If the Reserve Bank suddenly launched a bout of quantitative easing - effectively money printing - the market would scratch its head and wonder what was happening, as the New Zealand economy was nearing full capacity, Reserve Bank Governor Alan Bollard says.
Bollard and RBNZ head of economics John McDermott were asked in Parliament's Finance and Expenditure Select Committee this afternoon what the effects would be if the RBNZ were to undertake quantitative easing like that seen by major central banks around the world.
Bollard first pointed out that those which were undertaking the policy had first exhausted all conventional monetary policy tools, while the NZ Reserve Bank still had room to move on the interest rate front, with the Official Cash Rate sitting at 2.5%.
On what impact the policy would have on the New Zealand dollar, Bollard said a lot would depend on what the market thought the central bank was trying to do with the QE, how credible they thought that was going to be, but also on what other pressures they saw in the New Zealand economy.
“The sorts of growth rates we’re talking about [in New Zealand], while not huge, are actually reasonably strong by OECD standards now,” Bollard said.
“So, if being completely hypothetical, we were to try and put in place some form of quantitative easing at the minute, first of all they’d scratch their heads because they wouldn’t understand what we were trying to do. Secondly they’d say that this country is growing and is near full capacity – that’s got to mean inflationary pressures. Therefore the OCR is going to at some stage have to go up faster than it otherwise would," he said.
"Therefore the NZ dollar might look attractive to buy in.
"I don’t know, is the answer. But I wouldn’t just assume it would depress the value of the New Zealand dollar,” Bollard said.
The economy had some spare capacity at the moment, although once the Christchurch rebuild started up, the economy would return to full capacity.
“Then we’ll of course have a real focus on any extra inflation that could be generated off that. The forecasts we’ve got are assuming there isn’t much [inflation], but that’s always going to be a risk there. This economy in some ways is actually in a sweet spot in that sense of where inflation is,” Bollard said.
“Hypothetically, if we were to feel that something further needed to be done, it would be more likely that we would reduce the Official Cash Rate as an acknowledgement of the fact that the high dollar is resulting in less inflation in the New Zealand system," he said.
It would be very unusual to just launch into quantitative easing before the OCR was at zero.
Currency might fall, but real exchange rate may stay the same
Meanwhile, McDermott said quantitative easing could lead to inflation, which would mean the real exchange rate may stay the same even if the nominal exchange rate did fall.
“If we were to have expansionary monetary policy – either low interest rates or quantitative easing – more than would be the case for our inflation target, you could imagine a case where the New Zealand dollar would depreciate – that would be fine – unfortunately we’d have more inflation, and the real exchange rate wouldn’t really change," McDermott said.
"New Zealand’s competitive position won’t actually have improved. Our tradable sector won’t have gained any advantage from that particular policy move,” he said.
Taking the Swiss central bank as an example, which set a cap for the Swiss Franc against the Euro, Bollard said it had lost Switzerland €70 billion last year with its interventions.
“That’s a lot. So there’s very big financial risks in doing that,” Bollard said.
“It depends on how you’re going to measure success. On the other hand it does look like it’s had some effect in suppressing the value of the Swiss Franc," he said.
“Now they’ve been in a much worse, much more difficult, position: Entirely surrounded by the Euro, with a very large part of their trade in the Euro, so it really has been hurting them much more. It does look like at the minute they have successfully pegged that rate – there may be problems ahead for them as that economy grows a bit and you start to see more inflationary pressure there. At the minute they’ve got effectively zero inflation.”
New Zealand was very limited when it came to currency wars among the world's major powers as their policies devalued their currencies.
“Let’s be clear. The New Zealand economy is growing at a growth rate that is pretty respectable by OECD standards at the minute. It’s not great by historical standards, but there’s a lot of countries looking at the New Zealand record at the minute and saying they would like to be there," Bollard said.
"That is one reason why there has been capital flowing into the country, and some effect on the exchange rate,” he said.