By Jenée Tibshraeny
The trend we’ve seen over the past few years of governments playing significant roles in managing economies looks set to continue.
After decades of governments outsourcing economic problems to central banks, there was a move towards greater government involvement in these money matters pre-Covid.
The pandemic exacerbated that shift, as have the prominence of rising living costs and the distributional impacts of interest rate changes.
The swing isn’t necessarily ‘good’ or ‘bad’, but is worth noting.
It means we can’t assume that what happened in the past will necessarily happen in the future.
The change increases the risk of public opinion and electoral cycles disproportionately influencing policymaking. On the other hand, it creates space for more public involvement in policymaking.
Change coming from a revamp of the Reserve Bank Act 1989
Let’s rewind to 2017, when the Treasury started reviewing the three-decade old legislation under which the Reserve Bank (RBNZ) operates.
It took monetary policy decisions out of the hands of a governor and gave them to a committee with four internal and three external members and a Treasury observer.
It also added employment to the Committee’s inflation target. Those changes took effect in 2018.
The next phase of the review saw the Government in 2021 decide to make the RBNZ more accountable to it. From July, the Treasury will officially be made responsible for monitoring the RBNZ. Previously this was done by the RBNZ board. Under the change, the board will adopt a more hands-on governance role.
The new structure goes further in diluting the power of the governor.
While monetary policy decisions will firmly remain with the RBNZ, the Treasury will have more influence over financial policy, including how financial institutions are regulated and how credit is created.
QE saw RBNZ/govt relations intensify
In addition to legislative change, the RBNZ’s use of quantitative easing in response to Covid-19 saw fiscal and monetary policy work closely together.
The RBNZ launched its bond-buying, or Large-Scale Asset Purchase programme, because it didn’t have much room to keep loosening monetary conditions with the Official Cash Rate (OCR) nearing zero.
The programme saw it buy $53.5 billion of New Zealand Government Bonds on the secondary market.
The intervention helped the RBNZ by putting downward pressure on government bond yields and thus interest rates. It helped the Government by lowering its debt servicing costs and ensuring there was a buyer for the flurry of bonds it issued to cover Covid-related expenses.
The RBNZ plans to unwind the programme by selling down its bond holdings over five years from July.
The Government will once again be implicated. The indemnity it provided the RBNZ for the programme stipulates the Bank can only sell the bonds back to the Treasury. The requirement is there to avoid a sell-off by the RBNZ intervening with the Treasury’s bond issuance, potentially causing dysfunction in the market.
It’s likely Treasury will need to borrow more than it otherwise would’ve to get the cash it needs to buy bonds back from the RBNZ.
It’s no secret the loosening of monetary policy in the lead-up to, and during the initial stages of the pandemic, pumped up asset prices, which has had political consequences.
Finance Minister Grant Robertson came under so much pressure over the impact loose monetary policy was having on house prices, that he in 2021 he required the Monetary Policy Committee to start assessing the impact its decisions were having on house prices.
The RBNZ is also aware of the issues. It will consider whether it should put any weight on housing or the distributional impacts of its policymaking, in a five-yearly review it is doing on its monetary policy mandate.
Back to 2021, the Government also required the RBNZ to have regard for its housing policy in the way it does its job maintaining financial stability. The Government’s housing policy was defined as supporting more sustainable house prices, including by dampening investor demand for existing housing stock, and improving affordability for first-home buyers.
It's debatable how much influence these changes have had. The RBNZ recently put aside the Government’s desire to make it easier for aspiring first-home buyers to get a foot in the market, when it tightened loan-to-value ratio (LVR) restrictions to maintain financial stability.
Nonetheless, the changes have put the spotlight on the RBNZ and required it to better explain the impacts of its policymaking.
The key point is, the Government hasn’t held back trying to get the RBNZ to row in the same direction as it is on key policy fronts.
Higher interest rates will only do so much to curb inflation
So, the relationship between government and the RBNZ has evolved a lot since 2017.
The inflationary environment we’re in provides further reason to pay attention to the government’s role in policymaking.
The OCR is rightly on its way up, but there are limits to its effectiveness is curbing the type of inflation we’re facing.
While seismic amounts of fiscal and monetary stimulus provided in 2020 and 2021 have boosted economic demand, factors outside of New Zealand’s control are suppressing economic supply.
Russia’s invasion of Ukraine is raising oil prices and Covid-induced supply chain disruptions are increasing the cost of goods.
While the RBNZ lifting interest rates will stop the wealth effect in its tracks and reduce households’ disposable incomes, this will only go so far in dampening inflation.
Mountain of mortgage debt a handbrake
The enormous amount of mortgage debt New Zealanders have taken out since the start of the pandemic might also restrict the RBNZ from hiking the OCR too aggressively.
Households will be fine on aggregate, but those at the margins – including recent first-home buyers with large mortgages – will feel the pain.
What’s more, it’s difficult to know how much further consumer confidence will fall should mortgage rates keep climbing and house prices fall - as expected.
A high inflation/slow economic growth combo is a very real prospect.
Inflation now the hottest political issue
While inflation is technically the RBNZ’s problem, “the cost-of-living crisis” has become a political problem for the Government.
The Opposition has zeroed in on the issue since the end of last year. Poll results suggest this is working.
There are of course things the government could do to alleviate domestically-driven cost pressures – ensure housing supply is keeping up with demand, make the building supplies and supermarket sectors more competitive, and ensure government spending is targeted.
But, because the Government can’t stop Russia from invading Ukraine, or China from responding to Covid outbreaks with lockdowns, the focus is being put on what can be done to alleviate the pain of inflation.
Going into next year’s election, much of the debate will centre on how broad or targeted this support should be. Broad-based support, in the form of income or fuel tax cuts for example, will be popular.
Targeting support is more progressive and prevents it from exacerbating inflation. However, this can be a harder sell, especially for politicians eyeing the coveted “middle New Zealander”.
The Government knows this. Last week, Prime Minister Jacinda Ardern offered a couple of journalists rare one-on-one interviews to talk through welfare changes, announced at Budget last year, which have just taken effect.
So, in summary, the nature of the inflationary environment we’re in, as well as changes to the Reserve Bank Act, tweaks to the RBNZ’s remit and the use of quantitative easing have brought the government and central bank closer together.
The landscape has changed, but have we?
The moral hazard created by the government and RBNZ response to Covid-19 is huge. One might have been led to make risky investments with the understanding that when the next crisis comes along, policymakers will once again slash interest rates and loosen credit conditions, rolling out the red carpet for asset owners.
While this is a logical approach, given the size of the housing market and banking sector in the context of the New Zealand economy, one can’t be 100% certain history will repeat.
Furthermore, it will be harder to slash interest rates to lift economic demand should inflation become embedded.
The same could be said for the loosening of credit conditions. While credit creation has soared in recent years, economic output hasn’t to the same extent.
So, if governments are less able to outsource economic management to central banks, how will this affect policymaking?
Decision-making could become more driven by public opinion and electoral cycles. This could promote short-termism and create uncertainty.
On the upside, politicians will have to be more mindful than the RBNZ of the distributional impacts of policies. The RBNZ isn’t specifically required to consider how using blunt tools, like the OCR, affect different parts of society. But the government has more levers at its disposal to target/refine policymaking.
The RBNZ will also be more accountable for its actions, alongside democratically-elected members of parliament.
Finally, more government involvement creates more space for public participation.
The onus is therefore on us to push politicians to create forward-looking policies that will serve us well across electoral cycles.