Listener: 27 May, 2000

Keywords: Macroeconomics & Money;

New Zealand’s economic debate can be bizarre. Take the recent rises in the Reserve Bank base interest rate. Hardly anybody made the point that world interest rates are rising. The American Fed(eral Reserve Bank) is putting up its base rate, the European Central Bank is too, so is Australia’s Reserve Bank (RBA), and so on. Can we ignore a rising tide? The rest of the world could then borrow unlimited quantities from the Reserve Bank of New Zealand (RBNZ), a scenario too absurd to contemplate. Something horrible would happen to our monetary system and economy if we ignore what happens overseas.

Once we could run a monetary policy with some independence from the rest of the world. There were interest rate controls, credit controls, money controls, exchange controls, and the government (the taxpayer) was subsidizing credit by borrowing overseas dear and lending domestically cheap. Moreover, gross foreign borrowing was much lower than today, relative to the size of the economy. It seems unlikely that the past controls could be reimposed effectively given the current external debt level and the evolving world financial markets.

Because of the particularities of the Reserve Bank Act, the Bank’s angst-ridden justification for the interest rate rises is the need to control inflation. It would be easier if the RBNZ Governor, Don Brash, could say something like “My good friend and colleague Alan Greenspan (chairman of the US Fed) is putting up interest rates yet again, and everyone else in the world is too, so we have to follow. The issue is whether we should put them up more or less than average. Higher interest rates are slowing down the world economy by braking credit-based decisions (such as investment and consumer borrowing). In our view that will sufficiently slow down the New Zealand economy. So we think it only necessary to raise our official cash rate in parallel with world trends.”

Financial commentators are not restricted by the Act, and they are ill-disciplined as a consequence. They seem to think that Brash running the monetary system on the margins of the world economy, is doing the same as Greenspan at its centre. So they parrot American commentators. It is a colonial attitude with its holders subservient to the imperial view of the world. Today it is a US view, although their grandfathers were as subservient to a view from London. Rather than think through what is distinctive about the New Zealand economy’s circumstances, they ape analysis of the dominant economy, often using tipster sheets that come from the US, or from equally cringing Australians.

The same problem bedevils the discussion on monetary union with Australia or the US. Let me make just a few points, for it is a complicated issue. (You would not suspect so from the public discussion.)

In many ways the fashion for monetary union is an acknowledgement of the failure of the last fifteen years, both in policy and performance. After all, a monetary union involves a fixed exchange rate, in which the value of the New Zealand dollar is rigidly anchored to a set rate of another currency. In March 1985 the rogernomes changed from a fixed to floating rate, probably the most important single decision they took. So were they wrong? I have yet to find any account of why those who supported the past reforms have changed their mind so dramatically.

And if the rogernomes got that wrong, their supporters seem to think the same of the RBNZ. A monetary union would transfer its powers to the central bank of the uniting economy. Now there are no controls as there was in the past, to enable an independent policy to be pursued. Those who want to fix must be assuming that the RBA or the US Fed can run New Zealand’s monetary policy better than the RBNZ. Perhaps it can, but that is something we ought to discuss, rather than assume. (Any monetary authority in an economy which has its share values so dangerously out of line with reality as in the US, cannot be given a top grade. History will be less generous with Greenspan’s reputation, after the millennium depression.)

Many of its most prominent advocates have a self-interest in monetary union. The policies they supported have failed the economy so desperately that even the financial sector is suffering. (They might stop whingeing about the poor performance of the local share-market, and instead reflect on how policies in their short term selfish interest have damaged us all in the long term.) A fixed exchange rate allows the financial community to get in on the financial action of more successful economies, irrespective of what it does to the rest of the country.

The point of this column is not to argue that interest rates should or should not be raised, or that we should or should not fix the exchange rate. Rather, it has tried to indicate the deep policy issues. It is a plea that the public deserves something more than the froth and bubble, and the naked self interest, that dominate the public debate.