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The Reserve Bank drives economic policy with officials, rather than elected Government, in the driver’s seat. But the Reserve Bank mandate provided by the Government is where it all starts

The Reserve Bank drives economic policy with officials, rather than elected Government, in the driver’s seat. But the Reserve Bank mandate provided by the Government is where it all starts

By Keith Woodford

There are two key institutions that drive New Zealand’s economic policies. First, there is the elected Government which, through the Minister of Finance and with Parliament’s approval, controls fiscal policy.  Second, there is the Reserve Bank which controls monetary policy, largely independent of the elected Government.  

Fiscal policy is widely debated, both inside and outside Parliament. It is all about how much the Government should spend and on what items, and from where should the Government obtain the necessary money. If taxes are insufficient, then the balance has to come from borrowings such as Treasury bonds that are sold into the market.

In contrast, monetary policy is discussed and debated a lot less. Instead, the Reserve Bank simply tells citizens the policy measures it intends to apply. The major tools include:

  •  the Official Cash Rate (OCR),
  • maximum loan to value ratio (LVR) restrictions on bank loans to investors
  • reserve ratios that the trading banks themselves must hold
  • quantitative easing (electronic money printing) which soaks up Treasury and other bonds out of the market, and
  • direct lending to banks by the Reserve Bank of newly created money for the purpose of on-lending, called ‘Funding for Lending Programme’ (FLP)

These monetary concepts lie firmly within the discipline of macro-economics, but they lie well outside the thinking of most citizens. Yet it is these concepts that help determine many of the basics of daily life, including the cost of housing, the cost of everything else, interest rates, inflation and the availability of jobs.

It might seem remarkable that there was close to zero comment on monetary policy by any of the political parties during the recent 2020 election campaign.  When asked, the major parties demurred from comment, saying this was the territory of the so-called independent Reserve Bank.

If there is an exception to the statement that monetary policy lies outside mainstream citizen thinking, then surely it has to be at It appears to be the one media platform where widespread commentary on monetary policy is currently to be found.  The leading citizen blog on monetary policy, but from a very specific perspective, is Croaking Cassandra  from former Reserve Bank staffer and critic Michael Reddell.

Within the last three decades, it has become both the rhetoric and the reality in most Western nations that Governments do not get directly involved in monetary policy.  Instead, in each country there is a separate entity of the State which has Central Bank functions and which is run by officials. In New Zealand, this Central Bank entity is the Reserve Bank.  

This creates the remarkable situation in most Western nations, including New Zealand, that it is officials who are not only determining economic policy, but also societal outcomes. It is New Zealand officials who are setting the policies that currently are making New Zealand property investors richer, that are making savers poorer, and which make debt leverage the biggest game in town.

The role of monetary policy

The original notion with monetary policy was that its purpose was to dampen the effects of economic cycles on the overall upward projection of the economy. It was there to lessen the effects of recessions and it was also there to prevent excessive exuberance. 

The logic of keeping monetary policy away from the politicians and in the hands of the Reserve Bank has always been that monetary policy is technical. History provides multiple examples of how politicians cannot be trusted with the tools of money creation.

Mr Mugabe could never have run amok with the Zimbabwe economy without control of monetary policy and the associated power to create money.  But there were many predecessors whose path Mr Mugabe was following.

Back in 1974, I was in Argentina when the Argentinian peso was dropping in value every day for exactly the same reason – too much money was being printed. As a consequence, as foreigners we would never change more US dollars into pesos than we needed for just a few days.  With inflation at about one percent per day, prices were doubling every ten weeks, and increasing more than 30-fold over a period of a year.  That is what daily inflation of one percent does!

Back in the 1920s, there was hyperinflation in Germany from massive money printing, leading to trillion-fold inflation over a period of just a few years. This set the preconditions for the German extremism of the 1930s, which in turn led to the Second World War.

The problem right now is that, both in New Zealand and across the Western World, monetary policy is being determined by technocrats in an environment that lies well outside traditional economic cycles. This means that the technocratic economic predictions are based on empirical models structured on behaviours from another time. Those models cannot even approximate current reality if the historical behavioural underpinnings and the historical global settings no longer apply.

Central Bank economists are trained in econometrics, which is the quantitative arm of economics. These economists are strong on statistics and economic modelling.  Every econometrician is taught not to extrapolate beyond the limits of the data. However, in the current world, econometricians are left with no tools if they follow that rule.

 I am told that the Reserve Bank has no behavioural specialists with expertise in psychology and sociology. If this is correct, then it is hardly surprising that the Reserve Bank has been caught out by what is happening to house prices right now.

It is pretty simple really. With interest rates on fixed deposits dropping down to levels not seen since Babylonian times, and with share prices looking inflated and highly risky, many savers perceive they have no alternative to property investment.  Unfortunately, Reserve Bank models are currently only able to view this through the rear-vision mirror.

The world has changed

Independent of short-term economic cycles, the so-called developed world has been struggling for at least the last two decades to maintain economic growth rates that were achieved throughout the second half of the previous century.  If it were not for the massive growth rates achieved by China, and to a lesser extent India and some other developing countries, then world growth would have been particularly anaemic throughout this period.

Here in New Zealand, and despite being a relatively developed country combined with low growth  in productivity, we have benefitted greatly from being in the slipstream of Chinese growth. China wanted the primary-industry products that New Zealand was producing – dairy, meat, timber and kiwifruit – and we sailed along nicely.

The advent of COVID-19, coming on top of the declining economic growth that was already occurring, is a mega disruption unlike anything experienced since the Second World War. It is an environment in which the standard tools of monetary policy no longer work in the way past history might suggest they should work.

Inflation and the Reserve Bank mandate

Although the Reserve Bank operates independently of the elected Government, it does operate within a mandate set by that Government. Every few years, that mandate gets tweaked. Right now, the mandate says that the Reserve Bank has to try to keep inflation between one percent and three percent per annum, and aiming for the mid-point, but also has to try to maintain maximum sustainable employment.

When inflation targeting was first brought in some three decades ago, the target was zero to two percent, and the focus was totally on lowering inflation. The thought that inflation could be too low was not on the radar.

Right now, the notion is firmly embedded within Reserve Bank thinking that deflation is a greater economic threat than inflation. The Reserve Bank Governor has made that explicit on multiple occasions. 

The theory seems to be that if prices turn negative then citizens will actually buy less rather than more, because a delayed purchase will be cheaper. However, the evidence for that is very limited.

A good example is petrol for which the price has declined in recent times. Is there any evidence that people have bought less petrol because it has been cheaper? Or have petrol-buying decisions between driven by other factors such as lockdowns and loss of jobs?  If anything, low petrol prices have helped people buy more petrol.

There is also an important distinction between inflation of tradables versus non-tradables. Tradables are items such as oil, machinery and foods that can be are traded internationally. Non-tradables are items that do not trade across international borders. Local body rates, taxi fares, house rentals and restaurant meals are all non-tradables. 

Right now, the low inflation that New Zealand is experiencing is driven by the tradable sector, with oil having a particular effect. But that won’t be long term. If and when the world economy stabilises post-COVID, then oil prices will undoubtedly experience major increases.

