In the 30 November issue of your paper, Finlay MacDonald urges the new government to “reform” the Reserve Bank Act by putting monetary policy back under the day to day influence of politicians. He correctly notes that the Act allows the government to determine the inflation rate which the Reserve Bank is obliged to target, but quarantines “operational activities” from government control.
He then goes on to argue that “plenty of people” see this Act “as a relic of failed economic dogma, well past its due date for reform”, though he mentions only two people by name – Jim Anderton and that well-known economist Winston Peters. He links the Reserve Bank Act and similar legislation elsewhere to the current financial crisis.
Whatever the cause of the current crisis, nobody that I know of seriously suggests it was caused by our Reserve Bank, or other central banks, focusing monetary policy on keeping inflation under control by keeping interest rates too high. Indeed, there are many observers who believe that the trigger for the current crisis was interest rates in the US being kept too low for too long, with the result that banks were encouraged to lend to a large number of borrowers of very marginal creditworthiness.
Several points must be made.
First, the central banks of virtually all developed countries – certainly the United States, the United Kingdom, Canada, Australia, and the countries of the European Monetary Union – have removed monetary policy from the day to day influence of politicians. Why? Because experience over decades has shown that politicians have a tendency to manipulate monetary policy for their own political advantage, to the economic cost of their countries.
Second, why have our interest rates been higher than those in most other developed countries over the last few years? Because we have had stronger inflationary pressures than most other countries.
Third, why have virtually all central banks (including the Reserve Bank of New Zealand) been easing monetary policy aggressively in recent months? Because all central banks have a floor to their inflation targets – either an explicit floor (as in our case, and that of Australia and the United Kingdom) or an implicit floor (as in the case of the European Monetary Union and the US). These central banks all recognise that, with their economies slowing sharply, there is a serious risk of inflation falling below the floor of their inflation target. Thus an inflation target creates a strong presumption that the Reserve Bank will tighten policy when activity gets a bit too hot and ease policy when activity looks like slowing sharply. And I assume that that is exactly what Finlay MacDonald would want.
Fourth, nothing about New Zealand’s experience since we reached price stability in 1991 suggests that focusing monetary policy on keeping average prices stable damages growth or employment. We’ve had some of the best growth in our history over the last 16 years, and until recently we had the lowest level of unemployment in the developed world.
Fifth, while dropping interest rates can stimulate economic activity in the short-term, all countries have learnt from bitter experience that in the longer-term using interest rates to try to get faster economic growth results only in damage to economic growth, as inflation makes it harder to interpret the price signals coming from the market. Sustainable economic growth ultimately depends on increasing output per person employed – in other words, on productivity – and tolerating higher inflation does nothing to achieve that goal. If it did, Zimbabwe (with high inflation) would be enjoying fantastic economic growth and high living standards, and the United States (with low inflation) would have poor growth and low living standards.
And finally, the people most hurt by inflation are those on low incomes. Most of those with significant wealth can not only protect themselves against inflation but can actually make themselves richer, by buying assets with borrowed money and enjoying the inflationary rise in the price of those assets.
To be sure, there are things I would like the Reserve Bank to be able to do differently, as I have argued on other occasions, but putting the Bank’s “operational activities” back under the direct control of politicians would be a recipe for disaster, and to the best of my knowledge no developed country is contemplating doing this.
Copyright © 2024 Don Brash.