Opinion: Don't listen to the bank economists' hype, Mr Bollard
19th Jan 09, 12:57pm
By Roger J Kerr Economic leads, lags and transmission times are important facets to comprehend when managing monetary policy. RBNZ Governor, Alan Bollard will be deciding this week ahead of the OCR review on 29 January, how much store he places on current short-term moneymarket pricing of interest rates much lower and how much he trusts historical "cause and effect" relationships in the economy. It seems that he will fulfil moneymarket pricing and cut the OCR by 1.00% to 4.00% and then place monetary policy settings "on hold". By historical standards, a 5.00% OCR is already a monetary setting that is quite stimulatory for the NZ economy. The problems in today's much-changed world, historical norms and standards are largely out of the window. The old (and now discredited) Monetary Conditions Index ("MCI Index") which is a combination of the TWI exchange rate and 90-day interest rate is -600 today. That signals "loose" monetary conditions, but not "super-loose" yet. In 1999/2000 when the NZ economy was last in recession the MCI Index was -1000. So, some ways to go yet in terms of lower interest rates and exchange rates to be in that "super-loose" monetary setting category. However, history also tells us that monetary policy was set "too loose" in 2000, and again in 2003, which caused a subsequent residential property boom and a monetary restraint response in 2005/2007 that was "too tight", with major collateral damage to the economy. Monetary policy has to be managed much better in New Zealand than these swings from one extreme of policy setting to another. How big a risk does Mr Bollard run today of taking monetary policy "too loose" for the long-term health and stability of the economy? According to most of the bank economists and to moneymarket forward curve pricing the RBNZ should be slashing the OCR not just to 4.00%, but further to 3.00% (and lower to 2.5% in Westpac's extreme view). As stated in last week's commentary, the RBNZ can only justify monetary policy at this "super-loose" setting if they have an annual 18-24 month CPI inflation forecast of less than 1.00% i.e. inflation going out the bottom end of the allowable 1%-3% band per the Policy Targets Agreement ("PTA") that the Governor has with the Minister of Finance. The PTA also mentions regard to growth, employment and stability of exchange rates/interest rates in the conduct of monetary policy. In making decisions about interest rates over coming months, Mr Bollard needs to focus on the medium term inflationary forces, not the short-term moneymarket pricing. I cannot see inflation being less than 1.00% in 2010 and 2011, even under a very slow and laboured recovery in the economy to growth. There are far too many rigidities, monopolies and non-competitive parts to the NZ economy to produce prices increases below 1.00%. The Parliamentary Select Committee inquiry into the monetary policy framework in 2007/2008 failed miserably to identify that competition in the economy is the largest influence on price-setting behaviour. The RBNZ also failed in the 2005 to 2007 period to correctly identify the true sources of inflation and realise earlier enough that their "high interest rate/high exchange rate" monetary policy through that period would do nothing to control those sources of inflation. It took until December 2008 before the Governor put the word on electricity companies, Local Government (rates) and the banks on their price-setting behaviour. Some economists may argue that even if the RBNZ takes interest rates too low on this cycle, they can always reverse them upwards quickly enough. I say "bollocks" to that, it is already too late, the damage is already done. The RBNZ held monetary policy too tight for too long in 2007/2008, and even though they have slashed rates since, that monetary policy action caused the economic recession, the property market bust and export industry destruction. If Mr Bollard allows money to become too cheap to borrow (despite tougher bank lending conditions and higher margins) we will all pay the price with rising inflation, interest rates and currency values in the medium-term. So, take care Mr Bollard and restrain yourself from reacting to moneymarket-hype and bank economist dooms-dayers. * 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.