RBNZ says possibility of needing unconventional monetary policy tools 'higher than it ever was in history' meaning it needs to be ready just in case

The Reserve Bank has detailed five options available to it should future economic conditions require the Official Cash Rate (OCR) to be reduced to zero.

They are moving the OCR into negative territory, buying domestic and foreign government bonds, purchasing interest rate swaps, and providing long-term lending facilities for banks.

The five are outlined in a Reserve Bank Bulletin article entitled Aspects of implementing unconventional monetary policy in New Zealand by Sarah Drought, Roger Perry and Adam Richardson.

The Reserve Bank notes that current NZ monetary policy settings are stimulatory, and it is not projecting a significant decrease in the OCR. Despite the OCR being at a record low of 1.75%, the Reserve Bank sees "significant further room" to ease monetary policy in a conventional way, and says conventional monetary policy remains effective in influencing inflation and activity.

"However, it is prudent to learn from other countries’ experiences with unconventional monetary policy and examine how such polices might work in New Zealand if the need arises."

Assistant Reserve Bank Governor John McDermott told Bloomberg whilst there’s “no imminent prospect” of using any of the five measures, “the probability of needing them at this point in the cycle is higher than it ever was in history” and “it would be silly of us not to be ready just in case.”

On a negative OCR the Bulletin article suggests that based on overseas experience, a "modestly negative OCR" could be implemented in NZ. The key consideration is how negative the OCR could go before different segments of the financial market begin to hold cash rather than negative yielding securities.

"At that point the transmission of further OCR reductions to the wider economy would be hampered," the article says.

In terms of large scale asset purchases, the article notes NZ's debt markets are small compared to other advanced countries, limiting the size of any purchases. The relatively small size of the NZ government bond market compared to most countries that have undertaken large scale asset purchases would constrain the scale of purchases the Reserve Bank could undertake. Outstanding government debt in NZ is about 30% of GDP, relatively low internationally.

With the supply of NZ assets available to be bought limited, the Reserve Bank could instead buy the high quality government securities of other countries.

"This would have the effect of selling NZ dollars to purchase the foreign assets, increasing the supply of NZ dollars, and allowing the monetary base to expand. In theory, a faster rate of growth in the monetary base relative to other countries could be expected to put downward pressure on the New Zealand dollar. This depreciation would raise traded goods inflation, and improve the competitiveness of exporters," the article says.

The authors also suggest the possibility of using the interest rate swap market to influence broader interest rates. They note NZ's interest rate swaps market is relatively large and liquid compared to the bond markets, meaning there may not be the same constraints on liquidity that purchases of NZ government bonds might face.

"The interest rate swaps curve (exchanging fixed interest and floating rate payments) is the main benchmark curve for banks’ funding costs, and borrowing costs for corporates. This contrasts with some other advanced economies, such as the United States, where the government bond curve is an important benchmark for the pricing of other financial instruments," the article says.

"Purchasing interest rate swaps could be a way to signal that the Reserve Bank expects to keep the OCR low for a prolonged period. Swap rates comprise the expectations of future policy rates, the term risk premium, and margin for bank credit risk."

The fifth option, targeted term lending for banks, can be effective for economies that rely heavily on bank financing such as NZ where 85% of credit to the non-financial sector comes from banks, the article argues.

"Some form of targeted lending scheme could be particularly useful if banks' funding costs were elevated or if credit supply to particular sectors was impaired, and the benefit of the low OCR was not being passed through to the real economy."

"This type of facility would provide collateralised term lending to banks at a subsidised rate if banks met specified lending objectives. These criteria would ensure that the low policy rate was being passed on to households and businesses," the paper says.

The authors go on to say that, while monetary policy has typically been the first line of defence against short-term economic instability, it could be desirable for fiscal policy to play a more active stabilisation role given the limitations on monetary policy when policy interest rates fall to zero.

"In this context, fiscal policy can play an important role in influencing the extent, scope, and duration of unconventional monetary policy that may be required in the aftermath of a large economic shock that pushes official interest rates towards zero. International evidence indicates that fiscal policy becomes more effective in severe downturns. And in New Zealand, fiscal policy played an important role in the response to the 2007/08 global financial crisis. This experience suggests that should the policy rate approach zero, the potential for stimulatory fiscal policy should also be considered."

McDermott also told Bloomberg that if the Reserve Bank was required to take any of these extreme steps, the Government might give the central bank more capital or indemnify it against any risk of losses, or ramp up fiscal policy.

"In that kind of world, I think coordination would be important,” McDermott said.