There is a further irony in that non-tradable inflation has been approximating three percent in New Zealand in recent times. Any effects of Reserve Bank stimulus will be on these non-tradables which hardly seem in need of stimulus.  

As for fixed-asset inflation, which lies outside the consumer price index (CPI) on which the Reserve bank relies to judge its performance, there can be no doubt as to what is happening. Housing prices in particular are travelling on a rocket ship.

Recently, I was an attendee at a seminar for valuation professionals (urban, rural and commercial) where I was one of the speakers on the economic environment. One piece of advice from within the valuation industry was that for any housing sales more than two weeks old, the prices are already out of date as a measure of current value. The most cogent market advice of relevance for vendors was that the only way to know the current value, where supply and demand might intersect, is to put a property to market via auction or tender and see what happens.

Further inflation is coming

The mantra from both the Reserve Bank and economists from within the banking sector is that right now there are minimal signs of inflation. What is not being publicly acknowledged is that considerably higher inflation must surely be close to inevitable somewhere down the track.

The key reason that inflation will rise is that the Reserve Bank has a suite of policies in place that are creating money. These policies are successful in lowering interest rates to such an extent that deposit holders feel forced to become property investors. How else can they protect their savings?

The theory says, with that theory developed in another time, that low interest rates should stimulate investment in the economy. Yeah, right! It is starting to sound like a Tui billboard.

The alternative perspective is that with interest rates so low and going lower, these policies are having no effect on new investment in productive assets that create new jobs.  At the big end of town, this is seen as a time to trim the sails, convert bank debt to long-term bonds wherever possible, and then sit tight.

The Reserve Bank, looking in its rear mirror, now acknowledges that its removal of LVR restrictions last May may be starting to create some issues. However, if the Reserve Bank understood more about the real world rather than being a prisoner of its models, then they would have realised from the outset that their suite of policies was a recipe for asset inflation.

The key problem with housing inflation that is driven by excessively low interest rates is that excessively low interest rates are highly unlikely to last for ever. And how will those people who are currently in their teens and early twenties ever be able to climb in future on to the property ladder unless they have parents who can hoist them up? Unless, of course, the bubble bursts and the current first-home buyers, and perhaps some investors, fall off the ladder.

Regardless of which way it goes, the inequality issue is mind numbing. There is no pain-free way of reversing excessive asset inflation. But essentially, the Reserve Bank is saying that to the extent this is an issue, then it is something for the future, whereas their focus is on the present.

It takes time for inflation to build up steam

The massive program of quantitative easing (QE) being undertaken by the Reserve Bank has greatly lowered interest rates, with further reduction in interest rates being almost certain. These effects will be driven by the existing policy of QE and the foreshadowed policy of Funding for Lending (FLP). However, the immediate effects on inflation as measured by the CPI are muted. In times like this, it takes considerable time for money creation and hence inflation to build up a head of steam.

A key reason for this right now is that the velocity of money circulation has declined. Citizens have responded to the current situation by saving more rather than less because of caution about the future. This means that there is lots of citizen-owned money sitting in the trading banks. These trading banks in turn have lots of reserves sitting at the Reserve Bank. The Reserve Bank, with its models constructed from a different world, and its rear-vision mirrors spattered with mud, apparently did not see this coming.

How is money created?

There is considerable confusion within society as to how money is created, with this money creation eventually leading to inflation.

 It starts with the Government giving a mandate to the Reserve Bank, with this setting up the preconditions. Next comes the actions of the Reserve Bank via quantitative easing together with a whole range of tools that affect the amount of reserves the banks are required to hold in support of their lending.

Then come the actions of the trading banks that create credit according to the rules of the game set by the Reserve Bank. Linked into that are the wishes of consumers and savers in terms of their desire to spend or save. These consumer wishes don’t directly create money, but they do influence the velocity of money and how it circulates within the economy.

In summary, money is created as a consequence of credit creation by the banks, but this can only occur according to the rules of the game as laid out by the Reserve Bank, underpinned by the Reserve Bank mandate from the Government, and also influenced by citizen behaviours.

A spring has been loaded

Currently, everything is in place for high inflation except that consumers, savers and real investors (with real investors being the people who make new investments and don’t simply purchase existing assets) are not doing what the Reserve Bank wants them to do. And so, the Reserve Bank continues to pump the balloon, working on the philosophy that the pump always worked in the past.

Eventually, with only the timing being unknown, the residents of New Zealand will decide that it is time to change their behaviours.  So first, let’s be clear as to what are these current behaviours. Very simply, it is to invest in the property market.  It is the dominant game in town. 

The only other game is the share market, but to many that seems riskier than property. Also, there are more restrictions on borrowing for shares than borrowing for property.

One possible change in behaviours would be through further reinforcement of the notion that property is the only game in town. This is on the cards as consumers take a while to respond to historical actions of the Reserve Bank. Those behaviours could go on for quite some time, until the Reserve Bank comes to its senses.

Unfortunately, property price bubbles do not deflate without a lot of pain to someone. It’s much kinder to stop the bubble inflation at the outset.

Another alternative is that consumers eventually decide to save less and go on a spending binge.  At that point nothing can stop consumer inflation except quantitative tightening. That will bring its own mayhem, most likely stagflation.

The other alternative is that key behavioural changes flow in from overseas. Assuming that Europe and the US eventually recover from the COVID mayhem, then oil prices are going to increase greatly. That inflation will be imported into New Zealand and it will inevitably flow through into considerable internal cost inflation. In turn, that will create demand for wage increases that will be very hard to manage. In all likelihood, those demands will not be managed.  

The big end of town can see all of these scenarios. It is precisely why, right now, the focus is on trimming of the sails and avoiding any long-term investment apart from property.

Asset inflation does not soak up the increase in money supply

It is remarkable how often I hear that inflation of fixed assets soaks up money. It does not. The money is still all there circulating around and around. This is why bubbles can keep on going for a long time until herd psychology finally cries ‘enough’.

When one person buys shares that already exist in the share market then someone else has to sell. The money transfers from Person A to Person B, who then has to find a new home for the money by buying another asset - either shares or property – from Person C.

Once inflation takes off, then no-one wants to be left holding the hot potato of dollars that will buy less assets tomorrow than they can buy today. And so, the velocity of money circulation increases, and the after-burners on the inflation-rocket burners fire up.

Getting out of the muddle

It all comes back to the Government and the Reserve Bank mandate. The Government has to say to the Reserve Bank to stop being fixated on lowering interest rates in its attempt to stimulate inflation. The simple step of lowering the inflation target by as little as one percent to where it was set as an aspirational target some thirty years ago, would send a strong message.

The Government might also say to the Reserve Bank not to be fixated by issues of employment. The Government could say that ‘We, the elected Government, will deal with employment matters and associated social welfare through our fiscal policies. We want you, the Reserve Bank, to focus on monetary stability’.

