Long before last year’s election, Alli-
ance leader Jim Anderton was heaping scorn on the Reserve Bank Act and general belief the management of monetary policy had been success. “I think it’s been disaster,” he told The Independent in March last year. “We have got inflation down, but there’s no evidence it wasn’t coming down or that it wouldn’t have come down anyway.” Australia’s inflation rate, for example, was about the same as New Zealand’s, but the Australians did not have legislation like ours, “so presumably you can get inflation down without going to the extremes we have”.
Labour’s Michael Cullen at the same time was arguing that it wasn’t enough to claim the Reserve Bank Act had been wildly successful because New Zealand had low inflation. “We would have had to work really hard not to have had low inflation over the last two or three years in this economy.”
On the other hand, Cullen went on, there had been some “wild variations” in the exchange rate over the longer term. This volatility was problem not only because of the immediate impact on the earnings in the tradeable sector, but also because of the impact on their willingness to invest.
If the Alliance had become the dominant member of the Government coalition, however, it’s fair bet the Reserve Bank Act would have been sent back to the law drafters by now, to change its aims and bring monetary policy more closely under the ambit of the Treasurer. The Alliance wanted the legislation to require the governor of the Reserve Bank to take into account not only inflation, but also the balance of payments, unemployment and economic growth when setting monetary conditions.
In contrast, Cullen advocated fine-tuning, not comprehensive change. Labour-led Government therefore promised it would commission an independent review of the operation of monetary policy. Pending the results, it would require the Reserve Bank to take account of the impact of its action to achieve its targets on the real economy, particularly the exchange rate.
Cullen had drawn certain clear conclusions from the past 10 years of looking at international monetary policy practice. First, central bank independence is crucial. Second, the great majority of central banks now focus at the very least on inflation as the primary target even if there are secondary targets.
But Labour believed there should be an independent review of the operation of monetary policy, Cullen said, because “over the past three or four years it’s not been that successful”. Whether the target band has been entirely appropriate and the effectiveness of Reserve Bank communication with the money markets were among key questions he wanted considered. Another was whether RBNZ officials have enough accurate and timely statistics to recognise turning points in the economy. Then there were questions about the extent to which the bank takes account of other factors in achieving its primary target of inflation. “In our view it should be required to take account of the impacts of its actions on the real economy, particularly the exchange rate,” Cullen said.
In line with this commitment, the Government in May published terms of reference for the inquiry to be conducted by an overseas expert. The review will address issues, like the bank’s economic forecasting and how it communicates its decisions as well as whether it has the tools it needs to help keep the economy on an even keel.
At that time, prompted by regular increases in the official cash rate since November, interest rates were rising and there had been sharp fall in the exchange rate.
Some economists were criticising policy management, contending the Reserve Bank’s focus should not be on rigorously stifling demand as inflationary pressures developed, but on being more flexible with its response, thus encouraging firms to meet demand by investing in extra capacity. Businesses would be more likely to make this investment if the Reserve Bank managed policy to take full advantage of the 0-3 percent range, allowing inflation to vary bit more over the growth cycle to encourage the capital investment needed over the cycle to build the country’s economic potential, they argued.
Others argued for the status quo, saying that at best movement away from the focus on inflation would generate nothing more than very short-run boom. More important, there might be very negative reaction by New Zealand to the perception New Zealand is not focused only on controlling inflation.
Maybe. But review will do no more than look and report, and there can be no harm in that. The critical bit of the exercise will come when the report is published and Cullen is obliged to implement all of the recommendations or some of them, or reject the lot.

Bob Edlin is Wellington-based economic commentator and journalist.

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