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50 Comments

What, no mention of Bagehot? That the purpose of a central bank was to provide credit to sound institutions during times of crisis, at penalty rates.

We are not a global hegemon like the US, so maybe more fiscal delinquency and less monetary debauchery would be better. Yes, you get to recognise the losses that have been clocked up in the preceding boom, and the governments books look bad, but then you move on, re-capitalise and get everyone back to work pdq.

Our current entrenched system of promoting a house price and immigration boom whenever there is a slowdown is a delusion. It does not lift all boats, only some of them. Better to face the facts and write off the bad debts as fairly and promptly as possible at the same time as you give everyone a nice big tax cut so people can pay down their debts or spend as they each see best. Help the people directly.

No, the purpose of a CB is to keep the National economy afloat in time of national / global financial crisis. So I can give you an example of why "penalty rates" is a bad idea, the outcome / aftermath of WW1 v WW2.

Tax cuts? no this is a) of little impact, b) the last thing you do when your economy is collapsing. If you wanted to actually give a kickstart then you "print" and give a lump sum to everyone aka Steve keen as then it is not very inflationary, b) its noticable right off.

Thankgod you are not near the levers of power is all I can say.

Actually I think giving everyone some money direct into their bank account is a much better idea, the effect of $1000 in everyones' bank account is probably a lot better than the equivalent tax cut. Tax cuts or more spending seem to be more acceptable for some reason.

My point is that transferring money from taxpayers and depositors to borrowers, ie the current scheme, is unfair and makes things more stuffed up (the borrowers think it is a good thing and society gets more indebted to the likes of Lord Westpac).

RW,

Good to see Walter Bagehot getting a mention.Few have had more influence on monetary policy than him.

In a speech in 2011,Larry Summers said this;"The vast edifice of orthodox economic theory constructed since the Second World War has been virtually useless." He went on to say that other traditions-less heralded ones-had come to his assistance(in dealing with the GFC). he nominated a trio of economists as his chief guides;Bagehot,Minsky and Kindleberger.
This is well covered in Felix martin's excellent book; Money,An Unauthorised Biography.

Larry Summers will leave a toxic legacy and has no credibility. He’s admitted that he can’t forecast the economy, which is quite funny. More importantly, he’s the father of negative interest rates, which are laying the foundation for the next episode of epic social upheaval globally. He will not be judged kindly in the future. We won’t have to wait long to see how the ECBs experiment works out. Chances are it will blow up before Draghi’s term ends next year. They are the ONLY buyer of EU govt bonds. Pull the pin on that and that should be interesting. If the RBNZ chooses this path then it will be a guaranteed failure and the subsequent recession will be epic to say the least. That won’t stop them from trying of course...

Oh look RBNZ is stocking up the disaster shelter in a calm, orderly fashion. I wonder why?

Yesterday the news that Westpac is broke. Today this from the RBNZ. Looks like we're ground zero for the new global debt crisis.

What do you mean the news that 'Westpac is broke'?

I think he meant Lord Westpac's spokeperson saying he thought static house prices for 30 years are in order looked a lot like smoke. It was an admission that NZ had reached maximum extractive capacity.

Westpac is broke? I missed that, do you please have a link J S, thanks

Yeah not exactly that comforting is it. This looks like the sort of contingencies relevant to Ireland in ‘07. Or a small South American country. Great.

'Following my breakfast meeting with Mr McClean,' Said Adrian. 'I thought I'd run through a few options that we might have.'

Oh dear me, what a pickle.

A good Q. So a decade after the GFC we are still globally in a mess and in fact its arguable the pressure is building again for another major event.

Then there is peak oil

So its it just chance?

I dont think the RB see's energy for what it is so I dont think they are preparing for an event from this direction.

Financial? I think anyone prudent would be getting ready just in case.

We’re not at peak oil. Today’s oil price is largely a result of hedge fund speculation. Oil supply is more than 1mbpd up on 3yrs ago and demand hasn’t changed that much, so why the increase? Speculative positions amounted to 2days worth of global oil demand 3yrs ago...now the speculative long positions amount to 14 days worth of global demand. It may yet go up more, but there’s also a high chance we’ll be back at $40-50/b within a couple of years.

The Reserve Bank has detailed five options available to it should future economic conditions require the Official Cash Rate (OCR) to be reduced to zero.

I think they may have forgotten to think about the exchange rate..??
It is plausible that our currency could ,kinda, collapse if we face a severe downturn.

