RBNZ Governor Adrian Orr doesn't believe he'll get less bang for his buck cutting interest rates, the lower they go; Bank economists beg to differ

RBNZ Governor Adrian Orr doesn't believe he'll get less bang for his buck cutting interest rates, the lower they go; Bank economists beg to differ

Reserve Bank Governor Adrian Orr doesn’t believe interest rate cuts will become less effective, the lower the Official Cash Rate (OCR) is.

He can’t pick a point at which cutting the OCR would be like flogging a dead horse, because he doesn’t buy into the concept of diminishing returns when it comes to monetary policy.

Speaking at a press conference, following the Monetary Policy Committee’s decision on Wednesday to cut the OCR to 1.5%, Orr said there was no evidence of bang for buck diminishing as interest rates fall domestically nor internationally.

He explained his view by flipping the situation on its head: “If we raised interest rates by 50 basis points here, as opposed to cut by 50 basis points here, would it be a real surprise and have a significant impact on monetary policy? I imagine the answer is yes. Likewise, it is symmetrical.”

The issue of diminishing returns is pertinent, as at 1.5% the amount of fuel the RBNZ has in its monetary policy tank is at a record low.

Allaying these fears to some extent, Orr said households’ balance sheets looked good, while the government’s balance sheet was “remarkably solid”. Government spending also contributed a “net positive impulse” to the economy.

“We’re not the only show in town,” Orr said, meaning monetary policy isn’t the only tool to keep the economy humming.

“There is plenty of scope to do whatever is needed [in terms of monetary policy] and our projection is we’ve done about enough for what we could see at present.”

While Orr didn’t consider diminishing returns to be an issue, he did acknowledge that markets weren’t responding to interest rate changes the way they did in the past.

“People have been setting their prices more on behaviour they’ve seen in the past, rather than what they expect in the future. That means we’ve had to have more stimulus than otherwise in the economy to get bang for buck.”

An economists’ dinner party topic of discussion

Coming back to this concept of whether you get less bang for your buck cutting the OCR, the lower it is, the bank economists interest.co.nz spoke to all had slightly different views.

Kiwibank chief economist Jarrod Kerr said that looking around the world during the 2008 Global Financial Crisis, effectiveness became limited when central banks started cutting interest rates below 1%.

“It’s probably why the Bank of England and others refuse to go below 50 basis points,” he said.

ASB chief economist Nick Tuffley acknowledged monetary policy could lose its effectiveness as interest rates fell, but said it depended on what was driving cuts.

If, for example, it was jitters over global markets, nervous investors seeking safe places to keep their money would be more tolerant of low term deposit rates. This would see banks better placed to pass on rate cuts.

If the problems were domestic and there were other more attractive places overseas for investors to turn to, banks would struggle to secure necessary funding from depositors less tolerant of low rates. They may then need to turn to borrowers for funding by keeping their rates propped up – thus not responding to OCR cuts as required.

Tuffley said banks had responded to signals – not even cuts – from the RBNZ in recent times. This indicated OCR moves were still pretty potent.  

Westpac chief economist Dominick Stephens said the diminishing returns issue was a double-edged sword.

On the one hand, a low OCR meant mortgage and term deposit rates were already so low, there was less room for them to fall.

But on the other hand, if the OCR was say at 1%, cutting it by 25 basis points would take a proportionately large chunk out of it. This would have a big effect on asset prices.

However if the OCR was say 3%, a 25 basis point cut would be relatively less major, so have a lesser impact.

Stephens considered both schools of thought, but couldn’t put his finger on how they interacted.

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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11
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No discussion of negative interest rates? CHF government bonds are negative out to 10 years, get your head around that... Basically, if you don't consume today we are going to take your money away.

The Bank of International Settlements has this to say:

Second, we find that the effects of interest rates on residential investment are twice as large during
housing booms than during the busts, and are clearly stronger when interest rates are rising than when
they are falling.
Third, drops in residential investment consistently lead economic downturns in the 99 recessions identified in our sample. This signalling property arises despite the small overall share of residential investment in GDP – around 6% on average over the past five decades. Prior to an economic downturn, house prices, construction activity and construction employment all decline.

https://www.bis.org/publ/work726.pdf

Panic at the RBNZ?