I first planned the writing of this article more than two months ago. At that time, it seemed evident that the Reserve Bank was flying blind. Indeed, the underpinnings were laid out in an article that I wrote back in June, where I focused on the reality of flooded capital markets and the dangers of excessive QE.  In July, I then focused on whether low interest rates could really stimulate the economy. However, I subsequently held back both with tongue and pen as we were moving into election mode. I knew that it was not the time when politicians and most other people would be in listening mode in terms of fundamental economic policy.

To jump from sailing and driving analogies to flying, during this time I thought I saw aspects of a Boeing 738 in relation to monetary policy. The plane refused to do what the Reserve Bank pilots wanted it to do because they were pushing the wrong levers, doing what they had been trained to do in a previous era of the Boeing 737.

Right now, the plane is still in the air. But things are more than a little unstable, and they have got a lot more unstable in the four months since I first penned that article on quantitative easing and flooded capital markets.

The reason that I now focus on the Labour leaders is that they are the Government. If National had become the Government then my message would have been the same. This is because in terms of monetary policy, the electoral options were Tweedledum and Tweedledee.

During the election period, Prime Minister Ardern was resistant to the notion that current monetary policies are increasing social inequalities. In response, she chose to focus on increases in the minimum wage, which in many ways is just a sideshow to the big issues of poverty and inequality in New Zealand.

Similarly, Finance Minister Robertson was quick to say that it was not his role to interfere in monetary policy.   But neither the Prime Minister nor the Finance Minister can hide from the reality that they are responsible for the Reserve Bank mandate.

One has to wonder at the depth of economic expertise on either side of the House when it comes to monetary policy. It is less than evident that many in the House have studied macroeconomics in any formal context beyond, at best, Stage 1 Economics. And once politicians get into Parliament, they have little time to come to grips with the complexities of money creation, inflation, and interest rates.

 It is also highly questionable as to whether either the Reserve Bank or Treasury environment is conducive to independent thinkers who question the adequacy of the flawed economic models.    I know a little about how the bureaucracy works. It is very hard to argue from within an organisation as an independent thinker. In general, it is not a good career move to travel that path.

Three steps forward

Finally, I come back to three linked steps that Government needs to be addressing.

The first is to move the inflation target back to a range between zero percent and two percent. That will immediately give the Reserve Bank a framework for modifying some important policies.

The second step is to advise the Reserve Bank that their mandate should focus primarily on monetary stability. The role of simulating the economy and managing unemployment is one that the Government will address through fiscal policies. That statement would give the Reserve Bank a good reason to reassess the extent of its current Quantitative Easing policy, and also its forewarned statements about a new ‘Funding for Lending Programme’ (FLP).

The third step is to state very clearly to the Reserve Bank that the Government is concerned with the current undeniable level of asset inflation that is impacting in particular on housing, and ask the Reserve Bank to urgently take steps to consider policies that will bring that under control.  The immediate imposition of LVR restrictions on the existing investment housing market (but not necessarily for new-build investors or first home buyers) would seem a good place for the Reserve Bank to start in its response to such a request.

In suggesting these three steps I have made no reference to the official cash rate (OCR). If New Zealand’s OCR gets markedly out of step with other Western nations, there will be profound issues relating to exchange rates. I might have more to say on that, together with the management thereof, at another time.

*Keith Woodford was Professor of Farm Management and Agribusiness at Lincoln University for 15 years through to 2015. He is now Principal Consultant at AgriFood Systems Ltd. He can be contacted at

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A good read (*Reserve Bank, not Rural Bank - last few paragraphs?!) summed up by:

There is no pain-free way of reversing excessive asset inflation. But essentially, the Reserve Bank is saying that to the extent this is an issue, then it is something for the future, whereas their focus is on the present.... It is very hard to argue from within an organisation as an independent thinker. In general, it is not a good career move

Let's hope that the new Government instructs the RBNZ to think beyond today. our last chance.

Thanks for spotting the 'Rural' error. I have sent a note to David to correct. Sometimes I see what I thought I had written rather than what I actually wrote.
Keith W

NZ is now a state controlled capitalist market.
Current policy between Orr and Robertson is defacto MMT as there is no suggestion of how the borrowing will be paid back nor how to unwind the zero interest rate environment. The only discussion is going deeper into debt and lower interest rates and no significant increase in taxes.
So I say this is defacto MMT but Politicians and RBNZ do not want to admit this.

I agree with you that we are observing strong elements of MMT, but without the Government usng that terminology.
One of the weaknesses of MMT is that it does not discriminate between different sectors of the economy in terms of the level of unemployment. If jobs are to be found for the unskilled, when other categories of unemployment are close to zero, then monetary policy of any type cannot be the way to address that situation.

Hi Keith,
The people of NZ don't want to hear it but either there has to be austerity spending cuts in the future or a significant increase in taxes to pay it back.
There is no political will on either side for this so we live in strange times.
Perhaps the strategy is its best not to talk about these things?
The country simply does not grow at significant rates for the tax take to increase overtime to cover our growing debt under the status quo.

I think the secret that people acknowledge but don't talk about, is that the debt most likely won't be paid back or reduced. Nor is their a plan to manage how all this debt can be settled without potentially causing another international conflict so that the rules of the new monetary system can be dictated by who ever wins that conflict (see Ray Dalio on the history of debt cycles, conflicts, world powers).

Grab a beer and watch the numbers on this keep climbing:

I lived in the US when Clinton was President and remember the debt clock going in reverse. It use to be proudly shown.....not now
Clinton introduced higher taxes and reduced federal spending.
In terms of the US deficit the Clinton years were good years.

One area where the MMT proponents (such as Stephanie Kelton in the USA) are correct is in pointing out that debt expressed in fiat currency, and held by the Central Bank, does not have to be and very often is not paid back. If it is paid back, rather than allowed to sit there, or simply be 'written off', then the effect will be quantitative tightening. However, Treasury bonds are also held by citizens and those do need to be repaid and will bear an interest cost until they are repaid. At some time qunatitative tightening - most likely by the RB selling Treasury bonds back into the market - will become necessary to counter inflation, for which the inflationary preconditions (money creation) are currently being set. But quantitative tightening to reduce inflation is always painful. It is also called 'austerity' and it always hurts someone badly. The alternative is to simply let inflation run. And that means other people - called savers - get badly hurt. It also leads to market distorions that hurt the real economy.

When is this inflation going to show up Keith? Would appear we've been searching around in the dark now looking for it but can't find it. What happens if we get deflation now and CPI keep falling while money keeps flowing into debt and asset prices. Is that in the economic text books? (honest question).

If we measured inflation based upon M3 we would have been keeping rates higher 5-10%, house prices would be stable and savers would be getting rewarded well without the need to speculate on asset prices (e.g. people in their retirement years now buying more rental properties which is an incredibly perverse incentive).

The Fed has set the scene for something very bad and the rest of the world has followed which I personally don't see a healthy way out of...but that is just my view.

