David Hargreaves would like to seen any review of the Reserve Bank undertaken as a part of a root-and-branch overhaul of its governing legislation

By David Hargreaves

One way or another it looks as though there will be changes in the operation of the Reserve Bank.

On the face of it that's a good thing - whether the change comes about from the review that Finance Minister Steven Joyce has asked for - or through a change of Government.

However, what we may, I suspect, likely get under either of these scenarios is a half-hearted tinkering around the edges.

And I think that would be a pity.

Thorough overhaul

I've thought for a little while that there would be much to gain from a thorough overhaul of the Reserve Bank Act, which has done a good job for us, but is now getting on for 30 years old. And yes, the world has changed a lot in that time.

There are some fairly obvious 'issues' that have been thrown up in more recent times around the operation of the central bank.

The one the current government is most likely to address is the question of interest rate setting and the fact unlike that which occurs in most major economies in the world our decision on rate moves is ultimately that of one person - the Governor.

While the present RBNZ Governor Graeme Wheeler's been at pains to stress that under his watch rate reviews have been done on a committee basis, this doesn't change the fact that the rule book says the right to make the decision is his and his alone.

Outsiders needed

The problem with having the decision made by one person, or even an internally constituted committee, is that there's still not sufficient input from outside. So, yes, the idea of a board that includes outside people with particular areas of expertise to make the final call on rate decisions seems sensible.

I still think if we had outside input into the rate setting decisions that it's doubtful the erroneous decision to hike interest rates four times in 2014 would have occurred (and remember the folk at the RBNZ have not even been able to bring themselves to publicly concede it WAS a mistake, which tells you everything you need to know about why they should not be totally left in charge of the decision-making process.)

The other 'hottie' in terms of the Reserve Bank of course is the Policy Targets Agreement and whether it should be left essentially as it is now with the sole aim of 'price stability' (give or take the odd tweak within that definition).

I'm not convinced about the idea of putting employment in the PTA, as Labour is now suggesting. But then I'm not convinced that it is sufficient anymore to just baldly target a rate of inflation and imagine this will do everything we want for the economy. Like the Reserve Bank Act itself, this has worked in the past. It does not appear to work any more.

How to do it?

The question would be, if it's a good idea to rework the aims of monetary policy, how would that best be done?

And here's where I think a much more fundamental review of how the Reserve Bank operates and other related issues such as whether it's still appropriate to have one organisation controlling both monetary policy and financial stability, should be looked at.

The natural 'pause' that we are going to see in the operation of the RBNZ between now and when a new full-time Governor is appointed next year would have been a good time to do that.

Alas, however, what appears likely between now and the election is some political posturing and half-hearted tweaks. That really isn't what we need.

It's true that you shouldn't try to fix something if it isn't broken.

However, after close on 30 years, and given the massive economic changes in that time, then any operating system should at least be given a thorough structural examination.

Pigs might fly

I guess it is as likely as seeing little pink piggies flying over the Beehive, but I would prefer the major political parties to agree to some sort of independent assessment of the Reserve Bank and the appropriateness of the current operation and governance functions of the RBNZ, with a view to making such an overhaul as is necessary.

If we go through that process and then decide that all is good and we only need tweaks then, fine. But to be honest I think any thorough review of the existing legislation and operating brief of the RBNZ would likely come up with a lot of ways it could be improved.

Does it matter?

It's easy to see the operating hows and whys and whats of the central bank as something of an essentially philosophic debate.

Except the impact of the RBNZ's actions is anything but philosophical.

If you take one look at the current state of the economy and ask the question: Did the interest rate hikes mistake in 2014 cost us anything as a country? - Well,  the answer most likely given would be 'no'. But we don't really know that for sure. Hey, we might have been in a much better situation. Who knows really?

Risks for the future

The point is, the further we go on with legislation getting past its best-by date and without looking at overhauling how the central bank operates, the more we do risk things going wrong in future.

And that's not philosophical.

That's us paying too much for our mortgages, or wages maybe not increasing as they should, or the economy being stymied.

I'm increasingly of a view that the three-year electoral cycle of this country is too short. That it leads to knee-jerk policymaking on the hoof for political expediency. Things are chopped and changed with too much frequency.

Then again, maybe it would not be absolutely necessary to extend the electoral cycle if the political parties could reach consensus on some key issues - and the operation of a vital arm like the RBNZ would fit into that category.

But okay, yeah, I know, I think I can see those little pink piggies sweeping over the Parliament Buildings again...