Thank you for the link Roger
Panic at the RBNZ ?
I suggest whats left of the RBNZ's independence has all but gone this comment from the Bank of International Settlements says it all "drops in residential investment consistently lead economic downturns in the 99 recessions identified in our sample"

15
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What seems to be happening in Aussie, who are ahead of us in the cycle, is that people with existing large mortgages now have too little equity to be able to get the lower rates. So the market splits into those with good access to credit and those who are stuck on high rates. Look at variable rates here:
https://www.rba.gov.au/chart-pack/images/interest-rates/variable-housing...
https://www.rba.gov.au/chart-pack/images/interest-rates/variable-housing...
https://www.rba.gov.au/chart-pack/interest-rates.html

The problem is that the credit creation mechanism very strongly favours housing, via the deceptive smoke and mirrors of risk weighting. So housing credit drives the business cycle. It works like this, the bank has to ascribe a full risk weighting to the debt of the company you work for, but only 25% to 30% of that for your housing debt. So it can lend 3 to 4 times as much to the employees than to the business upon which their income depends. Thus we have a debt driven consumer society that spends more than it earns and gets steadily poorer by the decade. A median house now takes nearly twice as many hours of work to buy, as in pay off, than it did before the dopey 2% inflation target was adopted.

The situation is easily remedied, but it needs a crisis to force change, and probably only after dafter but easier options have been tried and found wanting.

..And I would say that our overall share of residential investment in GDP might be considerably more than 6%?

Surely all committee members could have faced the 'audience.' Still resembles an old boys club.

Mr Orrs ( committee) reasons this morning for the cut is due to the global slowdown, and to get the OCR ahead of the curve, does that mean data dependency is some abstract term . What happens if this cut, and there has been many, does not stimulate the Auckland housing market.

12
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Cutting the OCR is a law of diminishing returns. Six more cuts and your at zero and then what do you do ? The lower it goes just increases the likelihood it will rise. By this point Joe Bloggs will still be maxed out even more on cheap credit and really get caught with his pants down when the tide goes out. Rates should be rising and not falling, its just fueling a credit boom and continued house price increases. The music is gonna stop one day and the only seats left will be on the Titanic.Its a desperate measure to try and keep the economy afloat at all costs. Labour will give the helm back to National just seconds before it hits the iceberg.

Cutting the OCR is a law of diminishing returns. Six more cuts and your at zero and then what do you do ? The lower it goes just increases the likelihood it will rise. By this point Joe Bloggs will still be maxed out even more on cheap credit and really get caught with his pants down when the tide goes out. Rates should be rising and not falling, its just fueling a credit boom and continued house price increases.

Fuelling a credit boom? No. It's a response to a credit boom that has been orchestrated, particularly in the Anglosphere. Our central and retail banks can only see one possible solution: lend greater volume at lower cost. This fits nicely with housing, but it doesn't make sense to pay more than necessary for a big ticket item such as a passenger car. If interest rates were to rise, the fixed constraints of most h'hold budgets means that house prices would fall and possibly quite drastically. That would strangle consumer spending and NZ would be rooned. Keep your eyes on Australia. The latest ABS data shows that consumr spending is tepid and not dragging the economy into the myre. That is very different to the pictire that the industry data is painting. For example, price discounting and promotions are higher acorss the supply chain in Australia and NZ compared to other countries. That means businesses are paying consumers to spend on their products. Not a good scenario. The realtionship between luxury car saes and house price growth has almost been a perfect correlation in Australia. Luxury car sales have fallen off a cliff.

Be wary of Orr and his cohorts. He may be very clever and understand his domain well. He is not Gandalf and I believe his sorcery is limited.

J.C is Australia being dragged or not dragged into myre? I give you a thumbs up or a hoof anyway.

"Official data" would show that Aussie is "muddling along" with regards to consumer spending. The RBA is "keeping an eye on it." Unlike most people, I believe there are better data sets to understand the reality about consumer spending. My point above about how manufacturers and brands are responding across the supply chain is a case in point. Oh, and luxury car sales. As far as I'm concerned, offical data on consumer spending paints a very oblique picture.

Money for jam, does not get one out of the jam.
Sticky fingers....with their hand in the pot...don't help.

