A new Governor with an extra target

Adrian Orr and Grant Robertson announce their new Policy Targets Agreement. Photo by Lynn Grieveson.

After almost 30 years the Reserve Bank of New Zealand has abandoned its pioneering approach of focusing solely on inflation. It will now aim to both keep inflation low and maximise employment, although it's not clear yet whether it's more than just window-dressing. Thomas Coughlan reports.

Reserve Bank Governor-designate Adrian Orr and Finance Minister Grant Robertson talked in public together today for the first time about the new-look monetary policy as they unveiled their first Policy Targets Agreement and previewed changes to the 1989 Reserve Bank Act. The Reserve Bank led the developed world in the late 1980s by focusing solely on lowering inflation, an approach that was adopted by some other central banks. The popularity of this pure inflation targeting has waned in recent years because inflation has been so low as to spark fears of deflation.

Robertson and Orr took the stage of the Beehive Theatrette on Monday morning to discuss the outcomes of Phase One of the Reserve Bank reform on the sidelines of the signing of the Policy Targets Agreement between the Minister and the Governor.

With the CPI target of 1-3 percent over the midterm and 2 percent over the long term left unchanged, the big story was the announcement that the Reserve Bank will in future look at “supporting maximum levels of sustainable employment” alongside its traditional mandate of maintaining price stability. 

There has long been criticism on the left that the Reserve Bank’s inflation target has come at the expense of targeting employment. If inflation rises, as it did in the 1980s, it erodes spending power and savings as wealth loses value. But if the Bank increases the OCR to calm inflation it can have the effect of cooling the economy and increasing unemployment. 

Countries like the United States, Australia and Norway have central banks with a dual mandate to consider both inflation and unemployment and Robertson’s victory in securing the dual mandate in New Zealand will be applauded by those who argue that the current mandate gives precedence to maintaining the purchasing power of capital and wages over decreasing unemployment.

A bold move or simply window-dressing?

Orr himself said on Monday that, “in general times, it shouldn’t make too much of a difference,” but added that towards the extremes of an economic cycle it might change policy outcomes.

Infometrics economist Hilary Parker agrees that in the short term we are unlikely to see the mandate lead to massive policy changes, but she could foresee a scenario when the dual mandate might change outcomes.

“There might be higher unemployment and high inflation at the same time so what does the Reserve Bank do?” she said. 

“If they raise rates to kerb high inflation that means unemployment could increase, so they might actually tolerate high inflation for a little bit longer to see unemployment go down,” she said. 

She pointed to the Reserve Bank’s decision to raise interest rates in 2010 as an example. 

“We had high inflation and high unemployment, they increased the interest rate by about half a percentage point within a couple of months so maybe if we’d had this dual mandate in place they might not have increased that,” she said. 

Bill Rosenberg, Chief Economist at the Council of Trade Unions, said that an example of when the mandate might have had effect was in the 2000s.

“The Reserve Bank was ramping up interest rates in order to try and put a lid on house prices. That would have had an effect on employment because it would have been heading off, making investment much more difficult,” he said. 

Parker added that the Reserve Bank already factors employment into its decision making as employment has a significant effect on inflation, which the Bank targets. 

“If unemployment falls below expectations there will be a situation where employers are having a tough time trying to find staff which means they’ll have to put up their wages to attract better staff which means their costs increase, which flows into general prices as companies try to maintain their margins. And that would result in inflation rising and they need to target that inflation anyway, so in effect they actually already consider unemployment,” she said. 

Cameron Bagrie of Bagrie Economics agreed that in the short term, monetary policy is not likely to change a great deal under the new targets, but the wording of the new employment target “made a lot of sense”.

“You get into problems if you phrase that such as maximising growth in employment  — you need that term sustainable,” Bagrie said. 

“The Reserve Bank’s only got so much influence over the labour market. The Reserve Bank’s hands are a little bit tied there so you need that sustainable term,” he said. 

Bagrie said that the key to the employment mandate was the word “sustainable”. 

“It would have been tempting to put in, ‘maximise growth in employment,’ but that’s a bit like going to a cricket match and trying to win it by hitting each ball for six. You want to give it a damn good nudge if the ball is there to be hit, but only if the odds are good,” he said.

He said that the most likely times the lever would be used would be at the top or the bottom of an economic cycle, but that it is unlikely that there would be an impact over the course of a cycle. Other levers like upskilling the workforce through education would be more effective in reducing unemployment.

“The Reserve Bank controls a couple of levers, but most of the levers in regard to driving labour market outcomes are actual government levers,” he said. 

Left unsaid

One of the most significant parts of the PTA was an omission. The statement did not include a reference to asset price stability. The stability of asset prices had been part of the Policy Targets Agreement Robertson signed with Acting Governor Grant Spencer and is traditionally mentioned in the PTA.

Christina Leung, Principal Economist at NZIER told Newsroom that this indicated that there would be an increased focus on CPI as the measure of price stability. 

Bagrie said that the omission could indicate bigger changes to come.  

“I’d have thought that asset prices are still a consideration for monetary policy. I think it’s a little bit surprising to have that little piece taken out,” Bagrie said. 

The omission might gesture at Government policy that could have an impact on asset prices.

“I guess the glass half full interpretation of that is you’ve got a Government that is pretty gung-ho in getting the supply of housing up and they’re looking at pulling that lever pretty hard,” Bagrie said. 

“Maybe they think they can get the housing market under control and leaving the Reserve Bank focused first and foremost on the inflation objective and maximising growth and sustainable employment,” he said. 

The omission might also flag some big reforms that could come from the review of the Bank.

“That might flag something that else might be happening like potentially the Reserve Bank might be split up and then we end up with an RBA model,” Bagrie said. 

In Australia, the Reserve Bank has a mandate for monetary policy, while the  Australian Prudential Regulation Authority handles bank regulation. 

Robertson hopes to introduce legislation to amend the Reserve Bank Act by the middle of the year.