The Reserve Bank has kicked off a public consultation process on potential changes its guiding remit for the Monetary Policy Committee. This may spark changes in its inflation target, or its employment target - or in how it balances the two inflation and employment objectives.
And there's also house prices. The RBNZ appears keen to remove direct reference to house prices from the remit.
The first remit was signed by RBNZ Governor Adrian Orr and Finance Minister Grant Robertson in 2019, and then amended slightly at the behest of Robertson to include reference to housing in 2021.
The consultation material suggests that instead of having house prices included in the remit, this could be included in the Minister of Finance’s Letter of Expectations to the RBNZ. The letter could define house price sustainability as a key research priority for Reserve Bank staff, the RBNZ suggests.
At the moment the current subclause 2(2)(d) of the remit says the RBNZ should assess the effect of its monetary policy decisions on the Government’s policy - which is to support more sustainable house prices, including by dampening investor demand for existing housing stock, which would improve affordability for first-home buyers.
Under the legislation passed in 2018, there is to be a five-yearly review of the monetary policy Remit. The Remit is provided by the Government and is used to guide the Monetary Policy Committee’s (MPC) decision making in its pursuit of low and stable inflation and supporting maximum sustainable employment.
Public consultation is open from June 1 to July 15.
“The Reserve Bank is seeking feedback to ensure that the Remit framework is the best it can be for our legislative purpose, and ultimately the prosperity and wellbeing of all New Zealanders. This is the first review of the Remit under new legislation that was passed in 2018,” Governor Orr says.
One key point of interest will be whether there may be any change to the current inflation target, which is a range of 1% to 3%, with the bank explicitly targeting 2%. Of course, inflation at the moment (6.9% annual rate as of March) is well above this.
One of the questions the public is being asked is: "Do you think this target is about right? If not, what do you suggest the target range should be changed to, and why?"
In the consultation document the RBNZ says "there are some arguments" for changing the specification of the 1% to 3% inflation target, such as by changing the targeted inflation rate, or by changing the approach to measurement of inflation for monetary policy purposes.
"However, it is not clear that these alternatives are superior to the status quo, and there are also significant costs to changing from the current inflation target specified in the Remit.
"Changing the target may reduce public trust in the price stability objective by creating an expectation that the target will be subject to further changes in the future, or cannot be achieved. In other words, expectations of future prices might become more responsive to changes in inflation, making it more difficult for the MPC to achieve price stability," the RBNZ says.
The central bank also notes that the Remit includes guidance on how the MPC should achieve its objective of supporting Maximum Sustainable Employment (the highest possible level of employment that does not generate excess inflation).
"The value of MSE at any point in time is uncertain, must be estimated, and is likely to vary substantially over time in line with factors that are outside of the control of monetary policy, such as demographics and labour policy.
"Although societies generally want high employment rates, the MPC does not set policy to persistently increase employment above its maximum sustainable level, as this would undermine its price stability objective," the RBNZ says.
The employment target was added into the RBNZ's monetary policy target by the Labour-led Government in 2018.
The consultation paper says the best contribution that monetary policy can make to employment is generally to set policy so that inflation is low and stable.
"However, in some circumstances, the MPC may face a trade-off between its objectives. The Remit could be extended to reflect the MPC’s current understanding that inflation forecast targeting is generally the best approach to achieving the dual mandate, and/or include more guidance on how to balance the economic objectives when they are in conflict."
The paper, in talking further about this balance between the objectives, says there are times when inflation can increase due to factors that have nothing to do with the underlying level of demand in the economy, such as when global oil prices increase.
"Such ‘cost push’ shocks can have negative impacts on household incomes—reducing output and employment—yet at the same time put upward pressure on inflation. If policy makers respond by tightening monetary policy (to reduce inflation), this will tend to put further downward pressure on output and employment, and vice versa.
"There is currently no specific guidance within the Remit on how the MPC should balance any trade-offs between its objectives. At present, when a trade-off does arise the MPC considers outcomes for both objectives in setting policy. In general, if employment is projected to be below its long-run sustainable level, the MPC will let inflation overshoot the target mid-point for a time, and vice versa (while staying within the 1%–3% target range).