Independent Observer,
The economic environment that we are seeing now is not in the text books. But some of the levers the RB is using are in the text books, albeit in relation to those historical environments. Mainstream economists never foresaw the current global conditions.
In my opinion, it is entirely feasible to get a combination of CPI deflation and asset inflation that continues for quite some time. It will further enhance inequalities. Overall, and with a medium term horizon of say two years, I see a much greater prospect of stagflation, at least under current policy settings. Within that stagflation, I see asset prices continuing to inflate faster than CPI inflation.
A key issue of any prediction is knowing what the Government will do. If you can tell me what you think the State (elected Government plus Reserve Bank) is going to do, and the timing of its actions, then I can have a go at what will happen in the broader economy. It's the State that is running the ship and their collective actions will take the rest of us wherever that ship takes us. In the absence of knowing when the policies of the State will change, I see some elements that remind me of the Titanic. I don't think we will actually sink, but there are common elements of the arrogance that doomed the Titanic. But it could be worse. Thank goodness for our primary industries which are currently keeping the ship afloat.

At least there will be lifeboats for the wealthy!

Hi Keith
I have listened to Stephanie Kelton talk on this.
For others interested see here:
(Note I am not promoting her ideas.)
Scary stuff.
The answer is likely nobody knows what is the right thing to be doing. But I think the comments on what would have happened had we not acted in this manner are overstated in NZ.
Having said that if the current situation of massive QE and zero or negative interest was a good idea why did it take until now for countries to start doing this?
But this is going to be with us for a long time to come and there will be no easy return to pre QE and a more normal rate of interest.

Neither am I promoting her ideas. Defintiely not. They are very dangerous in the wrong hands. But there are some interesting insights within MMT in relation to fiat currencies and QE.
I think it is clear that the RB has worked on particular assumptions about the extent of the NZ downturn, for example unemployment, and that those assumptions were flawed. As for next year, there are lots of uncertainties. If there is a downturn and the pumping by the RB continues, then asset inflation must also continue. My perspective is that the RB, dependant on a muddy rear-view mirror, has very slow reactions.

Keith, 100% agree on the RBNZ's reaction time.
But it is very selective.
RBNZ very quickly dropped the OCR to 0.25%, removed LVRs, removed requirements for banks to provide extra capital for what are non performing loans, negotiated the 6 and then 12 month mortgage holidays to anyone who wanted one. They then signaled negative interest rates and funding for banks.
Now that the market is roaring the only statement is a weak comment we are watching it.
Further with all the changes above the State has increased the risks to savers significantly overnight all the while refusing to bring forward the deposit holder guarantee saying more work is needed.
This all makes no sense at all.

Hi Kieth, first up brilliant article. Thank you very much.

Secondly re MMT, you are likely right in your views of MMT and Stephanie Kelton. I have read her book and done some little research into the various perspectives and find there is much I disagree with. But I would suggest that many of those proposing MMT forget the big picture and the critics don't understand how it works. The biggest offering of MMT, I believe, is that the Government does not have to tax to spend. But as you indicate in your descriptions of Uganda and Argentina, the risks are huge. But to understand those risks, one of the debates must be on what or how the value of a free floating national currency is set. This must be fully understood when endeavouring to manage inflation.

Under MMT the reason for taxation changes, and one of those reasons must be to limit the amount of currency in circulation, but this alone will not set a currency's value. I suggest that other bases are industry - what is produced at what efficiency, is some or any of it exportable and in demand, and are our people consumers?

You make mention of the velocity of money, but I suggest the vectors of money is as or more important. Current monetary or fiscal policy does not control the vectors of money hence it is mostly going one way, into housing, causing the current problems. While the Government may argue that it is not it's role to interfere in monetary policy, surely they are required to provide direction for it, hence the vectors? and if, as it is at present, the vectors of money are in the wrong direction, then it is the Government's role and not the RBNZ to address this?

Within the classical view of an economy, the Government has to obtain money from somewhere to pay for all of the things it wants to do. It can obtain this money through taxes, or through profits on Government businesses, or through borrowing. In New Zealand, that money is borrowed through the open market. However, the Reserve Bank can also play in those markets, and when it buys bonds (e.g. Treasury bonds) then it is completing the set of actions that create quantitative easing.

In contrast, under MMT the Government, or the 'State' that combines both the elected Governement and the Reserve Bank, simply creates the fiat money (in NZ's case the NZD) to pay for this. However, MMT acknowledges that this is only an appropriate option if the net effect is to employ resources that would otherwise go unused. Accordingly, if the fiat currency is not going to descend into worthlessness, then taxes must be imposed to soak up the excess money the State has created.

A fundamental weakness of MMT is that it generally fails to acknowledge that the role of monetary policy, at least as originally envisaged, was to manage economic cycles. As such, monetary policy levers are regularly adjusted. As to how taxes can be regularly adjusted in response to short-term volatility in economic cycles, this never seems to be addressed by MMT proponents. Rather, MMT works on the asumption that creation of fiat currency is a long-term funding mechanism. An additional issue is that the MMT proponents seem to have an implicit assumption that unutilised resources are fungible; i.e. that one can increase the use of these unutilised resources without creating additional demand for those resources that are already fully utilised, because all resources are interchangeble.

MMT provides a useful perspective that Governments never need to run out of fiat currency. Mr Mugabe understood that and he just kept creating more money. The problem arises when this leads to loss of confidence in the fiat currency, and amongst other things the fiat currency becomes worthless for conversion into international currencies such as the USD or Euro. The rise of Bitcoin is an early sign and a direct outcome of people having declining confidence in fiat currencies.
Keith W

Don't disagree with you Keith in principle. With MMT taxation is just as important as in classical economic models. And you've hit an important nail on the head - can taxation be responsive in the short term to changes in society to manage behaviour and other impacts on the economy? I am loathe to say it can't be done, just because it hasn't, but it would likely be a significant change to the way things are done. So in all likelihood much taxation under a MMT system probably would not change. However rather than to just fund Government spending, MMT would drive it from other perspectives such as changing behaviours like investment (in other words providing, or discouraging certain monetary vectors).

I also agree that resources must be constrained. Many economists seems to struggle to get out of the 'unlimited growth' mindset, and understand how this will impact on economies tomorrow. MMT does not offer a magic bullet, but perhaps makes it harder to constrain resource consumption.

The response to the COVID QE provided by the Government in the failure of the private banks to move away from pumping housing, provides some evidence that the Government needs to provide some mechanism which controls monetary vectors in an economy. Without that the economy becomes severely unbalanced and at risk.

Might I suggest there are some perspectives that you and others have overlooked.

While you refer very briefly in the article about money printing by the commercial banks, that is dismissed of no consequence in the comments that follow. How come nobody ever yells 'inflation' about that money printing - which has averaged $20 billion annually over the last couple of decades and was actually $32 billion last year. The only effective constraint on that is the availability of willing credit-worthy borrowers.

It's easy to quote Zimbabwe, Venezuela, and Argentina as the worst examples of money printing, but it's wildly inaccurate to throw them up as the old inflation bogey without examining the reasons. Money printing in excess maybe, but a whole lot of other factors led to it and the resulting inflation.

