Both the Government, and the Labour and Green parties, have recently announced reviews or policies relating to the Reserve Bank of New Zealand.
These fall within two areas, the first being the objectives to which monetary policy should be directed and the second the process for determining individual instances of policy.
But what is the background — current and historical — against which the reviews and policies are taking place? Where might they lead? Where ought they lead?
New Zealand’s present arrangements are to be found in the Reserve Bank Act 1989. The provenance of the Act was — in terms of the political narrative of the day — simple and direct. It was to ‘Muldoon-proof’ the conduct of monetary policy: to inoculate, in its design and execution, monetary policy from the distemper of short-term expediency and manipulation. And so the Reserve Bank was made independent — to a degree — from the Government. Policy decisions were for the Bank — or more specifically the Governor of the Bank — to make, and the general parameters within which those decisions would be made were codified in a Policy Targets Agreement between the Governor and the responsible Minister (the Finance Minister, except for 1997, when the responsible Minister was a ‘Treasurer’ — Winston Peters).
Under the regime the 1989 Act replaced, monetary policy was implemented based on written advice from the Government. The relevant section of the 1964 Act read:
“For the purposes of this Act, the Minister may from time to time communicate to the Bank the monetary policy of the Government, which shall be directed to the maintenance and promotion of economic and social welfare in New Zealand having regard to the desirability of promoting the highest degree of production, trade, and employment and of maintaining a stable internal price level.”
The Bank had a Board — as it still does — but in the late 1980s it was thought participation on it by the Secretary of the New Zealand Treasury risked the perception, if not indeed the reality, of a less-than-independent institution (across the Tasman, the Treasury Secretary continues to be a member of the Board of the Reserve Bank of Australia).
Note the reference in the 1964 charter to promoting economic and social welfare and to the “desirability of promoting the highest degree of […] employment and of maintaining a stable internal price level”. In short, this is known as policy dualism, and policy dualism—price stability and employment (economic output) — is the preferred direction of travel for Labour and the Greens.
At the time of the 1989 Act, the prevailing economic orthodoxy regarding policy targets and instruments essentially argued for a one-to-one correspondence. It was neither possible nor desirable to walk and chew gum at the same time. Couched in accountability terms, if I have one instrument and two targets I always have one excuse available to me.
And the political economy of the time provided a compelling case. Prime Minister Robert Muldoon had used monetary policy in an opportunistic and expedient manner. An alternative approach was required.
The 1989 Act was clear and to the point:
“The primary function of the Bank is to formulate and implement monetary policy directed to the economic objective of achieving and maintaining stability in the general level of prices.”
There would be one objective, and it was an economic objective (with no reference to the social realm).
There would be a Board, but its role would be restricted to overseeing the performance of the ‘agent’ (the Reserve Bank Governor) on behalf of the ‘principal’ (the Finance Minister).
As those who have advocated policy dualism have argued, other central banks operate with a dual mandate. The United States Federal Reserve System and the Reserve Bank of Australia are but two examples. Neither can be characterised as being outside the mainstream. Neither has dropped the ball on price stability as a result of being required to direct policy to output and employment. Indeed, in the post-global financial crisis world, it might be argued that having an output target has been an asset in providing credibility and legitimacy to policy.
One should also note that, since the passage of the 1989 Act, the absence of output or employment from the Reserve Bank charter has been a recurring point of debate. But those opposed to policy dualism appearing in the Act have been successful in limiting references to it—sometimes distilled to qualified ‘virtue statements’—to the Policy Targets Agreement (PTA).
Prior to the 1996 election, Winston Peters promised the Act would be amended. All he managed was the following reference in the PTA:
“Consistent with section 8 of the Act and with the provisions of this agreement, the Bank shall formulate and implement monetary policy with the intention of maintaining a stable general level of prices, so that monetary policy can make its maximum contribution to sustainable economic growth, employment and development opportunities within the New Zealand economy.”
Finance Minister Michael Cullen and his redoubtable adviser Peter Harris would be the next to try to secure a beachhead, but it would again be pushed back to the PTA. While on this occasion the provision would have more substance to it, the primacy of price stability would endure:
“The objective of the Government's economic policy is to promote sustainable and balanced economic development in order to create full employment, higher real incomes and a more equitable distribution of incomes. Price stability plays an important part in supporting the achievement of wider economic and social objectives.”
