Action and Reaction

Do We Need A Reserve Bank in New Zealand?
Listener: 10 February 1996

Keywords: Macroeconomics & Money;

The inability of the American government to manage its budget is notorious. In the early 1980s the Reagan administration and the US parliament cut taxes, raise military spending, and end up with a huge government deficit. As I write, over a decade later their successors, Bill Clinton and Congress led by Newt Gringrich, are still struggling with that heritage hoping to eliminate the deficit in another seven years. While the deficit stimulated the US (and world) economy during the 1980s, the rising debt as a proportion of GDP, poses a threat to the viability of the US and world economy. The President and the Congress know this, but they have not be very good at doing anything about it.

Meanwhile the Federal Reserve Board (nicknamed the “Fed”) of the US reserve banking system can change its monetary stance any day when necessary. But monetary changes act slowly on the economy. The rapid response in financial markets take a long time to percolate through to the real decisions of economic actors.

The irony of slow decision-makers having the fast reacting instruments (of fiscal policy) and vice versa (of monetary policy) had an American economist to make “the modest proposal … that the control of the rate of growth of money stock be given to Congress and the control of fiscal policy be give to the Fed.”

Contrast our debate on monetary policy. Every announced economic indicator is followed by an anxious question to our Governor of the Reserve Bank, and an expectation that the Bank should respond to the additional information. Financial markets jump when the Governor replies, and journalists and commentators agonize over the implications. Their commentary seems to assume that the Reserve Bank’s action will affect the economy almost immediately.

In contrast economic orthodoxy thinks that monetary changes take a considerable time to impact on the economy. If you want to blame – or applaud – the Reserve Bank for the current state of the economy look at what it was doing a couple of years ago, not a couple of weeks ago.

Regrettably the journalists’ (i.e the public’s) demand for instant comment is distorting the economic debate. Once the Minister of Finance, Robert Muldoon, gave an instantaneous opinion on everything, maintaining his political profile. Commentators responded, we revelled, and Tom Scott would sum it up in the following week’s Listener.

Today we dont have the “fancy footwork” economic management of Muldoon. So the task of instant official comment has fallen to the Reserve Bank Governor. Whatever he says is interpreted as commentary on the short term economy. Our understanding of the impact of monetary policy gets warped.

This (il)logic leads to the odd contribution of those who complain that the monetary authority should be abolished. As long as we have to pay taxes the government is going to have designate a currency in which the taxes are paid. It could be the US dollar, in which case the Fed would be our reserve bank. We tried to run the monetary system like this at first, but it proved unsatisfactory. In 1934 the Reserve Bank of New Zealand was established.

Once a means of payment is issued, someone has to decide how much to circulate. And so a reserve bank gets drawn into managing the money stock of the economy. To do this it needs a policy. Given the increasing complexity of financial markets, that policy is going to be complicated (and, inevitably, it will be over simplified by journalists).

Any good policy needs some organizing principles. Under Muldoon monetary policy was, I think, that the Reserve Bank should ensure there was adequate finance for the government’s debt at as low an interest rate and as high a dollar as the minister thought he could get way with. Today monetary policy is targeted by statute on “price stability” (although always there is the underlying task of ensuring the integrity of the monetary system).

Some people do not like the current monetary policy. They may want modest changes, such as redefining the relevant price index and range (with which I am sympathetic). They may want restraint on the side effects of the policy on employment, growth and the balance of payments (again I am sympathetic). They may want better co-ordination between monetary and fiscal policy (ditto, but it has been quite good recently).

Or they may want to target monetary policy on other objectives (like employment – although I am not sure how). Others want greater political direction of the Reserve Bank (but not of operating policy?) Those I dont comprehend want to abolish the Reserve Bank. What monetary policy do they have in mind?

Yet I understand the confusion arising from the perception that monetary policy can and should be concerned with day to day management of the economy. We need to move the Reserve Bank out of its instant commentary stance. It may be, especially with an MMP parliament, we need to reinstate the Monetary and Economic Council to fill the vacuum.