By David Hargreaves and Jason Walls
The Reserve Bank must now target "maximum levels of sustainable employment" as part of its management of monetary policy.
It has also been revealed that as part of "Phase 1" of a review of the Reserve Bank Act announced by the Government last November, the previously sole mandate for setting interest rates that rested with the RBNZ Governor will be replaced by a committee.
Both the inclusion of the employment target and the change to the way the Official Cash Rate is set (IE now through a committee) had been widely signposted.
The Government has agreed a range of five to seven voting members for the new Monetary Policy Committee (MPC) for decision-making.
Minister to appoint 'externals'
“It is my intention that the first committee of seven members would have four internal, and three external members. Treasury will also have a non-voting observer on the MPC to provide information on fiscal policy,” Finance Minister Grant Robertson said.
The Minister of Finance will be responsible for the external appointments, while the internal members include will include the Governor, who will chair the committee, and the deputy Governor.
The other members will be nominated by the board after consultation with the Governor who will be the sole spokesperson on the committee’s decisions.
Minutes of the MPC meetings will be available, but the balance of votes will be published without attribution.
The MPC is expected to begin operation in 2019 following passage of amending legislation. There will be a full Select Committee process for the legislation.
Concerns alleviated
The RBNZ has previously expressed concerns about the inclusion of outside people or "externals" on the new committee - but will have had its concerns probably somewhat alleviated by the fact that these 'externals' will be a minority.
Robertson and incoming Reserve Bank Governor Adrian Orr have put their signatures to a new Policy Targets Agreement on Monday that, as expected, contained for the first time a reference to targeting employment. The PTA can be read here.
Specifically, the new part of the PTA reads: "The conduct of monetary policy will maintain a stable general level of prices, and contribute to supporting maximum sustainable employment within the economy."
Otherwise the targets remained the same - a target for inflation of between 1% and 3% with a focus on achieving a 2% rate as the midpoint.
The PTA is an agreement between the Finance Minister and RBNZ Governor that basically sets out the parameters of monetary policy. Since introduction of the Reserve Bank of New Zealand Act 1989 the primary function of the Reserve Bank has been to deliver "stability in the general level of prices." Section 9 of the Act then says that the Minister of Finance and the Governor of the Reserve Bank shall together have a separate agreement setting out specific targets for achieving and maintaining price stability. This is known as the Policy Targets Agreement (PTA).
Thanked Spencer
At a press conference on Monday Robertson thanked outgoing Acting Governor Grant Spencer for his years of service to the central bank – “he has served the bank extremely well and on a personal level, I’m very grateful for what he has done over the period of his term as Acting Governor.”
Robertson said it was important the role monetary policy plays as a tool to support the real, productive economy and the effect it can have on employment outcomes was recognised.
On the inclusion of external, expert, members on the Monetary Policy Committee, Robertson said this would help ensure a "diversity of perspectives is harness in the decision making".
'Significant discussion' over Treasury official presence
He did say that the presence of the Treasury official "was the subject of significant discussion during the first phase of the review".
"I was to assure people that the Treasury observer will be just that – an observer; they will not be part of the decision-making process."
New RBNZ Governor Orr said the PTA "recognises the importance of Monetary Policy for the wellbeing of all New Zealanders".
'A means not an end'
Low inflation, was, he said a "means, not an ends in itself to economic wellbeing".
The Reserve Bank’s flexible inflation targeting had always recognised and taken on board concerns about employment.
"What the [new] PTA does is make the employment side far more transparent and the Reserve Bank will be obliged to talk openly and transparently about how its short-term considerations have been taken into the decision-making framework when setting interest rates."
The trade-off
One of the concerns, as outlined by the likes of former Reserve Bank Governor Don Brash, is the trade-off between targeting employment and inflation with the official cash rate.
Brash told RNZ: "If there was a serious divergence with unemployment going up, and inflation going up quite strongly as well, the Reserve Bank would be a situation of having to choose between following one objective or the other; that's where life would get tricky for them."
When asked about this, Orr said it was "always going to be conditional on the issues".
In general times, it would not make much difference as the bank was always considering short-term volatility in both inflation and employment when considering interest rates, Orr said.
'Economic shocks and extreme business cycles'
"But there can be times, such as in an economic shock or an extreme business cycle where you have to really trade-off short-term inflation versus employment."
One extreme, Orr said, was stagflation – in which inflation and unemployment were rising at the same time.
But Orr said on the other end of the spectrum, during negative economic shocks, monetary policy had shown an enormous ability to stabilise economies globally – for example through the Global Financial Crisis.
Robertson said other central banks with the same mandate have been making these decisions on the basis outlined by Orr.
What is ‘maximum sustainable employment’?
Orr said "maximum, sustainable employment" would be determined by a "very wide range of economic factors", beyond just monetary policy.
"It is not monetary policy alone that will determine what is the maximum, suitable level of employment, but we need to be cognisant of the level of employment on future inflation, and also our role in stabilisation when needed."
Robertson said the Government’s unemployment target was 4% but it recognised there were a "number of factors and policies that influence that".
It was up to the Reserve Bank to report back to the Finance Minister on what it considered to be "maximum sustainable employment" and what considerations it was putting in place to measure this.