Like Roger says.... NZ is not the Global reserve currency that USA is..
We are vulnerable to Global Capital flows...

They might find they would have to rethink things..???
Their 5 ideas might only work if the rest of the world were in a worse position..??

This came through via email a couple of days ago, and yes the exchange rate is mentioned. If I recall correctly they are essentially saying a plunging dollar may do their job for them and make lowering interest rates unnecessary. Being a smaller economy, we don't have the obstacles to a lower exchange rate that the bigger economies do.

scarfie, why would
"a plunging dollar may do their job for them and make lowering interest rates unnecessary"?
I thought a lower NZD makes imports more expensive which feeds through to higher inflation which would lead to the need for higher interest rates? I'm happy to learn, please explain.
Thanks

The exact words in the email (guilty of being lazy and letting interest.co find the detail)

The authors, Sarah Drought, Roger Perry, and Adam Richardson, find that there is qualified potential for such policies in New Zealand. Interest rates could likely be lowered into modestly negative territory, and targeted term lending facilities could be introduced. Asset purchases would also be effective. However, the structure and size of New Zealand’s financial markets could limit the overall scope of such a programme. In addition, the exchange rate is likely to play a more important role in easing financial conditions than was seen in the United States and the euro area.

You would have to ask the RBNZ what they mean by that, I can only guess as well as you can. My guess would be something along the lines of investment in New Zealand is what brings money in and keeps the dollar high. Interest rates are a part of this, but other yields also. A crisis would see a return to safety, and New Zealand is somewhat down that list. Money would flood out of New Zealand irrespective on interest rates, thus leaving room to keep interest rates high to mitigate the outward flow. In this instance high interest rates would be acting as stimulus. Or I could be talking nonsense, my mind is on a more important job of actually innovating something today :-)

The RBNZ mandate is to control inflation, if the dollar falls and capital flows out, imported inflation rises as imports become more expensive, this raises the CPI and the reserve bank is compelled to increase interest rates to stay in their target band, which makes us more attractive to foreign capital. Exporters win, consumer loses, eventually the cycle reverses as the flight to safety becomes one of chasing yield.

In the short term the event will be global / external. So I'd suggest the exchange rate of no matter immediately. Now later on yes probably however NZD is a risk adverse currency so "investors" would run anyway collapsing our exchange rate so if we print a bit? fractionally worse, maybe.

On top of that this is a "what if" that doesnt mean we automatically trigger an action it just means its a possibility of the circumstances match and demand it.

"worst position" yes exactly.

Good on you Gareth, and interest.co.nz, you have saved me having to read through the report myself :-)

WOW, there are some stunning statements in this article that give a clear indication that ther RBNZ does NOT want interest rates to rise, specifically:
- "... should future economic conditions require the Official Cash Rate to be reduced to zero"
- "Despite the OCR being at a record low of 1.75%, the Reserve Bank sees "significant further room" to ease monetary policy in a conventional way"
- "On a negative OCR the Bulletin article suggests that based on overseas experience, a "modestly negative OCR" could be implemented in NZ"
Yes these statements are made in case of "worsening economic conditions" but my god how different are they from the MPS statements earlier this month of a "balanced likelyhood of the OCR being raised or cut"

Stunning indeed.

Like this - taxpayers are going to be subsidising speculators to give them a lower interest rate?

"This type of facility would provide collateralised term lending to banks at a subsidised rate if banks met specified lending objectives. These criteria would ensure that the low policy rate was being passed on to households and businesses," the paper says.

basically its a "we have 5 panic buttons we can try pressing to try and stop a Second Great depression".

"These criteria would ensure that the low policy rate was being passed on to households and businesses"
I understand this as households and businesses will be able to access subsidised rates, not that that households and businesses will subsidise the rates

But who is providing the subsidised rates, in the end?

It's the households and businesses who pay tax, funding the difference. There's no one else.

As I understand it, qe type operations and bank liquidity assistance involve the Rb "printing" reserves not taxing the citizenry....

As I understand it, qe type operations and bank liquidity assistance involve the Rb "printing" reserves not taxing the citizenry....

I read this article and the RB statements as addressing what Armageddon options they had in the case of GFC2, I didn’t read it as RB setting out options for the maintenance of low rates in the ordinary course of events?

That is how I see it also.

I agree with you both Bobster & steven.
Still, the fact that the RB has not only considered the possibility to drop the OCR to zero but it has also proposed 5 different ways in which the OCR could be dropped to nil and has now published their study is, in my opinion, an important shift in their thinking with significant consequences

I think you are seeing this the wrong way.

a) I think the RBNZ does want to raise the OCR but it sees/expects that circumstances will prevent it doing so.

b) MPS is a "business as normal" expectation, these tools are for an abnormal situation.

