much weight the Committee put on the domestic versus the international landscape in its decision-making.

“There’s no clear dividing line. We are part of the global economy,” he explained.

The RBNZ revised down its gross domestic product (GDP) forecasts from its May Monetary Policy Statement. It cut these for the June, September and December 2019 quarters from 0.7%, 0.9% and 0.8% respectively, to 0.5%, 0.6%, 0.7%.

Its GDP growth forecast for the first three quarters of 2020 remained at 0.8%.

While the MPC kept a watching brief on movements in the economy right up until it had to make an OCR decision on Wednesday, Assistant Governor Christian Hawkesby effectively assured its decision to cut by 50 basis points wasn’t a knee-jerk reaction to a particular event, like global equity markets tumbling and China interfering in its currency.

Commenting on the economic data out this week, Hawkesby said: “We are conscious that we need to be disciplined and we need to take a medium-term view. We are conscious that some of this data is volatile.

“It’s unlikely that we’ll ever be tilted by one particular outturn.”

All eyes on the banks to ensure they pass on the cut 

Orr wasn’t concerned about the effect low interest rates would have on banks’ largest source of funding - deposits.

Nor did he see lower interest rates sending house prices through the roof.

He said the lending restrictions imposed on banks via limits to high loan-to-value ratio residential mortgage lending make him “much less nervous” about the “extreme levels of debt” previously taken on by “small pockets” of households.

Orr didn’t see lower income for savers curtailing their spending more than lower rates for borrowers would prompt more spending.

He said he’d be watching banks to ensure they passed on the OCR cut to borrowers, including riskier ones like farmers and small business owners.  

“I know a lot of banks were wanting to effectively hide behind our possible changes to the capital ratios as their excuse to exit farming. But we’ve made it very clear that it’s their issue that they’ve built, that they need to work through with their customers.”

Orr also noted how a low OCR, feeding through to a weaker dollar, would benefit exporters including farmers.

Ha added: “The exchange rate has always played a useful shock absorber role for New Zealand. Independent of what might be going on internationally, we still think that’s an important channel for a country.”

Yet Orr cautioned: “Exchange rates are a zero-sum game. It’s always relative to some other country and many other countries are wanting to use that channel.”

He didn’t believe it was viable for the RBNZ to manipulate the New Zealand dollar.

We welcome your help to improve our coverage of this issue. Any examples or experiences to relate? Any links to other news, data or research to shed more light on this? Any insight or views on what might happen next or what should happen next? Any errors to correct?

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16
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“Orr didn’t see lower income for savers curtailing their spending more than lower rates for borrowers would prompt more spending.”
Well at least they acknowledge they are screwing workers/savers while advantaging speculators and encouraging/forcing people into debt. Such a perverted system. Ironically enough, we will be in exactly the same situation further down the line where we will need another cut to support our increased levels of debt on unproductive assets. But hey, what do I know. I don’t get paid a bunch and work for the RBNZ.

A major long-term cost of this monetary easing environment is going to be lower productivity (negative in our case) and a worsening R&D expenditure-to-GDP ratio.
When enterprises with 'limitless' access to cheap funding could make significantly more simply by speculating on asset prices, why take up long-term risk of research and innovation?
Also, these enterprises have the financial ability to entice highly-skilled workers away from productive businesses to a career in flipping assets.

Exactly! kick the debt cycle down the road.

Will it get to a point when there is so much debt that any increase to the OCR would trigger a meltdown, leaving the RBNZ impotent.

The message does appear to be, "wake up and go and spend". Every patriotic NZer needs to go out there and do their bit.

Unemployment is low, rents and wages, are going up and mortgages are going down so get out there and buy a house. Cars have never been cheaper. Sharpen up your wardrobe, clothes have never been cheaper.

It's only an unintended consequence that landlords who are slightly negative, neutral or positive will be better off than most.They need it though for the extra costs involved with being landlords.

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old people wont spend , thats what they dont get instead they will tighen their belts, if we had high interest rates yes they would spend.
a lot like to not touch the capital at all as they have long memeories and have it drummed into them to save
its young people that spend like a drunken sailor but they do it on credit

Never seen a hearse with a trailer on the back. If the elderly want to spend their twilight years as hermits living off bread and water to keep their hoard intact that's their choice. The next generations turn is coming and the old won't be taking their homes or TDs with them to the grave.