And where's the discussion about the Reserve bank money creation going straight to the government for it to spend instead of into the financial markets to buy up bonds and leave cash flush investors with a nice profit to pour into the fire of the housing market. They are 'clipping the ticket' to the tune of $11 billion over the next couple of years. Direct funding the government would avoid the massive debt and interest build up (roughly $4 to $5 billion annually). Those items over three years would be enough to build a tunnel under Cook Straight to link the North and South islands. If it's good enough for the commercial banks to 'print money' to buy government bonds off Treasury then why not let the Reserve Bank print money to buy government bonds off Treasury. At lest then we'd be borrowing off ourselves and we could chose when to pay it back - or not.

Not a beer, but in the time it took me to go make a coffee and sit back down +$18,794,385 in debt there.
I wonder what they bought with that?
5 or 6 of the flasher houses in Auckland maybe?

Put the brakes on using unrealised equity gain to purchase another property. Its just loading-up a borrower with increased debt.

yep, level the playing field by making them use cash as a deposit. Just like FHBs.

This will only make lawyers and real-estate agents rich as people need to cash out to cash straight back in. LVR restrictions are much more efficient and effective.

it will also increase liquidity and financial stability (leveraging paper gains no longer distorting price discovery) in the market which is a big positive.

The current situation is friendly valuers doing desktop navel gazing are implicitly deciding borrowers' debt capacity. Which then is driving (distorting) market prices.
All becomes a self-fulfilling fly-wheel with incumbent owners/"investors" benefiting the most.

Great article. It always astounds me how decisions made with the best intentions (e.g. including employment in RBNZ mandate) can have disastrous consequences when fully played out. I have to wonder though, could most of these problems not be solved if the tax system was changed to include housing and their capital gains? Surely this would leave stocks and businesses as the best place to harbour funds while bank account returns are minimal. Bit of a win-win if we slow down house price growth and improve investment in business and productivity. But then again, as mentioned earlier this would probably lead to some other unforeseen clusterf*** in another sector.

Inflation is low but for average family when shopping for grocceries and other essentials cost has gone up much higher. Even the way inflation is calculated may be flawed or why not even add house price to it, if using to measure economy. Is housing not the main and may be only economy in NZ.

Food prices are increasing because of the disruption to food distribution (worldwide) due to Covid restrictions (imposed by Governments around the world). This is quietly building inflation in one sector only.

If the RBNZ's measures and mandate worked you'd surely expect NZ not to be continuing to fall behind in the productivity stakes. IMF now predicting NZ being one of the few to have negative productivity (GDP per capita) growth by 2025.

But why would people be more productive? Hard work is not rewarded, but penalised by the RBNZ. Only ownership of land is rewarded.


A very sensible and we'll thought out article and good recommendations.

I don't even understand why zero should be the lower bound with inflation targeting. We are punished for improvements in productivity. Our living costs are completely out of control due to CPI gerrymandering and some mild deflation could help with that over time.

Yes, that makes life harder for debt junkies. Boohoo the world's smallest violin is playing.

Absolutely spot on these clowns know their models are broken, that lowering rates makes the problem worse and is building huge problems for the future. But they do it anyway and act surprised about what any man on the street could have told them. It's incompetence.

I think you are right that the inflation will eventually come and they will let it rip to reward debtors and screw savers as always.

The one enduring lessons that the RBNZ has taught us is that productivity and working for a living is for idiots in this country.

The firefighting arsonist burns one house at at time and gets sent to rehab.

The central banker destroys an entire housing market (and bond market, and in some respects sharemarket). Where is the central bankers rehab?


“until the Reserve Bank comes to its senses” – good luck with that one.


Reserve Bank Drives Economic Policies.....

Heading should be :


Reserve bank drives housing prices to hide its inability / Failure and best way to protect from criticsism in future is to follow FED.

My 2013 rework of the quantity theory of money led me to make the prediction that the velocity of money would drop over time. What is the velocity of the sale of a house? In particular in comparison to the overall velocity of money? If you borrow money to buy a house that increases the price over when it was last transacted, then I'd suggest you both increase the money supply lower the velocity of money.

My revision of teh quantity theory of money was to account for interest. The right side of the equation is GDP.

M.V=P.Q becomes (M.V)+i=P.Q

The main prediction is that interest rates will trend down and eventually hit zero. Money must inflate in inverse proportion. At some point you get debt (asset) write off or failure of the monetary system. Note that it is possible for GDP to show a positive print without an increase in goods, just an increase in prices.

That more or less aligns with what Ray Dalio talks about with most of his content and his work on big debt cycles. Eventually the fiat currency fails and people will rush to make claims on hard currency/other stores of value.

Take a look at the US 10yr history. Current cycle looks very much like the 1890-1945 one, just compressed.

Thank you for writing such a clear and insightful article Keith. I hope the Politicians and Reserve Bank are also reading!

Hi Keith, really enjoy a lot of your commentary/articles but I think you are mislead in some of the statements above. Right now people are indeed reacting to lower interest rates and buying property. But I think the opposite of your suggestions would be the best solution. The RBNZ needs to be clear with the Govt: the current situation in the NZ housing market is the result of decades of failed govt policy. People are just responding rationally to the signals that the Govt have given them. Land use restrictions/preferential tax treatment and rampant migration (obviously not a problem right now.. but will be again) all say one thing.. buy property.. its not going down. Low interest rates are just the final nice to have. If we had a functioning land market, with a level of migration that didnt just mean we were bringing in builders to build homes for the builders we were bringing in and a tax landscape that didnt encourage you to put everything into the family home then no one would be bleating at the RBNZ. Imagine having to pay virtually nothing on your mortgage, or in rent, while having higher incomes.. Housing wouldnt even be a dinner party conversation. Denmark has had low rates for a lot longer than us, with one bank even offering a negative rate to borrowers 2 years ago. And yet their prices have gone up about 20% over the last decade ( Food for thought?

"the current situation in the NZ housing market is the result of decades of failed govt policy."

Precisely! And that's why if there is any hope left at all, it's with this 'new' Government.
All sides of politics have failed us, and in fact, they've benefited, personally, from the failure of the pubic policy that they have enacted.
Let's remember Helen Clark, who famously boasted that she had "7 investment properties! They are my retirement fund".
When that is seen as the 'way to go' what hope was there for change? None.
At the risk of repetition. Jacinda Ardern - this is it. Fail to enact change and you will fail us, today, and New Zealanders of the future for a long time to come. It's up to you now.

Problem is, both the RBNZ and the Treasure keep sending the message to the government that houses are only allowed to go up.

The RBNZ and Treasury need to acknowledge the negative effects of their love affair with pushing prices up, rather than being continually telling government ministers that prices are only allowed to go up and must not go down.

I agree that land availability is a signficant issue. Here in Christchurch, where lots of land has become available linked to post-earthquake opening up of land to the south of the city particularly in Selwyn District at the requirement of Brownlee, price rises have been lower than most other cities. That outcome is not by chance.
I have previously written at this site about immigration and fixed-resource availability.