Gareth, I can only see 3 options in your article:
- Large scale asset purchases
- Purchasing interest rate swaps
- Targeted term lending for banks
What are the other 2 options ? Sorry if I'm blind

The five are listed in the second paragraph;

Negative OCR, large scale asset purchases, purchasing foreign assets, interest rate swaps, & targeted term lending.

Thank you Gareth. I understood that asset purchases, interest rate swaps and targeted lending were options that would allow the RB to drop the OCR to zero. I guess I'm wrong

The rbnz governor has effectively come out and stated that the financial system is in a precarious state. Should that be the case, and economic conditions tank then the rbnz will need to step in and pick up the slack by buying asset backed securities. You and I as tax payers would fundamentally bail out the banks, by offering them a line of credit. If this is the case then I certainly hope this comes at a significant cost to the banks, and a massive premium to the state. Finally wouldn't the rbnz be wise to start cranking up the orc now, in preparation for this overdue correction whilst economic conditions are benign?

Should be in exchange for equity.

When the government bailed out Air New Zealand it wasn't just a hand out of cash, it entailed taking ownership in the company too. Bankers will want to be absolved of their risk while retaining all rewards.

Shareholders shouldn’t be bailed out. Likewise any intercompany debts, or options should be written off. If the State does eventually become owner under an OBR event then I would hope to think ownership was retained by kiwis, and the resultant entity amalgamated with KB.

I would hope that this is only an emergency re-action that stabilizes the market long enough to natiionise the bank(s) in question. natioanlising would consist of share holders taking 100% haircut and the board(s) and CEO's being sacked. My fear is we end up indeed throwing billions down "investors" pockets AKA the USA and not fix the moral hazards..

No the RBNZ would not be wise to crank up the OCR. That is like saying lets take away the food of the healthy person so we can stuff them full of food when they collapse from starvation.

All these are are just variations on the same theme. Here we are after 10 years in a world where these policies have been applied to a reckless extent and all we have to show is a huge asset bubble that is about to burst, massive debt and the object of this stimulus, economic growth or inflation is only moving timidly. Manifestly these ideas are very infective and bordering on counter-productive in the long term.
Maybe a totally different approach is required? Maybe the best place for the solution does not lie in the hands of the Reserve Bank but rather with Governments taking more responsibility for restructuring the economies to address the underlying causes of the problems?
At best we are run by idiots, at worst??????

At worst .... we're run by banks

30 years....30 years if neo-liberalism / free markets has brought us to this mess.

Under lying cause is simple, peak oil. The fix is actually harder and no one wants to pay for it.

Peak oil? There's still plenty out there and its still relatively cheap (until the taxes are piled on), that's why governments are putting false supply constraints like banning exploration. Peak carbon emissions is more truly what we are approaching due to social/political factors and we haven't (yet) found a truly better option for cheap energy. Renewables is the future but its a long way from being cheaper overall and our collective lifestyles will be hindered by it and any climate impacts.

Lower interest for lot longer is what this is implying. Did put some beers on OCR going down in the next 6 months, sub 4% interest rates. Just my thoughts and experience in financial markets. No doubt abusive replies coming my way, this site blogs are mainly doom and gloom. I read for a laugh. :-)

I keep trying to be humourous, but it comes out all wrong. People do so want to believe in impossible things, they just have to listen to the snake oil salesmen.

Subject to a GFC2 and if the RBNZ were to adopt some of the five tools, what unconventional tools will foreign central banks be forced to adopt? Given their limited head room, it seems likely the next Global slump could well be longer and deeper. Some of our major trading partners used some if not all of these five methods post 2008 didn't they?

Winter is Coming....

I am a financial noob, but barring an external or internal event, surely the exchange rate is our achilles heel? I mean in the short term... If the NZ dollar dropped would that be inflationary? and the OCR unable to raise?

The RBNZ is in panic mode. It can pursue a slow motion train wreck strategy like the ECB or a faster pace Argentinian type strategy. Either way, both end in disaster. What is obvious though is that they will not be working to protect the average hard working person. Prepare accordingly.

The RBNZ is in panic mode. It can pursue a slow motion train wreck strategy like the ECB or a faster pace Argentinian type strategy. Either way, both end in disaster. What is obvious though is that they will not be working to protect the average hard working person. Prepare accordingly.