Published in Insights, The New Zealand Initiative’s newsletter, 2 May 2014
When Labour announced its so-called “Monetary Policy Upgrade” this week, their finance spokesperson David Parker was aware of what a radical departure from conventional monetary practice it was. When asked whether one of its key proposals, a compulsory variable savings rate (VSR), was in place anywhere else in the world, Parker had to admit that “nowhere currently” was such a scheme practised.
It is not the only feature of Labour’s monetary package which is out of sync with current international practice. To be clear, that in itself does not make it wrong. For every good policy idea, there is always someone who first comes up with it. However, in looking at Labour’s monetary policy it is more than dubious that these are, in fact, good ideas.
Labour’s basic approach is simple: they want the Reserve Bank to focus on more than price stability alone. As Parker correctly pointed out, other central banks such as the US Federal Reserve, or the Reserve Bank of Australia, are already operating under mandates requiring them to take issues such as employment, prosperity and welfare into account.
However, such prose in central banks’ mandates cannot detract from the fact that these diverse targets remain inherently contradictory. Yes, it is possible to boost employment in the short term by an unexpectedly expansionary monetary policy. However, this will have an impact on the price level, which then negatively affects employment.
Those who believe they can neatly choose between higher unemployment and higher inflation, typically end up with both. Labour does not seem to be aware that policies which will drive down the exchange rate and boost employment can even have a price level effect.
Labour proposes changes that would give the Reserve Bank the power to target any of a smorgasbord of different variables: price stability, the balance of payments, the exchange rate, the national savings rate and, ultimately, aggregate demand. In order to achieve this, they propose to allow the Reserve Bank to initiate variations in KiwiSaver contributions, which would be made compulsory for every employee.
Such broad control over the levers of the economy is asking too much of any central bank. The knowledge required to get the size and timing right of any such interventions is almost impossible to gather. However, the worst aspect of these proposed changes is that it questions the Reserve Bank’s most important task: its focus on price stability.
This is what it should deliver. By giving it a conflicting mandate, we will compromise the Bank’s ability to do its job. And by burdening it with other economic policy objectives, we would question the Bank’s independence.