New Finance Minister Grant Robertson faces a tough time convincing existing Reserve Bank staff that they can run the economy hotter to get unemployment below four percent, at least for now.
Acting Reserve Bank Governor Grant Spencer said the labour market was already well balanced or in equilibrium with unemployment at 4.6 percent, and that unemployment below four percent was likely to heat up inflation too much with the current structure of the economy.
The debate is current because Robertson announced a review of the Reserve Bank Act this week to look at how to include a dual mandate of maximising employment alongside low inflation. Robertson has said he wanted to get unemployment down below four percent, without specifying this as a target for any Policy Targets Agreement or to be written into the Act. But it does imply Robertson sees room to help stimulate and reform the economy to reach full employment below four percent.
The potential for a conflict is growing between the Reserve Bank board, which is set to recommend a new Governor to Robertson, and the new Government's push to reform the bank. The existing board members were appointed by the previous Government and do not see a problem that needs fixing, creating the potential that its recommended candidate comes from within the bank and is satisfied with the status quo. Robertson must choose to accept or reject the recommended candidate under the current Act. If he is to avoid either amending the law or removing the board, he will have to hope the board members change their spots and pick a 'change manager' from outside the bank who is willing to do things differently,
This debate over where full employment is and whether the Reserve Bank needs to run looser monetary policy to achieve it is a test of any appetite for change.
The Reserve Bank and Treasury refer to this 'equilibrium' level as the NAIRU, which is the non-accelerating inflation rate of unemployment. This is also often described as full employment, beyond which the economy starts to 'rev too fast' and generate wage and other inflation. Treasury has estimated the NAIRU in New Zealand at 4.25 percent, while the Reserve Bank has said the level is unobservable, but Spencer said it was somewhere between four percent and five percent at the moment.
Spencer, who is scheduled to retire on March 26, said the Government would no doubt try to improve labour market practices and other structural elements in the economy to try to lower the level of full employment below four percent.
He said a dual mandate that included maximising employment would not change the Reserve Bank's policy-making that much, given it already used flexible inflation targeting that aimed to run the economy at full capacity anyway. That flexibility already left open the option of letting inflation run above the three percent top of its one to three percent target band to promote stability in output, employment or foreign exchange rate markets.
"I would say, and this is something shared by my colleagues, is that moving to a dual mandate is unlikely to have a major impact on the way that we run monetary policy," Spencer said.
"For example, sometimes we're happy to see inflation move outside of our target band in order to promote the stability of output, employment and the exchange rate, and this is a requirement in our policy targets agreement," he said.
"With a dual mandate, it may mean that our approach becomes more flexible in the sense of allowing greater volatility in inflation in order to promote more stability in employment, for example. There may well be situations where a dual mandate may shift our approach, particularly if the labour market was a long way from equilibrium.
"But in the current situation, I would say that the labour market is pretty balanced, and therefore I don't think a dual mandate, if we had it right now, would make much difference at all to our current policy stance."
'Worthy, but not possible right now'
Asked if he thought accelerating the economy to push unemployment below four percent would be inflationary, Spencer said it would without structural change.
"The estimates of full employment or the NAIRU are quite uncertain and we're doing work on this, particularly if we're moving to dual mandate, we need to do a lot of work on this on pinning down some of these numbers. Presently estimates of natural rate of unemployment vary between four and five percent.
"The Government is saying they would like to see unemployment below four percent. That's a very worthy objective of course, but in part that reflects attempts to use structural policy to reduce the equilibrium rate of unemployment, not just the actual rate of unemployment.
"Monetary policy can't affect the equilibrium rate of unemployment. We can have short term influence through the cycle. But if you want to get the equilibrium rate down on a sustained basis then the Government will need to work with various policies such as education etc. That makes a lot of sense, but this is something the minister has said. He's not saying he's expecting monetary policy to achieve a sustained lower rate of unemployment, say below four percent."
"If the equilibrium or NAIRU was between four and five, then the further you get down below that, then that would tend to be inflationary, unless you can bring in other policies to get the equilibrium to a lower level."
Robertson was asked to respond to Spencer's reluctance to try to use monetary policy to push unemployment below four percent.
"Four percent is our initial target in this term. I think the way we can move below that is by making some pretty significant policy and structural changes. For example a heavy investment in education and skills would start to lift our productivity, and I believe at that point we can go below four percent, but our initial target is four," Robertson told reporters in Parliament.
Pay equity caution
Spencer also cautioned about the inflationary effects of big new pay equity wage deals, similar to the $2 billion deal done earlier this year for aged care providers.
"That is a potential risk, yes," Spencer said about the potential inflationary effects of further pay equity deals, beyond the 0.2 percent increase in annual wage inflation forecast from the new Government's $20/hour minimum wage policy by 2020.
Fiscal stimulus offsets housing slowdown
Earlier, the Reserve Bank held the Official Cash Rate as expected at 1.75 percent. It also moved forward its expected first rate hike by three months to mid-2019 from late 2019, although it only lifted its forecast track by 10 basis points. The bank lifted its headline inflation forecasts over the next year, in part because of a recent fall in the New Zealand dollar.
Elsewhere, it estimated the Government's new policies would generate an economic stimulus equivalent to 0.5 percent of GDP, and that its plan to increase the minimum wage to $20/hour by 2020 would lift annual wage inflation by 0.2 percentage points per annum over the next three years. The fiscal stimulus offset the effects of a slightly slower domestic non-government economy because of a slowdown in the housing market.
Spencer also said the bank was reviewing its current Loan to Value Ratio limits and would say more about that review when it releases its Financial Stability Review on November 29. He said any relaxation would be gradual and could be done in various ways. Spencer said the bank was still interested in having some sort of debt to income multiple restriction in its toolkit, but did not see the need to use it at the moment because house price inflation had moderated.