The economy might not be intended target for this rates cut, it might just be Auckland and that would explain the timing. Auckland Council from 2010-16 restricted housing supply to inflate their house prices to 25-45% above value. This idiocy created a problem that is easy to solve in a physical sense, with Auckland lifting the harshest restrictions in 2017. Yet very difficult to solve in terms of economic perception, because a reduction of 25-45% for Auckland house pricing will look a lot like a housing crash. From 2017-19 NZ house prices and building rates have been increasing, whilst Auckland has increased building activity and reduced pricing (the ideal scenario). However the most recent indication of building intention survey has shown a big fall in Auckland, which suggests the price slide is about to impact demand and economic activity. The RBNZ has cut interest rates to stimulate demand.

Um, not arguing with the thrust, but some math: getting back to 100 from 125 means a 20% cut, from 145 means a 31% cut.

Relative to 0% being the floor, yes :)

12
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The role of a Central Bank is to take the punch bowl away when the party is getting out of hand. They didn’t do that, now all they can do is spike the punch bowl even more. To what end ...

Actually, it may be the new 1.5% is about right. The problem has been rates that were far too low for far too long. A good proxy for the neutral rate is the market based 2 year government bond rate, currently 1.38%. So 1.5% is slightly contractionary. The daftness was 2015 when it should have been 3.5% according to the crowd sourced wisdom of the market:
https://www.interest.co.nz/charts/interest-rates/government-bond-rates

The market sets rates on current best guess based on the presence or absence of better options.

I highly doubt any economist believes the neutral rate in New Zealand is currently ~1.5%.
Confidence estimates may put in that territory, but I'd say the estimate is ~3%.

Also, IIRC it's the 10-year bond rate wrt to 5 year business cycles that is the primary instrument for which to estimate the neutral rate. Not the 2 year.

16
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As I have said before the RB model linking low inflation and lowering the OCR is crazy and only serves to raise fixed asset prices, fuels capital asset speculation, robs the general population of the benefits of increased productivity, and increases the wealth divide between high worth individuals and the rest of the population.
I read research somewhere that lowering interest rates makes people feel more vulnerable and so they only increase there savings, further fueling the capital asset investment and speculation. i.e. totally counterproductive. In the GFC, we have just witnessed the effects of extremely loose monetary settings and how ineffective they are at stimulating anything other than capital asset speculation and arguably the fact that we still have low growth risks and are "having" to lower rates further simply illustrates how ineffective this strategy is. (We have not recovered sufficiently to need to raise rates yet after the GFC)
This is a classic example of the definition of insanity. - To continue doing the same thing and expecting a different result. If I were in charge I would be restricting immigration and force more competition for labour through wage competition. The mainstream economists are remarking that despite low unemployment we have surprisingly little wage pressure.

Great comment. I admit that reading such opinions feeds my confirmation bias.

The effect on the tradeable economy may well be a wash. A lower NZD - which is already occurred - means imported factor inflation immediately - fuel, components, international freight. So much depends on how far ahead companies have hedged. Export revenues expressed in NZD may well rise, but that need not translate into realised NZD in an NZ domiciled bank: the FX revenue might just stop offshore in its originating currency as a natural hedge for imports required in that currency. And local interest rate effects on companies depend entirely on the amount owed, the effective rate per lender per loan, and the specific loan conditions.

The effect on the property part of the economy??? Too soon to tell.....

Right. Important to note that It does not mean NZ will gain more revenue (in NZD) selling more milk powder at greater volume.

Just me or is it odd that the RBNZ (and actually many reserve/federal bank) moves to create stability, do the opposite and will in time create instability? (i.e. we're going to create more credit to stabilise our growing debt problems).

And I though Mr Orr wanted less short term thinking? Might it be better over the long term to have a (healthy) recession now and stable growth over the long term? Instead of delaying the pain by pushing out the recession as long as possible, knowing the longer it takes to happen, the worse its likely to be?

Stability itself is destabilising as the saying goes.

Problems everywhere
From Grant’s Interest Rate Observer about Canada
"The debt-soaked Canadian consumer is up against the wall. According to a March report from Statistics Canada, household debt climbed to 178.5% of disposable income at year-end 2018, up for a fifth consecutive quarter. That compares to 85% of disposable income in the U.S. in the fourth quarter. Meanwhile, debt service chewed up 14.9% of Canadian household income in the fourth quarter, up from 14.2% year-over-year. By comparison, that metric peaked in the U.S. at 13.2% in the third quarter of 2007 and stood at 9.9% at year-end."

Capitalism can't work without capital and to have capital u need an interest rate that reflects risk.

