Reserve Bank is coming full circle

Published in the New Zealand Herald (Auckland), 28 May 2021

As American historian and philosopher Will Durant observed, “Civilisation is not inherited; it has to be learned and earned by each generation anew.”

That is a more polite way of saying that humans make mistakes, cause damage, then repair the mess. . . only to repeat the whole process again and again.

Monetary policy is no exception. No matter how often we witness what happens when politicians meddle with money, we let them do it again.

Once we have cleaned up the damage of the last round of interventions, that is.

The Reserve Bank is a case in point. It is currently in the “causing damage” phase.

To put matters into perspective, let’s go back to 1996.

Don Brash was invited to deliver the Hayek Memorial Lecture in London. That was before his later political career, and he spoke as a proud Governor of the RBNZ. New Zealand’s Remarkable Reforms was the title of his lecture.

Brash had every reason to be proud, not least of his RBNZ. From a central bank with a poor inflation record before 1984, it had become one of the most stability-focused central banks in the world.

As he explained, the reason for the RBNZ’s previously poor records was political interference.

“The Reserve Bank operated under legislation which required it to consider all manner of real economy objectives,” he said.

That had made it one of “the ‘least independent’ of central banks, and [it] had an inflation performance to match.”

Indeed, the 1970s and early 1980s RBNZ experience was one characterised by stagflation and mortgage interest rates exceeding 20 per cent.

The reforms of the Fourth Labour Government set out “to put an end to the cynical manipulation of monetary policy for political purposes,” Brash declared. The idea was “to ‘Muldoon-proof’ monetary policy”.

The whole idea was to remove the RBNZ far enough from political tampering so even the most interventionist politician could not do damage.

We remember what that “Muldoon-proofed” RBNZ looked like. It was a central bank shielded from politics, protected by the Reserve Bank Act 1989, tasked only with maintaining price stability — with ultra-dry economic rationalist Brash at the helm.

A quarter of a century on from Brash’s speech, the RBNZ has moved on.

The Government elected in 2017 had many objectives. To preserve the legacy of the 1984 reforms was not among them. The Finance Minister’s speech on the 2021 Budget underlined it once again.

Where the Fourth Labour Government set out to repair the damage of the Fourth National Government (Muldoon), the Sixth Labour Government is undoing the reforms of the Fourth Labour Government. We are coming full circle in monetary policy.

Among the first things Grant Robertson did as Minister of Finance was to appoint Adrian Orr as Governor of the RBNZ. Orr is an experienced bank economist and fund manager. He is a colourful and entertaining speaker.

But no-one would describe Orr as a dry economic rationalist. Nor is he a traditionalist, unwilling to change established structures.

In this sense, the choice of Orr was inspired. Robertson wanted to transform the RBNZ from the stability-focused Bank Roger Douglas created to a much more political institution. If that was the goal, then Orr was the right Governor.

As a first step, the old policy target agreements went out. In came a new Monetary Policy Committee. Its remit commits the RBNZ to support the Government’s broad economic objective.

This goes far beyond price stability. It includes measures “to improve the wellbeing and living standards of New Zealanders through a sustainable, productive and inclusive economy”.

The Government broadened the RBNZ’s goal to include “maximum sustainable employment”.

Even before Covid-19, the RBNZ had two-and-a-half goals: price stability, high employment — and to support the Government’s other policies if and where possible.

After Covid-19, and partly brought about by the quantitative easing programme with its effects on asset prices, the RBNZ shall now also consider house prices in its policy actions.

That makes it three-and-a-half official goals.

For conventional central bankers, these would probably be two-and-a-half goals too many. In Brash’s time (or in Alan Bollard’s or Graeme Wheeler’s, for that matter), price stability was what the RBNZ was about.

Not so under Governor Orr. Indeed, the politicisation of RBNZ policy may not have gone far enough for the RBNZ leadership. It thus engages in policies which, though perhaps commendable on their own, have little to do with central banking.

Going through the list of the RBNZ’s recent media releases, we can see how it focuses on other matters. And so it makes its views known on housing, climate change, or the Māori economy, as if it held a mandate or the policy levers in these matters.

To be fair, many central banks around the world have jumped on fashionable bandwagons. The European Central Bank goes on about the green economy and diversity.

The Federal Reserve stresses the importance of diversity and inclusion in the workplace.

And even the Bank of Japan has joined the Network for Greening the Financial System.

The difference seems to be that for many other central banks, such non-monetary initiatives are essentially lip service.

The RBNZ, however, means it. So busy is it now with all its non-monetary policy commitments that critics like ex-RBNZ official Michael Reddell keep taunting the Bank for not properly setting out its monetary policy thinking.

However, the real problem is that central banks not focused on price stability will not deliver price stability, either.

And central banks following political goals and acting politically will become politically compromised institutions.

That is not just a truism, but the lesson New Zealand painfully learnt in Muldoon’s time. When Brash referred to the failures of the RBNZ under Muldoon, these were the failures of a politicised central bank.

The remedy: removing the RBNZ from the political process via the Reserve Bank Act of 1989.

As Brash explained back in 1996, the intention was to Muldoon-proof the RBNZ.

Today, 25 years later, we see that it did not last. Reforms of the past have been undone by a Government imposing non-monetary goals on the RBNZ and a complicit RBNZ leadership all-too-willingly accepting new roles as demi-politicians.

If experience is anything to go by, the new RBNZ era will end in tears and inflation and it will take another Minister of Finance, and another RBNZ Governor, to clean up the mess.

And whoever it may be, they will be able to give a Hayek lecture sometime in the 2030s.

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