Yes, Keith, Brownlee has consistently been mocked for many aspects of his performance over the earthquakes sequence, but the LURP, which threw restrictions on subdivision under the bus and opened the way for swathes of new suburbs, was unquestionably a Triumph of Central Planning. One of the few, lest we all get carried away and Want More.....

Very well timed article, we should all be writing to Grant Robertson and Adrian Orr to read it.

The level of group think in the RBNZ and other central banks around the world is huge and hugely destructive.

What they collectively need to do (and very quickly) is discourage unproductive asset investment and encourage people to open businesses and employ people. Combined with lots of support for small businesses/startups and big tax breaks for R&D for existing big businesses. The program Labour started in it's last term to help people into trades training etc needs to be accelerated right across the education sector, particularly focussed on the more productive industries (film/tech etc) to ensure we are more productive in the future, not less. Utilising our own people to create highly skilled people and encouraging new businesses is the way to get long term economic benefits.

At the same time we need to be lowering house prices, to make sure there is free investment to go into businesses, to ensure people living in their house aren't paying huge amounts of rent or mortgage, just to live. This increases economic mobility, a key necessity for future economic growth.

TOP party has many of these policies which they can quickly adopt, if in part only or a slightly different version of it. And they definitely wouldn't complain if the government were to do so.

Well done Keith. The fact is that the New Zealand socio-political-economy has developed into a well oiled machine designed to produce ever increasing house prices. No one dares to change any of the settings for fear it might break down.

The politicians want higher house prices, the bureaucrats in their institutions want higher house prices, the banks want higher house prices and homeowners want higher house prices. Every country in the world wants higher house prices and is doing their level best to keep the machinery working.

As you point out, at some point reality bites back. Petrol at $5 a litre. Beef mince at $20 a kg. Bread at $10. Bizarrely, this is exactly the sort of inflation the central banks are trying to create, on the basis that wages must rise to catch up with house prices. All nice straight lines on graphs produced by models. Reality tends to be much more volatile and nasty.

But companies and households are loaded up with debt. Rising inflation will just increase the debt burden so where would pay rises come from? Everyone will put up the price of goods and services and the banks will ask for more money as well to pay the debt (i.e WACC/IRR required increases). To think that businesses first choice will be pay rises over servicing the debt burden - well have a chat to your banker and shareholders about that...

Stagflation looks more possible if we have inflation, but perhaps deflation is more likely again (then pay rises under deflation - still have the same debt burden? Yeah nah...).

Makes no sense to me either. Rising food and petrol prices means less to spend elsewhere, which means jobs will be lost. Wages are unaffected, except for highly unionised jobs or in the special case of full employment.

For some reason, sophisticated models appeal very strongly to bright people, they are very strongly attracted to the most compelling and internally consistent argument. This leads them to believe their theories are correct. Anyone questioning, or attempting to identify the assumptions and test them, tends to get socially excluded. As Keith says, awkward buggers are not welcome.

Economics is fractal, volatile and non-linear. Complex systems are a bugger to model as you have to start with unrealistic assumptions, ie doublethink.

Awkward buggers have played a significant role in world history! Sometimes for good, sometimes for bad.

But yes there is an odd 'conformity/herding' thing going on in society at present, but its also divisive - see the US. Two herds heading in different directions.

Economics is fractal, volatile and non-linear. Complex systems are a bugger to model as you have to start with unrealistic assumptions, ie doublethink.

You nailed it bro.

Either house prices need to fall off a cliff, or they need to remain stagnant while wages double (triple? quadruple?) in order for house price-to-income rates to return to acceptable levels. It is obvious that no-one in power wants the former to happen, but it's incredibly difficult to see how the latter is going to be achieved by current monetary OR fiscal policy. Great article.

Stagnant house prices would reveal the true state of the NZ economy (i.e. that we don't produce enough goods & services to support the lifestyle that everyone has become accustomed to). Its going to be a painful correction whichever way it happens...

Keith, this is best article on here I have read in years.
unfortunately as you say there is little informed and independent thinking re macro-economics in parliament.
labour is blind re inequality and who is driving it right now and for last 20 years.

Nice article, finally someone touched on topic on inflation, gave me a bit more clear pictures about how inflation is going to impact on assets prices and OCR rate.

Through their actions and utterances the RBNZ have effectively signaled a guarantee that residential property prices will never fall – the result being that for many property is now perceived as a sure one way bet, underwritten by the RBNZ.

Ultimately the RBNZ may well find itself horribly “stuck” at some point if the above is left unchecked.

As a democratic nation, the current way the RBNZ works is unacceptable. Why would the finance sector have their own government body in contrast to others like industry, farming, etc.?

In contrast, monetary policy is discussed and debated a lot less. Instead, the Reserve Bank simply tells citizens the policy measures it intends to apply. The major tools include:
- reserve ratios that the trading banks themselves must hold

Point to the current declared RBNZ reserve ratio

Great article Keith, can you please email a copy directly to Mr Orr & Mr Robertson?

Do they care !

Are they not aware of it !

There is no mention in this article that taxation destroys money, it ceases to exist. "and from where should the Government obtain the necessary money".Mr Woodford asks. Well where do you think that the NZ Dollar Currency comes from that the government spends Mr Woodford except from the government itself? Taxpayers cannot create it and banks cannot create currency only money as credit and it certainly cannot be created overseas to be "borrowed". The Levy Economic Institute of Bard College tells us here why taxation and borrowing are incapable of financing the government.
Economist Bill Mitchell explains here why money creation on its own will not lead to inflation.

Brilliant article. Just wish the RB Governor and Minister of Finance had similar insight and vision. Really hope they both read and consider these words very carefully.

A question for commentors while we are on the topic:
Does the RBNZ (and other central banks) pay using reserves (like the FED) or in more broadly usable money for its LSAP bond purchases?

I can't seem to find this information explicitly stated anywhere.

The Reserve Bank credits the trading banks with NZD reserves which are freely available to then underpin credit creation. A direct consequence of the credit creation is that some of these reserves then transfer, not directly to the citizen borrower, but once the borrower uses the funds, by a transfer of funds to other financial institutions. This is an interbank transfer via the Reserve Bank. There is a myth - propagated at times on this site by commenters who focus on individual elements and do not appreciate the way the broader system works - that the reserves are not readily usable. This is totally false. The reality is that they directly augment the fuel availabe to the banks, and which the banks need and use in the process of creating credit. Right now, the banks are struggling to find enough borrowers to relieve them of these reserves. Hence, although for a very short time way back in March it might have seemed that there could be a liquidity crisis, the reality is that the banks are awash with funds that they hold as reserves at the Reserve Bank. If there had been zero QE, then there may well have been a liquidity crisis given the fiscal deficits, but excessive QE (like now) can be and is 'too much of a good thing'.

Thanks Keith
So reserves can be used as payment to settle asset purchases from another bank (with a RBNZ reserve account)? This has not been pointed out me before and makes reserves seem way more useful. This allows them to liquidated, i had herd they needed to sell other assets on their books to cover losses.
Yes the banks need additional capital (is this what you mean by "fuel"?) to lend but the bonds they already had were also capital (or capital equivalent). Audaxes characterises QE as just an asset swap from fixed interest to floating, do you disagree with this?
I'm also not sure in what sense your using the word liquidity (crisis). Yes, govt bond yields spiked right before the introduction of QE, forcing the RBNZ hand, but is this relevant to reserves vs cash.