It's more that they fear how long they'll have to make those savings last, I'd reckon. That and potentially wanting to leave more to the kids.

I guess in that regard a very low interest rate becomes an effective inheritance tax.

there is a big difference in generations adittude , leaving as much as they can for the next generation compared to the younger bridgade i want and i want now
it was even on the news last night with an old lady with 100k in the bank saying exactly that she tighen her belt because she only get 2k a year to spend on luxuries now

Is that the younger generation who have to pay for their tertiary education and are loading into kiwisaver because they know that there'll be no super when they get there?

compared to the younger bridgade i want and i want now

That's bollarks, though. Recent research presented here on Interest showed that younger generations were saving at 19%, a rate only equaled by pensioner age groups.

We only need one car, and barely even that one. We have more clothes than we need. There is nothing we really need that we don't have.

On another note, as there is no way to realistically unwind these interest rate cuts. I wonder when the war on cash will start? Negative interest rates are practically a certainty in the future and the ability to hold cash would undermine that so I think we will see cash transaction limits introduced first (as they are trying to do in AU at the moment) then cash will be banned outright. All under the guise of targeting crime etc.
Not only is our inflation targeting monetary system unsustainable, it will also see the erosion of our financial freedom and independence. Not good for our futures or our children’s futures.

There could be a huge push into cryptos...

I do like the idea of cryptos however they will be targeted by the gov as well especially as they are seen as a currency used by criminals (unfairly in my opinion).

If you like a gamble

11
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I need to set up an LTD company borrow as much as possible from a bank and spend it into the economy. I'd be a patriot, a risk taker. Sort of like a Council, they should expand the LGFA because the last 12 billion didn't do much, councils blew it with not much to show so twice as much should work, say ALK council goes to 200k a household from present debt of somewhere around 120k a household ,must start to show up in inflation numbers soon.

Low interest rates are not helping much, the savings for a dairy farmer is minuscule, probably less than this years rate increase. Do these guys don't know what they are doing.
I worry sometimes that the outcome from all this will be a violent one.

In a negative interest regime, will the banks be giving interest free home loans ?

why stop at interest free.. how about negative interest rate on your mortgage.?

Its happened in Denmark..
https://www.bloomberg.com/news/articles/2019-05-23/bankers-stunned-as-ne...

Nope - the banks will come up with a new range of fees so to maintain their margins. Gotta keep the shareholders happy!

One thing Im noticing is, the uncertainty is making people want to pay down debt. Thats going to suck money out of the economy and could be self reinforcing.

No one is talking about the wealth imbalance.

The whole policy approach is full of holes. Unintended consequences and negative feedback loops.
It's really not pretty.

Who really believes that low interest rates will save our banks? It's an artificial construct.

Since March 2016, shortly after the country’s negative interest rate policy was introduced, net income at major banks has declined by a fifth. At regional banks, the decline has been steeper: Net income is a third below its level three years ago.

Practically all of Japan’s regional banks have seen their share prices fall in the past 12 months. More than half have had declines exceeding 30%. They have underperformed the broader Japanese market for decades.

https://www.wsj.com/articles/japanese-banks-are-circling-the-drain-11565...

More spins than a day at the laundromat

15
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Firstly, have to agree with and echo Withay's comment - what a perverted economic system we have built. Countries battling each other in a race to the bottom to see who can borrow more and spend more and 'grow' their economies before the music stops...

As Adrian himself said - the message here is - if you have any savings at all, take them out, borrow/leverage as much as you can and spend. But on what exactly?

Overpriced crappy houses? Falling stocks? Bonds paying sub 2%?

It's like a perverse call to war. Your country needs you. Blow all your money and take on all the debt you can so you can personally take the hit whilst growing our economy!

Where are the old fundamentals - living within your means? saving for a rainy day? avoid debt unless absolutely necessary?

It's like the global economy is in a whirlpool and every country is trying to one up each other on the way down the spiral.

Sooner or later (later it seems, when everything goes boom and there's no other option) - we'll have to buck the trend, tighten our belts and accept lower, zero or even negative 'growth' for the sake of maintaining our current way of life.