The occasion for this revision was Alan Bollard’s appointment as Reserve Bank Governor. Bollard was still Governor when the Government changed and Bill English became Finance Minister. A new PTA was drafted, and the reference to full employment was a casualty. The new PTA read:
“The Government's economic objective is to promote a growing, open and competitive economy as the best means of delivering permanently higher incomes and living standards for New Zealanders. Price stability plays an important part in supporting this objective.
This provision remains in force today, and the present Government dismisses any revisiting of the Reserve Bank charter as “trainspotting”.
The alternative proposed by Labour and the Greens is clear. It is to amend the Act and to make reference again to full employment. There is, however, a potential political problem regarding ‘full employment’ and that is that, in the sense of zero unemployment, it is no longer realistic. Frictional unemployment means there will always be a degree of unemployment.
Central bank charters that refer to ‘full employment’ have been around for some time, so the notion and sentiment are embedded. In the contemporary New Zealand context, the aspiration may well resonate politically in places where it is designed to, but the devil may be in the detail. Having to concede one is really not talking about ‘full employment’ is replete with political risk.
And then there is the fact that the models the Reserve Bank uses include a Non-Accelerating Inflation Rate of Unemployment (the NAIRU, sometimes referred to as the ‘natural rate’). Just what that rate is can be debated. And it may well move over time. But the import of this is that a central bank like the Reserve Bank will determine that below a certain rate of unemployment price stability will be compromised. Therein one detects a tension and the seeds of an interesting conversation, with no guarantee it will be a public one.
The important take-out for Labour finance spokesperson Grant Robertson is that other central banks operate with dual mandates, and that what leading academic and former central banker Alan Blinder refers to as practical and modern central banking is about price stability and output, including employment.
But there has been pushback in the past and more is to be expected between now and the September general election.
The second significant issue—and on this there is more general agreement in principle, if far more diversity in terms of specifics—is the relative strengths of a single Reserve Bank decision-maker versus a committee structure.
Again, the model we see in the 1989 Act was informed by economic theory. The literature of the time referred to the desirability of a single decision-maker with a conservative set of policy preferences. Don Brash met the role description perfectly. But central banks are the repositories of a wealth of advice on matters economic and Brash’s successors—as he himself may well have done—have collectivised processes within the Reserve Bank with the use of committees such as the Official Cash Rate Advisory Group.
Graeme Wheeler, from the outset of his term as Governor, made no secret of his desire to have official cash rate policy decisions made by the “Governors” (note plural) and had to be reminded the Act meant there was only one decision-maker. I have no doubt that, in practice, decision-making now is by committee.
However, there is a world of difference between decision-making by committee and the kind of broader governance role a Board might play.
When the Labour-Alliance Government commissioned a technical review of the New Zealand arrangements in 2001, one of the recommendations was that a formal monetary policy committee be established comprised of the Governor and four other Reserve Bank staff. Michael Cullen demurred, in large part because he did not want there to be—as is the case with the Bank of England’s Monetary Policy Committee—the publication of minutes, and decisions influenced by concern about after-the-event perceptions.
In my view, he was correct. Equally, however, I believe vesting decisions on monetary policy in a Board that combines internal and external representation is the appropriate way to proceed. There is a model in place that appears to work well and it is the Board of the Reserve Bank of Australia. There the Board makes the decisions and the Governor communicates them. Board minutes are published but are limited to an assessment of the context within which a decision is taken.
I have argued elsewhere that central banks and what they do has to meet the test of credibility and legitimacy. There is currently a risk of a deficit in the latter, and a Board that brings together a range of expertise and advice—and why not advice on the social impact of monetary policy decisions?—would be an appropriate innovation.
As the Government and the Labour and Green parties consider the Reserve Bank, two issues are in play. One relates to charters and the merits of amending the 1989 Act to make explicit reference to output and employment. The other goes to processes for making individual policy decisions. The former is likely to be more controversial. In terms of the text, I would revert to phrasing akin to the 1964 Act —“the desirability of promoting the highest degree of production, trade, and employment …” But a word of warning to those seeking to prosecute change. There will be pushback. It may even come from the Bank and will most certainly come from its proxies in banking and finance, and from some economists.
The primacy of price stability will not be surrendered lightly or quietly.