Opinion: RBNZ mandate must be expanded

By Roger J Kerr It may be my ever-increasing cynicism about the conduct of monetary policy management in New Zealand, but the current very aggressive easing of policy by the RBNZ has all the hallmarks and an aura of déjà-vu from their very aggressive monetary policy tightening in 2006 and 2007. Both monetary policy actions are extreme and both could prove to be "inappropriate" and serious policy mistakes. Inappropriate, in that neither action has or will do anything to influence the inflation rate, but can (and has) caused substantial collateral damage to the economy. We stated at the time of the 2006 tightening that the "high interest rate/high exchange rate" policy would have no impact on inflation (the inflation was coming from oil/commodity and Government sources that interest rates did not affect) but would only send the NZ$ higher, cause problems for exporters and eventually cause a recession. That proved to be an accurate assessment of what subsequently occurred in 2007 and 2008. Today the RBNZ seem to be pressured once again by the short-term and changeable views of bank economists (as they were in 2006) into extreme monetary policy action at the other end of the scale. The bank economists did not predict that the 2006/2007 monetary tightening would cause economic recession in 2008/2008 and goaded the RBNZ to push 90-day rates to over 9.00%. That was a grave policy error and the export and household sectors have been paying the price of that policy mistake ever since. Moneymarket pricing and bank economist forecasts today are again pressuring the RBNZ to cut interest rates to record low levels of 2.50%. The RBNZ are obliging with 1.5% OCR cuts, but who will pay the price in 2/3 years time if this proves to be another policy error and inflationary pressures are re-ignited through interest rates being too low? I agree with a couple of the bank economists who have recently stated that cutting interest rates from 4.00% to 2.00% will prove to be counter-productive, in that it will not make any difference to the GDP growth rate this year or next, but it has a major risk of sending inflation upwards again. At some point, someone independent has to stand back and look at the last five years of monetary policy management and interest rate movements in New Zealand from 4% to 9% and back to 3.5%, and conclude that the extreme changes have done nothing to control inflation, all that they have done is destroy investment in the wealth/growth-creating export sector. The Government enquiry into the monetary policy framework last year failed miserably to identify this reality. In analysing what has happened here, it appears to me that the RBNZ has a relatively poor understanding of the importance of the export sector to the NZ economy and have become pre-occupied with asset-price bubbles (e.g. the residential property market) and how they influence inflation. Their mandate has to be expanded to have responsibility to identify and report all sources of inflation, rather than just not caring where the inflation comes from and clobbering it with the blunt interest rate instrument. There is also a very strong argument that the latest easing of policy has moved them out of their PTA mandate. I will be interested to see if they have an annual inflation forecast of less than 1.00% for 2010 when they update their economic forecasts in the MPS in early March. To justify the now super-loose monetary policy setting they have to have an annual inflation forecast for 12-24 months time of less than the 1% minimum allowable under the PTA 1% to 3% band. If the latest monetary easing does prove to be another policy error when we look back on this early 2009 period in 18 month's time, borrowers are well advised to take advantage of the now artificially low interest rates available and fix interest rates to the maximum. Investors must now hold-off from investing new money long and should be selling existing securities to shorten the duration of their fixed interest portfolios. The capital gains for investor will help off-set the lower market investment rates prevailing over the next 6 to 12 months. * Roger J Kerr runs Asia Pacific Risk Management. He specialises in fixed interest securities and is a commentator on economics and markets. More commentary and useful information on fixed interest investing can be found at rogeradvice.com