That horse should be sent to abattoir for pets food .. No point flogging it anymore

I’m certainly not the only one here who has been saying “watch out” when it comes to the NZ property market (bubble). It’s not good for all those people with little equity and recent big mortgages, and for the wider economy. However, for those with money to invest after the manure hits the fan, it may be a very good opportunity indeed to invest in various undervalued (eventually) and distressed assets, property and sharemarket included. Such is capitalism, and value investing.

TM2 will be here shortly to preach that you should buy in CHCH and look for those selling under market value with high rental yield. And by renting out investment properties is way to provide invaluable service to wider community.

Chairman, he should take a look at some of the current values in Sydney and Melbourne where they were considered to be selling under market value 18 months ago. Wow do those previous prices look expensive now, and still sliding. NZ is diffrunt though, right. Although Mr Orr is clearly concerned.

Hi all... we see TD rates going down, and currently sub-optimal return, no doubt....but they still have (a tiny bit of) room before zero/negative zone. (before tax factored in at least)

But what about on-call? i note my anz on call is a mere 0.1% now... does it mean these accounts will soon be "charging" a % of their value to stay open? (on top of any fees)

Does it mean if/when the next OCR cut that the 0.1% (+ve) will almost certainly vanish and go into neg territory?

Go easy on me.. i work in a factory as a dust monkey.. im not economically trained in any way, but i have been a student of this site and forum for a long time. And i learn daily from you all.
I also dont carry any substantial $ in on call, its merely a qstn.
thks in advance

European savings account interest rates generally sit at 0.03% so there is a long way to go.

Best get some physical US Dollars and stuff 'em somewhere safe, because the Kiwi dollar usually drops first in a global recession.

This whole edifice of monetary policy rests on the idea that cuts in the OCR will boost aggregate demand via wealth effects prompting consumer spending and increases in investment spending. The thing is when households hear the OCR is being cut they think, oh dear, things are bad, my job might be next to be cut and they pull back spending. Businesses don't want to invest when current capacity already meets current demand as households pull back. The animal spirits turn pessimistic and the OCR cut is pretty useless.Furthermore, households are at peak debt and can't borrow more even if they want to put in a new kitchen. Now we do have a long forgotten tool called fiscal policy - was quite popular in the 50s and 60s I believe when people still had hope for a better future and saw rising incomes. It involves directly putting money in people's pockets that is likely to be spent (unlike monetary policy which is indirect). It is time to rediscover that tool. Look at US and Japan - big deficits - no inflation. Yes there are bottlenecks in some sectors, but we are nowhere near genuine full employment, the kind that sees wages go up.

“If we raised interest rates by 50 basis points here, as opposed to cut by 50 basis points here, would it be a real surprise and have a significant impact on monetary policy? I imagine the answer is yes. Likewise, it is symmetrical.”

Really.. does that 'logic' work for everything every time?
Drop sea levels 100mm thats becomes less than a max tide difference.. raise 100mm that a huge effect..
A builder cuts a stud 3mm short.. same effect if too long? At least the too long can still be cut the right length
List can go on and on.
That sort of thinking from such a position of influence is a worry.
Japan tried to drop interest rates, and tax breaks to stimulate their stalled economy...traditional RB/treasury bench tools.. didnt work.
The issue as to banks passing on.. we just got to look back in history.. they never have, so why should the RB or anyone expect them to do so this time?
The concept is , lower interest rates increase dispoable income, increase spending of the center 50% middle class where most effective.. stimulate demand, and therefore growth.
Basic economics.
This works very well when the 50% middle class, those who housing is affordable, those who are not living pay day to pay day and with debit, those who at the bottom of the 50% dont need rely on rent/ income subsisties.
If they do then any extra money will not be disposable to spend on extra goods and services but to pay off debit...If a mortgage or loan, they keep their repayments the same..not reduce payments, and if do its to payoff other debit.
Bottom line, before any interest rate or tax break can have any effect on demand, then the real income.. the wage/ salary of the middle come 50% needs to be brought back up being around the 50% of the nations wage/ salary/ bonus level..
The balance is so far out it cant be done by tax redistribution or subsisties any longer. It has been these 'patches' that have been used in the past by previous governments to address the issue on the national wage/ salary distribution moving away from the middle section of the population. Putting off the inevitable for a few more decades..