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Michael Cullen Speech On Monetary Policy Review

Tuesday 9 May 2000

Professional Development Function
Australasian Institute of Banking & Finance
EDS Presentation Room, Level 12
8 Gilmer Terrace
7.40 am Tuesday 9 May 2000

Hon Dr Michael Cullen
Minister of Finance
Minister of Revenue

Thank you for inviting me to speak to you this morning. The banking and finance sector is very much a newsmaker these days, what with mergers, closures, profits and fees and, underpinning the whole debate – the function of the Reserve Bank.

In monetary policy this Government is committed to maintaining the price stability focus and the operational independence of the Reserve Bank of New Zealand. The aim of the first monetary policy review is to investigate ways of enhancing the Reserve Bank's ability to implement the Policy Target Agreements with minimal disruption to the economy.

We have already negotiated a change to the policy targets agreement with the Bank to make explicit that in pursuing its price stability objective the Bank will try to avoid unnecessary instability in output, interest rates and the exchange rate.

It is 10 years since the Fourth Labour Government passed the Reserve Bank Act. The New Zealand economy has made a long transition to sustained price stability. The transition was not without pain, but the results – low inflation and better average growth than in our history – are generally good. I supported the RBA and I continue to support its intentions.

Generally is the operative word. Because along the way our export sector, the engine room of our economy, was put under tremendous stress, particularly in the mid 90s when the dollar soared into the economic stratosphere. Could that have been avoided? Can we avoid it in the future?

It is timely to consider the lessons of the past and how we might do better in the future. Monetary policy has evolved over the last decade – the introduction of the Official Cash Rate is just one example. But have we arrived in the right place? It is to help answer these questions that we need to review the way in which our monetary policy is conducted and its effectiveness in contributing to broader social and economic objectives.

It is appropriate to now examine the Reserve Bank's operations and governance to ensure it has the tools it needs to do its job as effectively as possible with least volatility to interest rates and the exchange rate.

We are not seeking to reinvent the wheel or make fundamental changes to the Bank. The terms of the review are strictly limited. The Government is strongly committed to maintaining the operational independence of the Bank and to Section Eight of the Act defining the maintenance of price stability as "the primary function of the Bank".

So these areas have been fenced off from the review. What the review will consider is wide ranging:

 The way the Reserve Bank interprets and applies the inflation target set out in the Policy Targets Agreement with a view to ensuring that this approach to achieving medium term price stability is consistent with avoiding undesirable instability in output, interest rates and the exchange rate.
 Whether the Reserve Bank has an adequate range of instruments and is using its current instruments effectively in altering monetary conditions in the desired direction.
 The range of sources, availability, type and timeliness of data, and the impact of these variables on forecasting and decision making.
 Whether the policy decision making process and accountability structures promote the best outcomes possible.
 The co-ordination of monetary policy with other elements of the economic policy framework, including an evaluation of the relationship between monetary policy operations and other Reserve Bank functions such as prudential oversight of financial institutions.
 Whether the Reserve Bank's communication of monetary policy decisions to the public and financial markets is as simple, clear and effective as possible.

The review will be technical in nature and requires a person with a high level of expertise. It is the Government's intention to appoint a reviewer from overseas. We are now in the process of finalising the appointment.

The monetary policy review is expected to cost between $200,000 and $500,000. These costs will be met from existing allocations.

I am looking forward to an informed, inclusive and vigorous debate – one that draws on New Zealand's experience and the best of international thinking on monetary policy.

I would like to make the point that the Reserve Bank Governor, Dr Don Brash and I are of one mind on the merit of undertaking this review. He has been very helpful to the government in helping shape the questions, pointing out that we should not restrict the scope of the thinking about the best way to maintain price stability.

Recommendations arising from the review will be discussed with Dr Brash before the Government makes any decisions on how to proceed.

The review was yesterday signed off in Cabinet. It is now a fact. Solid, substantial and relevant.

