Opinion: NZ better off if RBA ran our monetary policy
30th Sep 09, 1:04pm
by




"Economic conditions in Australia have been stronger than expected, with consumer spending, exports and business investment notable for their resilience. Measures of confidence have recovered. Some spending has probably been brought forward by the various policy initiatives; in those areas demand may soften in the near term. Some types of capital spending are also likely to be held back for a while by financing constraints. But overall, it now appears that investment may not be as weak over the year ahead as earlier expected. Higher dwelling activity and public demand will also start to provide more support to spending soon and, hence, growth is likely to firm going into 2010. "The Board's judgment is that the present accommodative setting of monetary policy remains appropriate for the time being. The Board will continue to adjust monetary policy so as to foster sustainable growth in economic activity and inflation consistent with the target."The latest official statement suggests that the RBA has found reason to downplay what the leading indicators of growth were pointing to at the time of the statement. There is possibly some justification for downplaying the leading indicators in this case, but in my experience once an economy gets up a head of steam growth doesn't suddenly subside significantly, even if one-off stimuli played a key part in fuelling the initial growth. However, to his credit RBA governor Stevens has been warning for some time that interest rate hikes are coming. The following contains excerpts from the governor's statement to the Senate Economics References Committee on 28 September 2009:
"Economic growth forecasts are being revised up. "¦ In due course, both fiscal and monetary support will need to be unwound as private demand increases. "¦ In the case of monetary policy, the Bank has already signaled that interest rates can be expected, at some point, to move off their current unusually low levels, as recovery proceeds. "¦ These adjustments back to more normal settings for both types of macroeconomic policy are what should be expected during a recovery phase of a business cycle."The latest statement by Stevens confirms that the RBA will hike the OCR as the data confirm the economic recovery, which means they will be around a year behind the game. However, in my assessment being a year behind the game is close to international best practice in the operation of monetary policy. By contrast, RBNZ governor Bollard has been digging his heals in over an earlier commitment to keep the OCR at or below 2.5% until late 2010. The following contains excerpts from the governor's statement on 10 September:
"There is more evidence that the decline in economic activity is coming to an end, and that a patchy recovery is underway. "¦ However, the medium-term growth outlook remains weak. "¦ For growth to be sustained in the medium term there is a need for improved competitiveness in the export sector and a continued recovery of household savings. This rebalancing is required to stabilise New Zealand's external payments position. If the exchange rate were to continue its recent appreciation and/or the recovery in house prices were to undermine the improvement in household savings, then the sustainability of the present recovery will be brought into question. "¦ As we have said previously, the forecast recovery in economic activity is based on monetary policy continuing to provide substantial support to the economy. We expect such support will be required for some time. As a result, we continue to expect to keep the OCR at or below the current level through until the latter part of 2010."The market has been pricing in OCR hikes occurring in New Zealand well before the end of 2010. In an interview Governor Bollard has suggested that financial markets can get it wrong and that they need to learn that interest rates are not always either falling or rising. The governor's stubborn commitment to keeping the OCR low for a protracted period despite the surge in many leading indicators looks like an attempt to prove that he is smarter than the financial markets. Being in the game of trying to outguess financial markets, I am the last person to say they are always right. But it is perplexing to see a central bank governor to effectively suggest publicly that he knows better than the financial markets, especially when the leading indicators point to the markets being on the right path. In the RBNZ's defense, the surge in the September quarter Westpac-McDermott Miller consumer confidence survey wasn't released until after 10 September. However, existing house sales are a useful leading indicator of consumer spending in New Zealand and have for some months pointed to the likelihood of a strong rebound in spending over the second half of 2009. In the 11 June 2009 Monetary Policy Statement (MPS) the RBNZ revised down its predictions for consumer spending growth but at the same time released an alternative scenario that predicted an earlier and stronger recovery in consumer spending. The following comments in the June MPS are relevant (page 29):
"While improved housing market turnover may well continue for the next couple of months, we expect the pick-up ultimately to be short lived, and dominated by the risk of unemployment and high debt levels facing households. That said, house sales have historically proved to be an extremely good early indicator of future movements in household spending. As such, there seems a clear risk that, over the next few quarters at least, household spending turns out stronger than we currently project."The RBNZ dropped the alternative scenario in the September 2009 MPS despite the leading indicators suggesting it should be the central scenario. This reinforced my suspicion that the RBNZ was likely to repeat the same "go for growth" mistake it made between 1999 and 2006, which I have written about previously. The irony is that by committing to keep the OCR low the Governor is ensuring that the domestic economic recovery, led by the housing market, will be strong and that the desired recovery in household savings will not eventuate. Strong economic growth is just the sort of thing forex traders love so the NZD is likely to head higher this year, undermining the international competitiveness of exporters and firms competing against imports. By taking insufficient notice of what the leading indicators are pointing to, Governor Bollard risks looking unwise, but of more concern it means the boom-bust cycles that the RBNZ has sponsored in the past are likely to continue. Some industry groups will understandably applaud Governor Bollard's stance and his view that the market is misplaced in betting that he will start hiking the OCR before late 2010, but by burying his head in the sand he risks condemning New Zealand to a continuation of boom-bust cycles. Consequently, I have been recommending our clients gear-up and/or invest on the expectation of an earlier and stronger economic recovery than the RBNZ is predicting. Equally, I have been warning that reality will win out eventually, meaning interest rates will most likely be hiked both earlier and more than the RBNZ is predicting.

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