*This article was first published in our email for paying subscribers early on Thursday morning. See here for more details and how to subscribe.

We welcome your help to improve our coverage of this issue. Any examples or experiences to relate? Any links to other news, data or research to shed more light on this? Any insight or views on what might happen next or what should happen next? Any errors to correct?

We welcome your comments below. If you are not already registered, please register to comment or click on the "Register" link below a comment.

Remember we welcome robust, respectful and insightful debate. We don't welcome abusive or defamatory comments and will de-register those repeatedly making such comments. Our current Comment policy is here.


Nice article David, I think you are right that a more thorough review of the RBNZ is needed. I think the subject is a fascinating one as it largely determines how money functions in our economy and thus the business model of the country.

Our current business model is rather fuzzy, but it is not the productive model we are led to believe. Yes, we do have a sound export sector that exports food, oil and gold; and a sound export services sector in tourism. These allow us to import goods from overseas and remain a developed nation. However, this is weakened by the inflow of overseas capital coming in through immigration and overseas buyers on the one hand, and via overseas borrowing by the big foreign owned banks.

Nearly all this capital goes into the exchange of existing assets (ie Auckland houses for the most part) and does not increase our earning ability as a nation. It weakens the productive sector because it forces the currency up. In a sense this is what the current account deficit tells us - that the currency is too high.

This rather disfunctional model has been serving New Zealand sort of ok since 1973, not great, but ok. The sugar rush of foreign money coming in causes booms in house prices and forces the currency up, causing busts in the productive sector. The bust in the productive sector then leads to a bust in the financial sector, and an increase in government debt in order to provide a safety net to those who lose their jobs.

Successive governments in New Zealand have learned how to cope with the consequences of this model. They run a decent budget deficit when times are bad, and seek to reduce government debt when times are more reasonable.

Learning to cope is not the same as doing well. We are a blessed country with a very practical can do people. Why are we not doing better? My belief is the problem is that the business model is flawed and the weakness lies in our poor ability to play what I call "capital defence".

We are told that we are a capital importing nation and that we should therefore accept our fate. Make the most of it, this is as good as it gets, we are told. Be grateful that the rest of the world keeps providing the money we need. This is the business model of a company with a valuable asset that somehow never manages to get its act together and so has to raise fresh capital from its shareholders every few years.

The situation is not really of New Zealand's making, we just haven't learned how to win at a rigged game. The pressure to run a current account deficit actually comes from the massive, globally destabilising, current account surpluses run by Japan, Germany and China over the last decades. (Hat tip to Michael Pettis and the BIS for explaining this to me).

I'm not suggesting we should try to "break the cycle" or anything that radical, just that we should stop being a wimpy capital importing nation and figure out how to be a self reliant, profitable country that runs a small current account surplus over the medium term. That we choose a more sane business model. We already export a lot as a % of GDP, so we have sales income, we just haven't learned how to manage our capital account so we can make a profit.

My suggestion would be to go back to first principles and ask why a Central Bank exists in the first place..??

One of the fundamental premises of a endogenous Monetary system is that man is "rational"..
The GFC simply reaffirmed that this is NOT true....
Speculation, Malinvestment, irrational behavior, criminality.... ponzi investment..etc..etc. are the realities of our modern economy.. ( eg.60% of nZ debt is household debt )

To the extent that Man is rational, manipulated interest rates can/does lead to mis allocation of resourses and also malinvestment , because interest rates ( cost of money ) is an information transmission mechanism.
Ultra low interest rates and easily available money leads to over capacity...almost everywhere.

My guess is that Central Banks actually help "ampify" the effects of the business cycle( short term debt cycle ).. ie.. Central Banks have NOT mitigated the boom/bust cycle .... which was one of the promises of having Central Banks in the first place... ie.. to smooth out the ups and downs.

Maybe it is time to revisit these underlying fundamental ideas...

True wealth does not come from manipulating interest rates nor from printing money..
Wealth and living standards have more to do with work ethic...productivity... innovation.

Brian Gaynors article is interesting reading


ps... people forget that interest rate manipulation ( thru credit creation ) is simply a mechanism of wealth Transfer....and NOT wealth creation.

just my view....

I was thinking along the same lines the other day. One of the reasons for the inefficiency of the communist regimes in Russia and China was that there was no cost of capital. So they kept doing loss making things that consumed more than they produced. It is ironic that own version of central planning has brought us to the same point.

As I posted above, as a country, we have adopted a negative cash flow business model with a burn rate of 2.7% of GDP, or about $7 billion a year. This is not necessarily a bad thing if productivity is going up faster than that....

