Top Scoops

Book Reviews | Gordon Campbell | Scoop News | Wellington Scoop | Community Scoop | Search


No Right Turn: Second-guessing the Reserve Bank

Second-guessing the Reserve Bank

The political kerfuffle surrounding the Reserve Bank's latest rate increase has reminded me of something I read earlier in the month, and which has been chewing at the back of my mind for the last few weeks.

While in Washington a month ago, Michael Cullen warned of the danger of an "overshoot" by the Reserve Bank, but noted that the government was "in a very fortunate position", and that fiscal policy would "come into play". While he was quick to back away with talk about "automatic stabilisers" (the tax-take declining and benefit spending increasing during a recession), there's a definite implied threat there: if the Reserve Bank does a Brash and tries to strangle the economy to keep inflation down, the government could simply start spending the surplus. It's unclear whether this threat played a role in the Bank's decision to forswear further rate increases in the near future, but it's a possibility.

What's interesting is that this exposes a possible problem with our monetary policy framework, and perhaps with independent central banks in general. The idea that central banks should be independent came about during the 70's, in response to the failure of Keynesian demand-management policies. The Keynesian response to a recession was for the government to spend money to create jobs.

This drove up inflation, but this was seen as an acceptable cost for pulling the economy out of a recession. However, in the 70's, this seemed to stop working; recessions continued, and we got "stagflation" (a stagnant economy with high inflation) instead. The neo-liberal response was to claim that the government should stop intervening in the economy, and instead focus on "price stability" (low inflation) - if left to itself the market would naturally work itself out and solve all problems.

However, there was a significant impediment to this goal, as politicians would constantly be tempted to pursue Keynesian policies to secure re-election - exactly as Muldoon did in New Zealand - and this would detract from the credibility of low-inflation policies (Kydland and Prescott just won the Nobel in Economics for pointing this out).

The neo-liberal answer was simple: remove the economic levers from democratic control, thus allowing central banks to pursue "credible" low-inflation policies. Which is why we have the Reserve Bank of New Zealand Act 1989.

The problem is that there are two major levers on the economy: monetary policy, to do with the money supply, and fiscal policy, to do with how much the government spends. The Reserve Bank only controls one of them. While they are interdependent, and the Bank can with time adjust to changes in fiscal policy, the government could still in theory pursue old-style Keynesian policies.

This wasn't a problem when the idea of independent central banking was first conceived or when the Reserve Bank Act was passed, because back then governments were invariably running deficits - in order to "prime the economy", the government would have to borrow, and this was countered by a commitment not to do so (backed in New Zealand by the Fiscal Responsibility Act 1994 and fear of foreign investors). But if the fiscal policy is tight enough and results in large surpluses (as ours has), the government has no need to borrow.

And this puts it in a powerful position to second-guess the Reserve Bank. If the government thinks the Reserve Bank is unnecessarily strangling the economy or driving up unemployment (as Don Brash did repeatedly in the 90's), it can actually do something about it. While I don't for a minute think that the government is going to go to war with the Reserve Bank, the fact that it could is a constraint on the Bank's behaviour. As long as they continue to run surpluses, we're unlikely to be Brashed again.


© Scoop Media

Top Scoops Headlines


27-29 Sept: Social Enterprise World Forum Live Blog

1600+ delegates from more than 45 countries have came together to share wisdom, build networks and discuss how to create a more sustainable future using social enterprise as a vehicle. Attending the Forum were social enterprise practitioners, social entrepreneurs, policy makers, community leaders, investors, activists, academics and more from across the globe... More>>

HiveMind Report: A Universal Basic Income For Aotearoa NZ

Results from this HiveMind suggests that an overwhelming majority of Kiwis believe that due to changing circumstances and inefficiencies in the current system, we need a better system to take care of welfare of struggling members in our society. More>>


Scoop Hivemind: Medical Cannabis - Co-Creating A Policy For Aotearoa

Welcome to the fourth and final HiveMind for Scoop’s Opening the Election campaign for 2017. This HiveMind explores the question: what would a fair, humane and safe Medical Cannabis policy look like for Aotearoa, NZ in 2018? More>>


Lyndon Hood: Notes On National’s Election Campaign, In Poem Form

Nationyl’s bitumen-ing / As they du du / Seed groweth / River floweth / Then ‘dozer drives thru / Highway ensu. More>>