• The Reserve Bank Governor

    Alan Bollard is a big man – well over six feet [around 1.9 m?] tall – but even his shoulders are not broad enough to bear the burdens placed on them. To point this out is not so much to criticise the Reserve Bank Governor as to lament the role in which he is cast.

    He is, after all, lumbered with virtually the sole responsibility for what passes in this country for macro-economic policy. He alone must decide every six weeks on the direction in which monetary policy should be taken. He is given a single instrument – interest rates – and a single target – inflation.

    Beyond that, macro-economic policy is virtually non-existent. Little matter that inflation might be low on the list of economic policy concerns, or that cutting interest rates might make little difference to anyone in an economy mired in recession. Faced with our manifold problems, the Governor- with his tiny armoury of largely irrelevant and ineffectual weapons – is on his own.

    Little wonder then that – in deciding last week what to do about interest rates – he should have opted to share the responsibility by talking to the Minister of Finance. There was after all the small matter of continuing recession, with little sign of the much-touted recovery – and on top of that, the further blow of the 22nd of February Christchurch earthquake.

    There was, however, much tut-tutting that the Governor should have opted, by consulting with his political masters, to depart from the principle of absolute independence for the Reserve Bank. Many commentators and practitioners seemed discomforted by the thought that the elected government might be asked to bear some responsibility for the fortunes of our economy.

    The doctrine that macro-economic policy is a simple matter of setting interest rates – a task entrusted exclusively to the Reserve Bank – is of course greatly convenient for government. It means, in our current situation, that they can disclaim responsibility for a recession that is now well into a fourth year. Not only is it nothing to do with them but – according to the doctrine – anything they might try to do would be counter-productive.

    The paradox is that governments that are unwilling to intervene in macro-economic policy, on the ground that the economy is best left to look after itself, are likely to end up being more interventionist than they expect. As the economy languishes because macro-economic policy settings are inappropriate, governments typically resort more and more – and with greater and greater desperation – to micro-economic intervention of various kinds.

    So, we find more and more fiddling with tax rates and labour laws, more and more target-setting and micro-management for science and research and the delivery of education at all levels, tighter and tighter limits on benefits and public spending programmes – all in an increasingly futile drive to reverse our poor productivity and declining competitiveness.

    But, surely, it will be asked, the Governor’s interest rate cut was a step in the right direction? Well, yes, it had a certain value as a psychological boost and as a small benefit to those with mortgages – but it is hardly likely to stimulate spending and investment to the point where the recovery really gets under way. That will require measures of a quite different nature and order of magnitude.

    If monetary policy was really the key to recovery, we should surely have seen it by now. We have, after all, had falling and historically low interest rates for years now, and the economy has hardly stirred. As I and others argued in 2008 and 2009, using monetary policy as the only stimulus to an economy in a recession is like pushing on a piece of string.

    The Governor has, in other words, done what he can, but what he can do is pitifully inadequate and beside the point. His recourse to involving the Minister of Finance last week suggests that he might be moving to this view as well.

    No one doubts that our problems are endemic and that the Christchurch earthquake has added to the government’s difficulties. But the failure to take any decisive action over a couple of years means that the earthquake cannot be identified as the primary cause of our problems.

    The government has in effect contented itself with trying to look after its own finances, and has been happy to let the wider economy look after itself. The paradox is that public finances are the healthiest part of our economy. Focusing primarily on getting the government’s deficit down, while ignoring the need for a whole-of-economy perspective, has reflected an ideological rather than practical priority, and has left the economy ill-equipped to grapple with its problems – among which, sadly, the consequences of the Christchurch earthquake now loom large.

    Surely governments should be held to account for what they are elected for – providing an effective stewardship of the economy – and the Governor of Reserve Bank should no longer be abandoned to his lonely and irrelevant vigil?

    Bryan Gould

    12 March 2011

    This article was published in the NZ Herald on 16 March.

  • There Are Other Options

    The Reserve Bank Governor, Alan Bollard, used a speech last week to defend the policy that has been applied in this country for over two decades – a policy that he inherited and has since perpetuated. That approach to running the economy essentially revolves around monetary policy – and Alan Bollard’s advice to his critics was that they should accept a monetary policy framework which takes inflation targeting as its central element as the best means available of achieving good economic outcomes.

    His critics are unlikely to be convinced. It is not just that our economic performance over more than two decades has been less than impressive and has seen us slide down the OECD tables. It is also that the Governor seems to misunderstand the nature of the criticism.

    If we are to take his argument at face value, he is rather like a pastry chef who – using only flour – produces a flat and tasteless cake and then tries to rebut critics by insisting that flour is a very important and valuable ingredient. Most would argue that eggs, butter and sugar might also be helpful – just as, in economics, the Governor’s critics would say that to rely entirely on monetary policy is to ask it to do too much, including much for which it is not suited, and its exclusive use therefore prejudices the chances of achieving a buoyant and successful economy.

    No one says, in other words, that monetary policy should be abandoned. But what the critics do say is that we would do better if we used other policy instruments as well.

    The irony is that, if we read the Governor’s speech carefully, he seems to agree with this. And it may be better to watch what he does, rather than what he says. Whatever the headlines may say, Alan Bollard indicates very clearly that he is increasingly looking to other elements of policy, even while still focussing on the very narrow definition of his responsibilities with which he is saddled by our legislation.

    Let us take, for example, the Governor’s plea to the government that it should get fiscal policy under control by mid-year. We can put to one side whether or not he is right to call for a reduction in government spending, which seems a little misplaced, given that we are still bumping along on the bottom of the recession. What is significant is his argument that an effective fiscal policy will reduce the burden that has to be carried by monetary policy – an acknowledgment that monetary policy needs help from an integrated fiscal policy, even when the policy focus is as narrow as simply controlling inflation. How much more true would that point be if we widened the focus to the wider and proper goals of economic policy?

    He is also right to call for a re-appraisal of taxation policy, particularly as it affects the taxation treatment of housing as an investment proposition. This again is a recognition that taxation policy, by focusing on the micro-economic mainsprings of inflation, might have a useful role in a counter-inflationary strategy.

    And, the Governor’s rehearsal of the tighter regime he has applied to the banks in respect of their lending policies may find its justification on prudential supervision grounds, but it also has the merit of addressing one of the most significant of factors contributing to inflation – excessive bank lending, particularly for residential property. Again, the Governor has identified an important and additional ingredient – beyond interest rates -in a sensible policy mix.

    Alan Bollard, in other words, may talk a good fight against the critics of an exclusive reliance on a monetary policy focused on inflation targeting, but his actions tell a different story. The call for a new debate about macro-economic policy has not fallen – in his case – on entirely deaf ears.

    It should be acknowledged that the Governor made some points in his speech that even his fiercest critics would support. His rejection of an Anzac currency, as a means of achieving greater currency stability, is entirely right. A common currency could only work within the context of a common monetary policy; and a common monetary policy could be applied in a democracy only by a common government. Unless we see our future as an Australian state, we should maintain our own monetary policy – and currency.

    He was on less convincing ground when he also rejected the kind of competitiveness target that has worked so successfully for Singapore. But whether or not he is right in this, he has at least recognised that a debate on these issues is desirable and appropriate. We are at last making some progress by consigning the mantra that “there is no alternative” to the dustbin of history!

    Bryan Gould

    1 February 2010.
    This article was published in the NZ Herald on 8 February