Not quite so grounded in the here and now are monetary union, a common stock exchange, even becoming the seventh Australian state. These issues all periodically surface, bubble away for a few weeks and then run out of fizz as other events supersede issues that after all, are simply speculative.

But given the headline grabbing nature of one issue recently, I would like to share with you my views on a monetary merger, or to be more accurate – an un-hostile takeover - as any such union would inevitably be.

My views on this issue are fairly straightforward. I believe monetary union is an idea whose time has not yet come.

I am strongly of the belief that further and more in depth evaluation is needed before we contemplate such a major step.

But I acknowledge, while the issue may not be on the Government's current agenda, it is on the table. The Foreign Affairs and Trade Select Committee has included a single currency with Australia as part of a broader review of CER. If the committee comes up with a positive recommendation, the Government will naturally be duty-bound to consider it carefully.

I welcome the Institute of Policy Studies document - An Anzac Dollar?. It is a serious contribution to what is shaping up to be a most lively public debate. The government is, of course, monitoring this debate very closely.

Let me say, I have a great deal of respect for the document's authors, Sir Frank Holmes and Dr Arthur Grimes. Both are leading economists with solid reputations. The Treasury is now studying their findings and will report to me in due course.

In the meantime, it is worth noting that Dr Grimes and Sir Frank found the economic arguments for and against a monetary merger finely balanced.

What fuelled the media fire is the now well-publicised business opinion survey showing over 80 percent support for monetary union. Running commentary from the rest of the business community fanned the flames.

I have a minor problem with the 80 percent figure. That is a big majority by any estimation. The problem is that it was a self-selecting sample with a relatively low response rate. The questionnaire was sent to 1500 firms. Only 409 - or little over 25 percent - responded. And those advocating change would have had a stronger incentive to respond than supporters of the status quo.

But this is just a quibble. I have other, deeper reservations. A necessary consequence of currency union in a world of capital mobility is that monetary policy will at best lean heavily toward and at worst be dictated by the interests of the dominant partner.

The Australian economy is around seven times the size of ours. They sell over $85 billion worth of goods to the rest of the world compared to our $22 billion dollar export market. The market capitalisation of the Australian stock exchange is a massive $500 billion alongside the $50 billion value of the New Zealand stock exchange.

And to add insult to economic dominance, our closest allies have wiped our eye in 18
out of 38 test cricket matches.

But I digress. Back to the issue of monetary union, although closely related, our two economies do not always move in tandem. This would mean that if the economic cycles got out of phase, we would have monetary policy operating out of synch with the New Zealand economic cycle. That cannot be in our best interests.

To mitigate against the effect of a single currency operating against New Zealand's economic cycle, Dr Grimes and Sir Frank have suggested that a joint Australia/New Zealand central bank be established with appropriate representation from New Zealand. But again, that "appropriate representation" would always mean the bigger the partner the louder the voice.

I would also argue that, although Australia is our largest market for manufactured goods, the level of inter-penetration between the two markets is not high. Australia accounts for only 22 percent of our imports and exports and we account for only about 4 percent of theirs. Compare this to the European Union - and the Euro - where the member states conduct the lion's share of their international trade with each other.

So even if we had an Anzac dollar, we would still be prey to volatility against other currencies, especially the USD because the vast bulk of our exports are still denominated in US dollars.

This raises the question of whether, if we are to adopt another country's currency, because that is basically what we are talking about here, we should go with the United States rather than Australia, or enter a tripartite arrangement.

But that would mean being an even smaller fish in an even bigger pond. The risk of becoming submerged in, rather than strengthened by the partnership would simply be amplified.

So for all of these reasons I am refusing to commit to offering up our independence in the current rush of enthusiasm.

I admit there is a sense of inevitability about the eventual outcome but I have yet to be convinced the time is ripe for New Zealand to rush into a monetary union.

Although I have just touched on two, the banking and finance industry faces a number of issues, some serious and some speculative. Perennial favourites such as branch closures and fees continue to attract attention.

I would like to thank you for inviting me here today, to contribute -with no allowance for decimalisation or inflation -my own two pence worth to the debate.


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