Yes, banks settle with other banks through settlement accounts held at the Reserve Bank. This is where their reserves are. If you were to send me an invoice, and I decided to pay, then I would tell my bank to pay your bank. Both your bank and my bank holds accounts with the Reserve Bank and it is through these accounts that the transfer actually takes place. My bank then debits my account and your bank credits your account.

If I now want to buy a house from you then I will need a loan from my bank. My bank can only create this credit if it has reserves at the Reserve Bank. This is because when I pay you for the house with credit provided by my bank, then this money has to get across to your account. Once again it occurs through money held by my bank at the Reserve Bank being transferred across to your Bank.

People sometimes get confused because the reserves that my bank holds at the Reserve Bank do not get transferred to you directly, because you do not have a personal account at the Reserve Bank. So people then mistakenly think this means that my bank cannot use its reserves to pay you. But it can and does use its reserves in this way, but via the Reserve Bank settlement accounts that all financial institutions have.

Yes, I do disagree with Audaxes. He is correct in saying that QE involves an asset swap, but he is only looking at one part of the overall system.

Lookiing at that broader system, the RB has engineered that asset swap by purchasing the Treasury bond from the trading bank using money it has created electronically, and which is now available to be used by the trading bank. But when the trading bank purchased the bond from the Treasury it had to use its prior reserves to do this. And now, when it sells the bond to the RB its reserves are replaced. Looking at the overall change that has occurred:
1) The Treasury now has the funds it needs together with an IOU (the bond) which has finally made its way to the Reserve Bank.
2) The RB now holds a bond (an IOU from Treasury) which it has paid for by creating some electronic funds for its own use.
3) The trading banks, apart from having gained an intermediation fee along the way, are back where they started having bought and sold a bond.

As for liquidity, the GFC did involve a liquidity crisis where the financial system got gummed up. There were fears that might happen with the COVID crisis, but it did not. The two crises were totally different with fundamentally different causes and different outcomes. But the central banks of the world were concerned that the COVID crisis might precipitate a similar fiinancial crisis where an inherently unstable financal system fell apart. That could happen again, but given the amount of QE going on all over the Western World, there are no signs of this.

Thanks for that explanation on reserves. I'm still confused you make reserves sound like they are directly convertible to money but Jeffrey Snider and others who would be heavily criticised if the were wrong argue quite clearly that the reserves the FED buys bonds with in QE cannot leave the FED and be used for anything in the real economy. I'll figure out the practicalities and technicalities here one day, maybe it's different in the US. (I'm not asking you to explain this further.)

I'm just restating what you have said on QE with a different emphasise and little more added in:
The bank (or private sector as a whole) starts off with a bond or a govt guarantee of future cash flow that has a present value and can be repo ed or sold for cash/reserves now. This is most likely capital that it's required to hold for current or new liabilities.
The bond is then swapped for reserves giving the bank the the present day value of the bonds, earning the OCR. The cash flow the bonds would have payed out is now gone from the banks books. The reserve is still stuck in the bank due to capital requirements.
There is a temporary increase M1 in the system until the bond matures (or QT) with the downside being removing a far more useful asset or collateral from the system. And sometime in the next 20 years the cashflow, from tax, that would have entered the economy as bond principle never arrives (to cover the new bond purchase as the debt is rolled over).
I think this could be considered and modelled as complicated asset swap.

This is monetisation of cashflow and debt and effectively lowers current govt bond yield due to scarcity as they are removed from the system but as far as banks concerned the only benefit they received to their ability to lend is lower rates, their asset quality or amount has not improved, they make some money if rates are dropping while this happening I guess. I don't know what implications are for public cashflow.

Sorry, I reading this back I think we are doing a bad job of staying on each other's topics.

It is true that the reserves do not leave the FED. But they do transfer between the accounts of the various institutions that have accounts at the FED. This occurs through account settlements.
As such, they create the conditions necessary for the institutions to provide credit. Once an institution has created credit such that all of its reserves have transferred to other insitutions (via the settlement accounts) then that institution can create no more credit until it receives more deposits from people in the 'real economy', leading to an inward transfer of reserves from other institutions. If the FED through QE increases the reserves in the system, then this creates additional credit creation capability within the system but the reserves themselves stay in the system. And vice versa for quantitative tightening. These concepts are somewhat challenging to get one's mind around. There are actually a few more complications relating for example to people who choose to hold cash. But the above is the big picture.

Thanks I appreciate your time.
So if a customer transfers money between accounts to another bank and then withdraws the money as cash. The other bank must exchange these transferred reserves for cash (to maintain a fixed cash supply) and physical cash deposited at a bank must be exchanged for reserves?
So this all works nicely as long as the dollars remain inside bank with an account at the central bank? But this all breaks down when we get to the USD and Eurodollar (which is probably what Jeff is talking about). You can't settle transactions with reserves here without exchanging things first and Eurodollar system cant function on reserves. Bonds owned by people with accounts outside the primary dealers must be more difficult to keep purchasing from to replace QEed bonds.

The the bank deposit from the created credit will always replace any missing reserves somewhere in the system and this gets redistributed around by banks adjusting their deposit rates.

It is technically correct that banks do not 'lend out' their reserves.
However, a bank that has no reserves cannot create credit, because credit creation leads to a transfer of reserves between financial institutions.
QE leads to an increase in the total reserves in the system and creates the preconditions for additional money, via credit creation, to occur through the economy.
Right now, the additional credit is held by Treasury, which has issued bonds which have ended up at the RB without anyone else having a net reduction in credit.
Do you argue against that?

As I note down below: by Audaxes | 4th Nov 20, 11:47am

NZ has settlement cash balances which were, before QE, funded by forex swaps. The RBNZ injected NZD into the banks' settlement accounts while they created foreign reserves for the RBNZ. Settlement cash became an RBNZ liability. This can be viewed here and the attached xls spreadsheets.

A starting point for discussion would be that, as shown in that link, in the last 12 months the Govt + insitutional settlement accounts have increased from approx 13 billion to 47 billion. That is what QE has achieved. But of course that is not going to be the end of the story. It reflects that the banks have great scope for credit creation.

The amount of bank credit creation in New Zealand is regulated by RWA capital requirements and HQLA not deposited at the RBNZ. Bank cash settlement reserves are not a regulatory credit creation issue any longer.

There were two major evolutions in money and banking that seem to fall outside the orthodox narrative. The first was a shift of reserves and bank limitations from the liability side to the asset side. The second was the rise of interbank markets, ledger money, as a source of funding rather than required reserve balancing: replacing the old deposit/loan multiplier model. Courtesy of J. Snider from Alhambra

Various regulatory capital minimums apply. For example, excluding additional capital buffers, the ratio of common equity to risk weighted exposures cannot be less than 4.5% (if the ratio is less than 7% restrictions apply to the distributions that can be paid to capital investors). Total Tier 1 must be at least 6% of risk weighted exposures (8.5% if distributions are to be unaffected) and total capital must be at least 8% of risk weighted exposures (10.5% if distributions are to be unaffected). section 101 page 25-26 of 57-PDF

Hence, banks' retained earnings are a much bigger determinant of lending capacity than anything else.