"There is increased uncertainty on how to manage trade-offs between inflation and employment due to the nature of the economic objectives. The inflation objective is precisely defined and measureable, while the employment objective is imprecisely defined and not directly measurable. This makes it difficult for policymakers to accurately trade off these objectives in real time."
The paper asks the public this question on the issue: "Do you think the Remit should include guidance on the weight of the inflation and employment objectives? What changes to the Remit, if any, should the Reserve Bank focus on?"
Back on on the subject of house prices, the following question is asked: "Do you have any comments about the relevance of house price sustainability for monetary policy?"
The RBNZ paper says the Remit "could require" the MPC to take into account house price sustainability in its decision-making, to the extent that doing so did not undermine its legislated economic objectives of price stability and supporting MSE. This would require the MPC to consider setting monetary policy tighter than otherwise during periods where house prices are above their sustainable level, with the objective of lowering growth in house prices.
It says There are two possible benefits of this approach:
Deposit affordability: By lowering house prices, at least for a time, tighter monetary policy could make it easier for prospective buyers to afford a deposit to purchase a home. However, any improvement in affordability would be temporary because, as discussed above, monetary policy cannot persistently affect the sustainable level of house prices over time. Higher mortgage rates would also make it more difficult for both prospective and existing homeowners to service mortgage debt, and would have unclear effects on renters.
Financial imbalances and risks: Setting policy tighter than otherwise could also reduce the risks to the financial system and wider economy associated with unsustainable house prices. However, there is considerable uncertainty about how effective tighter monetary policy would be in limiting risks to the financial system. Although some research has found benefits from using monetary policy to pursue financial stability, most studies have concluded that the benefits are not likely to be large enough to justify using monetary policy in this way.
"The size of these benefits from using monetary policy to address house price sustainability are highly uncertain. In contrast, the costs of monetary policy being tighter than necessary to maintain price stability and support MSE—lower output and higher unemployment in the short run—are likely to have a higher expected value and are more certain. Having greater regard to house prices would also reduce the flexibility to use monetary policy to reduce volatility in short-run economic activity," the RBNZ says.
"Given the ways that house price sustainability is already taken into account by the Reserve Bank in its policy decisions, it is not clear that there are significant benefits in requiring the MPC to consider house prices through the Remit. To an extent, the MPC already takes unsustainable house prices into account through their impact on the economic objectives and financial stability. Moreover, financial policy can generally target financial stability risks in the housing market more effectively. Any additional benefits of tighter monetary policy for deposit affordability are temporary and are likely to be outweighed by the costs to short-run economic activity.
"The Reserve Bank will continue researching the interactions between monetary policy and the housing market. The Minister of Finance’s Letter of Expectations could define house price sustainability as a key research priority for Reserve Bank staff, as an alternative to the current subclause 2(2)(d) of the Remit. The current subclause has been misinterpreted by some as an active requirement to consider house price sustainability (rather than a reporting requirement).
"Over time, these perceptions may lead to unrealistic expectations about what monetary policy can achieve, and erode public confidence in the MPC achieving price stability and supporting MSE."
RBNZ Chief Economist Paul Conway is urging people to take part in the consultation process.
“Do people think the inflation target is about right? How should we go about supporting maximum sustainable employment? How relevant are major economic trends under public discussion, such as house price sustainability, distributional outcomes, or climate change? We hope to see a wide range of views,” he says.
People can have their say by completing a quick survey or by reading the full Consultation Paper and submitting feedback. The feedback will be used to inform an assessment of any possible changes to the Remit, which will again be consulted on later in 2022.
The RBNZ will then also seek views on the Monetary Policy Committee’s Charter – the document that sets out the MPC’s meeting processes.
The Reserve Bank’s advice will go to the Minister of Finance in 2023 for a decision on if and how the Monetary Policy Remit and Charter will change from 2023 to 2028.
We welcome your comments below. If you are not already registered, please register to 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.