What about the introduction of a stable money regime similar to that which fostered significant post World War II prosperity, until it was misappropriated and then discarded?

There is supposed to be a robust relationship between monetary policy, inflation expectations, confidence, and then inflation and output. That is what “accommodation” means, and the end of “accommodation” therefore must mean the confidence stage is finally turning into the activity stage; animal spirits progressing from confidence into actual inflation and activity.

At issue is the Phillips Curve which governs the theories about these relationships. It was at first believed in 1960, only a few years after AW Phillips first described his findings, that intentional policy could trade inflation for employment. Because they appeared to behave inversely, any Treasury Department or Finance Ministry could undertake “inflationary” policies especially underwritten by its central bank and reduce unemployment down to the absolute minimum. This “exploitable” Phillips Curve as introduced by economists Paul Samuelson and Robert Solow turned out to be an epic disaster. Read more

What about the introduction of a stable money regime

yes...that would be my preference..
And as we would have benign deflation from productivity gains, as a result of a stable money regime , we could simply reintroduce lower denomination currency.

You touch on a very important point there. Our present model does not tolerate benign deflation from productivity gains, in fact it is mandated to prevent it. If prices drop as a result of productivity gains the Reserve Bank is required to lower interest rates to stoke inflation. If a bunch of prices are dropping, guess where the extra liquidity goes? IMHO asset bubbles and propping up prices in sectors where productivity is very poor.
As I have said before, lowering interest rates as per the Reserve Bank IR/OCR model is very poor at stimulating the productive economy and very good at stimulating asset bubbles. (just look at what has been going on in the worlds economies since the start of the GFC) These bubbles tend to give rise to the next cycle of tightening so I think we are experiencing a series of booms and busts that serve the speculative sector but is doing long term harm to the productive sector.
As this article suggests we need a long and very hard look at how the Reserve Bank operates, but I would also include our banking system and the models we use for the wider economy. This is a weighty task and well beyond the scope of just a bit of tinkering.

"stable money regime similar to that which fostered significant post World War II prosperity .."
We do not have particular post-WW2 conditions ( post-war resurgence , US dollar dominance .. ) which made it successful - for a while so I am not even sure it would work to start with.
" until it was misappropriated and then discarded" - why would this time be different ?
Would be interested in your view as to why it would be able to persist better than the last time around .

Interesting article. I think I understood part of it, that Bill Phillips' curve sometimes works forwards as expected for several years, but sometimes it works backwards for several years, and sometimes it doesn't work at all.

What intrigues me though, is that Eurodollar chart, it looks like a major bottom may have been reached. The COT positioning suggests the same possibility. However, I am not sure what this means, if it is in fact the case. Does it mean that the Eurodollar credit contraction has run its course and that it is starting to expand again, or the opposite?

Also, I'm not making the connection between the Phillips curve and Euro dollar futures.

Here is a related chart I think you might like, it shows there is a relationship between lumber and Eurodollars, which fits with Snider's thesis (as far as I am able to understand it).

What actually was the big mistake about hiking rates in 2014?

"the erroneous decision to hike interest rates four times in 2014 would have occurred (and remember the folk at the RBNZ have not even been able to bring themselves to publicly concede it WAS a mistake"

Apart from the professional embarrassment for the governor of dropping them again very shortly after. What actual damage was done?

DO NOT MESS with the RBNZ mandate.

This is the only Institution in New Zealand that is willing and able to make tough or unpopular decisions that are in our best interests , when our economy is over-heating, or at risk of some shock(s) , or where there is a need to curb inflation or currency issues ( such as the GFC or Asian Banking crisis) .

Monetary Policy (MP) is about as loose as it will ever be right now , and God help us if we had politicians wanting to have MP settings that suit some political or ideological agenda.

The RBNZ makes decisions that elected politicians will not make , either for ideological reasons , or because they are too scared or because of the timing ( such as in an election year ) .

I tend to agree the risk in politicians tinkering is always very high.

Decision by committee is no 'magic sooty dust' solution to anything. Committees dilute accountability, don't guarantee good leadership or intelligent decision making and attract politicking like dung attracts flies.

I agree with Boatman. Any change may result in the doves being permanently granted control of the asylum. And i'm not sure that whining about the 2014 hikes is of any use whatsoever, simply hindsight sniping. The fact that they've since been reversed proves nothing. The collapse in inflation afterwards was due to a number of factors, mostly international.