A starting point for discussion would be that, as shown in that link, in the last 12 months the Govt + insitutional settlement accounts have increased from approx 13 billion to 47 billion.

A starting point would be Columns X, Y, Z which records the monetary base. Column Z is the residual cash settlement account. Link
You can cross reference this here

Keith a little bit of detail please just to clarify- when a bank issues credit, based on its reserves, can it do so as a ratio (i.e. 8:1), or is it $ for $?

This is potential where the real money creation lies, and as PDK identifies the bets against future revenues occur.

When a bank creates credit, it knows that the person receiving the credit will spend it, and that at that point the bank has to have enough money in its settlement account to be able to settle with the financial institutions where the money ends up. So effectively that is 1:1. But that is not the end. From there, the money that the other financial institutions have received can also be relent. Hence the reality of the systemic credit multiplier, which is only constrained by whatever RB-determined reserve ratios are in place, combined with the assumed willingness of new borrowers to take on the available credit, and the prudential lending attitude of the bank. That is why there is great scope for the inflation rocket to take off when everything aligns. Once the borders open, then therisk is that the preset fuse will have been lit.

Thanks Kieth, based on your view this is then where some misinformation lies as much of the commentary has been on credit creation at a ratio of reserves. Clearly this is without an understanding of the need to settle where the money goes to. So another question.

The current housing situation indicates a huge increase in the amount of money in the economy. So if the RBNZ has not created these reserves for the banks to lend out, where has it come from? Foreign borrowing? At what cost to the country?

It is the actionsof the RBNZ via QE which have set the cycle going.
It is their actions which have led to the Treasury bonds being financed without any one else in the market having had to pay; i.e it is the RB that has created the money.
Banks create credit.They do this within the rules of the financial system as set by the RB. Consumers also play their role by borrowing and saving decisions. But it is the RB that sets the rules and undertakes the QE.
Foreign borrowing is not involved.
However, if the RB (and hence the NZ financial system) was the only central bank acting this way then there would inevitably be an effect on the exchange rate as NZ inflated at a much faster rate than other countries, and the NZ dollar depreciated. However,in practice almost everyone seems to be playing the same game. I say almost eveyone because the Chinese do seem to play the game a little differently, but I have not studied the Chinese financial workings sufficienty to write about them.

When a bank creates credit, it knows that the person receiving the credit will spend it, and that at that point the bank has to have enough money in its settlement account to be able to settle with the financial institutions where the money ends up. So effectively that is 1:1.

Check out Westpac's stylised balance sheet for it's NZ subsidiary -Link - page 22 (27 of 145) Loans outstanding NZD 88.4 bn. Collective bank settlement cash as of 30 September 2020 was recorded at $18.731 bn.

You took that sentence of mine out of the context of surrounding sentences. And hence you misnterpreted, for whatever reason. I have no problem with the Westpac figures you refer to. The ratio of the two numbers is interesting but not at all surprising. The bank settlement cash does however indicate there is considerable scope for further credit creation under current RB settings.

Summarising the link if anyone's still reading this:
It is just a "forced" asset swap. The reserves from QE have to just sit there on banks balance sheets like the bonds would have on a CB chosen rate. That's not really printing anything.
All QE does is create scarcity of the safest fixed interest asset lowing the yield and the lower bound of all the riskier lending and borrowing as the alternative floating rate can be set as low as desired.
If the central bank ends up QTing the bonds back into the system for a loss the banks may make some money.

Yes, I do disagree with Audaxes. He is correct in saying that QE involves an asset swap, but he is only looking at one part of the overall system.
Lookiing at that broader system, the RB has engineered that asset swap by purchasing the Treasury bond from the trading bank using money it has created electronically, and which is now available to be used by the trading bank. But when the trading bank purchased the bond from the Treasury it had to use its prior reserves to do this. And now, when it sells the bond to the RB its reserves are replaced. Looking at the overall change that has occurred:

Please explain your bolded claim. Especially before QE when settlement cash was around $7.0 billion and in constant need to settle interbank claims on each other during the daily settlement process.

Reality is better understood here: Box D: Recent Growth in the Money Supply and Deposits

I have no disagreement with Box D which acknowledges how QE by the RBA contributed to increased money supply in Australia.

New lending (including to the government) by correctly captialised banks created new money supply (deposits) in the economy. The credit of RBA reserves to banks' settlement accounts as an adjunct to QE bond purchases does not add to the public's bank deposit tally.

The Reserve Bank's purchases of government bonds have created deposits
As part of the package of monetary policy measures announced in mid March, the Reserve Bank began to purchase government debt from the private sector, to support the three-year yield target and address market dysfunction. Around $50 billion of government bonds were bought from March to early May, and around $1 billion in early August. These bonds were purchased by the Reserve Bank from a panel of commercial banks via auction, and were paid for with newly created money credited into banks' Exchange Settlement Accounts (these balances do not count as deposits, as they are not held with the private banking sector). Some of these bonds sold by commercial banks would have been purchased from non-bank investors, generating a flow of funds into non-bank investors' deposit accounts.[5]

In normal times the banks will be using their excess reserves to buy up government debt as their reserves are a cost for them to hold, in this manner the Reserve Bank controls interest rates, more reserves lowers interest rates and less reserves increases rates as the banks seek reserves from each other. The Reserve Bank will always supply reserves to the banks if they fall short to operate their exchange settlement accounts so as to maintain stability in the banking system, these reserves are at a higher cost to the banks though. Bank reserves are created in the main through money created from government spending. The government credits bank accounts when it spends and it debits them when it taxes and what is left in the system becomes our savings. See (sectoral balances).
Economist Bill Mitchell gives a better explanation on the operation of the banking system here.

How can bank reserves be a cost for them to hold. The Reserve Bank pays them interest on those reserves at the current OCR rate.

In normal times the banks will be using their excess reserves to buy up government debt as their reserves are a cost for them to hold

I presume you are transferring US terminology to the NZ banking system. The implication of the statement in respect of excess reserves implies there are required reserves. Point to their existence on the RBNZ 's balance sheet.

NZ has settlement cash balances which were, before QE, funded by forex swaps. The RBNZ injected NZD into the banks' settlement accounts while they created foreign reserves for the RBNZ. settlement cash became an RBNZ liability. This can be viewed here and the attached xls spreadsheets.

Furthermore, since Covid the RBNZ pays OCR on banks' settlement cash balances.

Great article Keith

Here's an interesting article to read in conjunction with Keith's concerning Reserve Bank Policies in general and where we are headed.

The key insight that I take from that article is that inflation can suddenly turn to hyperinflation once the pupulace loses confidence in the fiat currency and treats it like a hot potato. It is those same behavioural forces that are currently a key element of asset inflation.