"We’re not asking the bank to come up with a specific target within the way they determine what maximum, sustainable employment is," Robertson said.
More details on this will be published in the RBNZ's next Monetary Policy Statement.
'A dynamic and broad concept'
Orr said maximum, sustainable employment was “a dynamic and a broad concept.”
He said there were many areas outside Monetary Policy that the Reserve Bank would need to consider.
“It’s dynamic in the sense that there is not only demand considerations for work, both domestic and international, but there are also a lot of supply considerations around willingness and capability and skill levels to work.”
Through time, Orr said, maximum sustainable employment would be a dynamic statistic which is why there is no target.
Asked if New Zealand was at the maximum sustainable level at the moment, Orr said: "we’re running a very, very healthy economy at the moment."
This was the statement released on Monday:
Finance Minister Grant Robertson and incoming Reserve Bank Governor Adrian Orr today signed a new Policy Targets Agreement (PTA) setting out specific targets for maintaining price stability and a requirement for employment outcomes to be considered in the conduct of monetary policy.
The new PTA takes effect from 27 March 2018, when Adrian Orr starts his five-year term as Governor. The new PTA has to be signed under the existing provisions of the Reserve Bank Act 1989, which has price stability as the Reserve Bank’s primary objective.
The agreement continues the requirement for the Reserve Bank to keep future annual CPI inflation between 1 and 3 percent over the medium-term, with a focus on keeping future inflation near the 2 percent mid-point.
The new PTA now also requires monetary policy to be conducted so that it contributes to supporting maximum levels of sustainable employment within the economy.
The new focus on employment outcomes is an outcome of Phase 1 of the Review of the Reserve Bank Act 1989, which the Coalition Government announced in November 2017.
“The Reserve Bank Act is nearly 30 years old. While the single focus on price stability has generally served New Zealand well, there have been significant changes to the New Zealand economy and to monetary policy practices since it was enacted,” Grant Robertson said.
“The importance of monetary policy as a tool to support the real, productive, economy has been evolving and will be recognised in New Zealand law by adding employment outcomes alongside price stability as a dual mandate for the Reserve Bank, as seen in countries like the United States, Australia and Norway
“Work on legislation to codify a dual mandate is underway. In the meantime, the new PTA will ensure the conduct of monetary policy in maintaining price stability will also contribute to employment outcomes.”
A Bill will be introduced to Parliament in the coming months to implement Cabinet’s decisions on recommendations from Phase 1 of the Review. As well as legislating for the dual mandate, this will include the creation of a committee for monetary policy decisions.
“Currently, the Governor of the Reserve Bank has sole authority for monetary policy decisions under the Act. While clear institutional accountability was important for establishing the credibility of the inflation-targeting system when the Act was introduced, there has been greater recognition in recent decades of the benefits of committee decision-making structures,” Grant Robertson said.
“In practice, the Reserve Bank’s decision-making practices for monetary policy have adapted to reflect this, with an internal Governing Committee collectively making decisions on monetary policy. However, the Act has not been updated accordingly.”
The Government has agreed a range of five to seven voting members for a Monetary Policy Committee (MPC) for decision-making. The majority of members will be Reserve Bank internal staff, and a minority will be external members. The Reserve Bank Governor will be the chair.
“It is my intention that the first committee of seven members would have four internal, and three external members. Treasury will also have a non-voting observer on the MPC to provide information on fiscal policy,” Grant Robertson said.
The MPC is expected to begin operation in 2019 following passage of amending legislation. There will be a full Select Committee process for the legislation.
Reserve Bank Governor-Designate, Adrian Orr, said that the PTA recognises the importance of monetary policy to the wellbeing of all New Zealanders.
“The PTA appropriately retains the Reserve Bank’s focus on a price stability objective. The Bank’s annual consumer price inflation target remains at 1 to 3 percent, with the ongoing focus on the mid-point of 2 percent.
“Price stability offers enduring benefits for New Zealanders’ living standards, especially for those on low and fixed incomes. It guards against the erosion of the value of our money and savings, and the misallocation of investment.”
Mr Orr said that the PTA also recognises the role of monetary policy in contributing to supporting maximum sustainable employment, as will be captured formally in an amendment Bill in coming months.
“This PTA provides a bridge in that direction under the constraints of the current Act. The Reserve Bank’s flexible inflation targeting regime has long included employment and output variability in its deliberations on interest rate decisions. What this PTA does is make it an explicit expectation that the Bank accounts for that consideration transparently. Maximum sustainable employment is determined by a wide range of economic factors beyond monetary policy.”
Mr Orr said that he welcomes the intention to use a monetary policy committee decision-making group, including both Bank staff and a minority of external members.
“Legislating for this committee will give a strong basis for the Bank’s use of a committee decision-making process. Widening the committee to include external members also brings the benefit of diversity and challenge in our thinking, while enhancing the transparency of decision-making and flow of information.”
Phase 2 of the Review is being scoped. It will focus on the Reserve Bank’s financial stability role and broader governance reform. Announcements on the final scope will be made by mid-2018 and subsequent policy work will commence in the second half of 2018.
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