I wouldn't trust this lot to run a corner shop, never mind the New Zealand economy... honestly ffs.

They don't realise that high asset prices mean future earning are lower and risk is higher. Low interest rates are making return worse not better.

Just talked to a friend in property, he is scarred ,house prices are too high, returns too low and fundamentals don't justify these prices. He's thinking of selling up even with low interest rates, better to be safe than sorry.

I say old chap, go for a new German car.

They’ve lots of new models coming out this year and with negative interest rates on the way, your benevolent bank will soon pay you to take the money off its hands.

Indeed, all the ducks are aligned..... we’re all in for a smashing time!

TTP

The central bank policy rate, and the mortgage rates offered by commercial banks are different. The former can go below zero, but the latter can not.

mortgage rates can and have gone negative elsewhere

https://www.bloomberg.com/news/articles/2019-05-23/bankers-stunned-as-ne...

It's not possible. They're talking about some kind of mortgage backed bonds, not the carded rate offered to the public. Mortgage rates can never reach zero otherwise asset prices would become infinite, and the currency would collapse.

I'm genuinely confused.
Does Adrian want us to spend and consume and deliver growth? Or does he want us to get on with this https://www.rbnz.govt.nz/financial-stability/climate-change

Maybe we can coin a new term here that reflects the idiocy of central banks. Something that encompasses competitive group think idiocy.

They have collectively come to the wrong conclusion and are all racing each other to implement the wrong solution.

Maybe this is a good time to completely rejig the "economy"and start operating the way people are thinking and that if we are tiring if this consume, consume, throwaway, throwaway way of life.

So lay out your 'rejigging Plan', oh wise one....

Sound money for the win!

"He didn’t believe it was viable for the RBNZ to manipulate the New Zealand dollar"

That is exactly what he has done!!! Cutting by 0.5 was always going to make the dollar dive, meaning goods sold in US$ like dairy would still maintain their income even if international prices are falling, and for goods sold in NZ$ they remain competitive.

Seems everyone is cutting rates so we need to too, just to keep our dollar down.

I could have sworn that RBNZ Assistant Governor, Christian Hawkesby, was giving an invitational speech in Japan a couple of months ago saying that there would be no more reductions in the OCR this year. The news filtered back to NZ a week later and our TWI rose on the news. How the worm turns!

I understand the idea of "rates are low... go out and spend".... but by cutting 50bps its an emergency move. The message everyone takes from this is "Wow, things are worse than i thought... i better bunker down and save more".

I do agreement with the sentiment of calling on fiscal policy... you cant expect monetary policy to do the work here. Labour needs to promote tax cuts and put more money in working people's hands now... no time for another pointless talkfest. Oh that's right, Robertson has already spent the money.... on what?

If you are not going to spend it wisely then do what you should have all along and give the money back via tax cuts. Its honestly the only thing I can see saving the economy from a recession and potentially saving Labour going into the 2020 election.

The IMF want the central banks to move to negative interest rates. Here is the paper that explains how they can do this.
https://www.imf.org/en/Publications/WP/Issues/2019/04/29/Enabling-Deep-N...

Well Orr really got this wrong didn't he ?

If he thought that lowering the OCR aggressively would weaken the Kiwi $ significantly and thereby feed some inflation into the economy , he sure as hell got it very wrong .

The Kiwi weakened by about 1 or 2 cents for about an hour or so , and was then trading pretty much as it had been earlier in the day .

Maybe he needs 2 orrs to get this ship going ........

The guts of it is Capitalism has been a long drawn out PONZI scheme
All debt is a gamble on MORE in the future
Now that MORE isnt coming the Central Banks are sh"@#ng bricks
And everyone knows the only way to avoid it blowing apart is MORE CREDIT
Its practically free but theres just fewer and fewer takers

Let me get this straight - Orr undertakes an action that's only happened three times before, all in times of crisis...and explicitly tells people to "borrow and spend".

Well, my gut reaction to this cut is "alarm bells" and zero desire to add to my leverage levels.

What these pointy heads don't realise is that people are smarter than their models give them credit for.

Perhaps these low interest rates actually CAUSE a decline in economic activity, rather than being a consequence of them?