John Walley is expected to rail against monetary policy and the effects of its singular targeting of inflation. He is chief executive of the Manufacturers and Exporters Association, after all, and must promote his members’ interests.
The surprise is that so much support is maintained for our monetary policy and its practice, even though it has contributed to the asset bubble in house prices, to consumer spending outstripping output, to balance of payments blowout (even when our terms of trade were booming), and to the strong exchange rate that makes selling tough for Walley’s exporters.
But early this year, Roger Kerr (the one from Asia Pacific Risk Management) said study of the past five years of monetary policy management and interest rate movements in New Zealand from four to nine percent then back to 3.5 percent would find the extreme changes had done nothing to control inflation. “All that they have done is destroy investment in the wealth/growth-creating export sector.” The Government inquiry into the monetary policy framework last year had “failed miserably to identify this reality”.
Others have weighed in, including Girol Karacaoglu, chief executive of the PSIS and former chief economist at the National Bank. He was prompted by political and Reserve Bank expressions of frustration at the trading banks’ reluctance in the past year or so to pass on lower official cash rates by dropping mortgage and other lending rates. But why should we want rates lowered? Trying to encourage bank lending to the household sector to sustain expenditure on retail spending and housing – at this stage in the rebalancing of the economy – was “as irresponsible as encouraging an alcoholic to keep drinking so that he does not feel the pain of withdrawal”.
More to the point of this column, Karacaoglu was bothered by the prospect of credit growth being encouraged by excessively low interest rates. Not only would private saving be discouraged, but resources (including credit) would be misallocated to unproductive (speculative) investments “which is the story of the past decade”.
Economist John Preston pushed things along in paper to the Association of Economists (his CV shows he’s former Treasury divisional director and International Monetary Fund economist). He champions the idea that the monetary policy framework system should focus on the supply of credit as well as interest rates.
To tackle the problem of the financial inflows that help feed our borrowing habit, he proposed system of mandatory deposit requirements to control imported money. The Reserve Bank would be empowered to regulate banks – and other financial institutions covered by deposit guarantees – with deposit requirements on specified sources of external funding. The resultant dampening of interest rates would discourage the “carry trade” that has helped strengthen the exchange rate, moderating any appreciation in the currency.
BERL at much the same time was pushing proposals to tackle volatile exchange rates; it says it got its idea from Karacaoglu. Volatility comes from our dollar being among the most heavily traded currencies in the world, thanks to our setting just one economic target: low inflation. What if the Reserve Bank was directed to lower an over-valued currency as well – and to intervene in money markets if it must?
Fleshing out the idea, economist Ganesh Nana suggests competitive exchange rate target be set under policy geared to gradually appreciate it, giving exporters time to adjust and become increasingly productive and competitive over (say) five to 10-year horizon. Singapore targets its exchange rate and sets band around it, and its central bank trades in forex markets to keep the currency within the band, backed up with other policies including currency controls.
Nana anticipates the objection that things went awfully wrong when the Reserve Bank was intervening in Muldoon days. But the government then was trying to prop up the dollar’s price. Our foreign currency reserves were run down as officials intervened to buy NZ dollars to protect the policy. Knowing the reserves eventually would be emptied, foreign speculators kept playing until New Zealand ran out of chips.
Lowering the currency is different game: we will be buying foreign currency with NZ dollars, and there is no limit to the NZ dollars we have – or can print. If market players try nudging the price above clearly stated target, we just keep buying foreign dollars (and build up foreign reserves) with our kiwi dollars.
Yes, there’s an inflationary risk. But so long as forex traders understand our determination to keep the NZ dollar where we want it, they won’t raise the price. Not when inflation would be the consequence, wiping out the value of the currency they are buying.
Bob Edlin is leading economic commentator and NZ Management’s regular economics columnist.
