Translating Labour’s goals for monetary policy

Labour has stated four goals for their special monetary policy.  Let me discuss what these mean in turn. [Note we already have two posts on this issue today].

Labour goals were:

  1. a stable and competitive exchange rate;
  2. reduced interest rates for businesses and home owners;
  3. continued priorities of price stability and low inflation;
  4. to guard against expectations of price rises.

So, with goal 1 they want to reduce the flexibility of NZ$ prices, which will lead to higher unemployment and a worse allocation of resources.  Furthermore, they want to keep the dollar low which implies subsidising exporters to the cost of households in the short-term.

With 2 they want to punish savers.

And with 3 and 4 they want to contradict themselves – as by limiting price flexibility and holding the exchange rate and interest rates down they WILL drive an increase in inflation expectations, dump price stability, and remove any chance of a low inflation environment.

  • “# a stable and competitive exchange rate;”

    Compared to what?

    US Dollars?
    Euro?
    Yen?
    Monopoly money?

    The only way for a stable exchange rate is pegging it against another currency, but then its still not going to be stable as it fluctuates against other currencies..

    what on earth are they (labour) smoking?

  • @MikeE

    I’m going with the monopoly money.

    And with regards to what they are smoking – there have been a lot of drug raids around Wellington recently. Maybe Labour has some contacts in the police force. If that is the case they could really be smoking anything!

  • pete

    Or, there are trade-offs in monetary policy, and Labour want to change the balance between goals 1-4?

    More apples means less oranges, not no oranges.

  • @pete

    Indeed, there is a clear trade-off between the first two goals and the second two goals.

    However, the first two goals aren’t necessarily good things.

    What Goff didn’t say was that the lower exchange rate is a subsidy to business, and that it would increase the volatility of prices faced by exporters (at the moment the dollar moves with commodity prices, helping to limit the extent of product price movements).

    Also he just decided to ignore savers when discussing interest rates – the interest rates should be set at its “natural” rate, which is what the Bank tries to do. Setting it lower will merely lead to more borrowing from overseas, lower domestic savings, and a transfer from people who already have a stock of savings to those who have a stock of borrowing.

    And the cost of getting these “rewards” is higher and more variable inflation. Great …

  • pete

    >What Goff didn’t say was that the lower exchange rate is a subsidy to business, and that it would increase the volatility of prices faced by exporters

    I read “stable” as the operative word and “competitive” as waffle.

    >Also he just decided to ignore savers when discussing interest rates – the interest rates should be set at its “natural” rate.

    Or you could reduce interest rates by limiting the banks’ oligopoly profits?

  • @pete

    “I read “stable” as the operative word”

    Well, given that commodity prices are very volatile, a stable exchange rate would lead to much larger volatility in the $NZ price of export goods.

    The government can’t make world prices more stable. Letting the dollar move to help prices adjust is a good thing.

    “Or you could reduce interest rates by limiting the banks’ oligopoly profits?”

    This has nothing to do with monetary policy independence. If he said he wanted the commerce commission to investigate banks I wouldn’t care. But he is saying that this is part of the breakdown in the monetary policy consensus – so he is saying that the RBNZ will have to keep rates below their natural rate.

    All the evidence tells us that this won’t change the level of output or employment in the economy over time – but it will lead to higher inflation. And furthermore, it will punish savers in the economy – a fact that shouldn’t be ignored.

  • pete

    >This has nothing to do with monetary policy independence.

    Goff: The consensus between us continues on the independence of the Bank. But today I am announcing the end of the consensus around the policy targets and tools of the reserve Bank( href=”http://www.stuff.co.nz/national/politics/3078458/Goff-announces-end-to-monetary-policy-consensus”>link)

    >Well, given that commodity prices are very volatile, a stable exchange rate would lead to much larger volatility in the $NZ price of export goods.

    So one of the policy targets might be stability in the $NZ price of export goods.

    >so he is saying that the RBNZ will have to keep rates below their natural rate.

    He’s not actually saying that, you’re inferring it. Goff mentions changing the RB’s tools as well as its policy targets.

    The main point of the speech was that monetary policy affects more than just inflation, and therefore a wider range of effects should be taken into account when deciding monetary policy.

  • @pete

    “So one of the policy targets might be stability in the $NZ price of export goods.”

    But we don’t see the commodity prices (or their future expectations, which is part of what matters) until months after they occur. Furthermore, other factors that should drive the exchange rate (such as the import sector, and indicators of relative economic strength) would be ignored in that case.

    “He’s not actually saying that, you’re inferring it. Goff mentions changing the RB’s tools as well as its policy targets.”

    Getting more money to borrowers implies lower interest rates. Any other tools that put money in borrowers pockets will be a transfer as well – the money doesn’t just appear from the air.

    “The main point of the speech was that monetary policy affects more than just inflation, and therefore a wider range of effects should be taken into account when deciding monetary policy.””

    With monetary policy influencing more than just inflation we have to remember how and why it influences other variables. Monetary policy influences other variables in the short run. Furthermore, by using monetary policy to control inflation it automatically smooths the economic cycle.

    On top of this, once inflation expectations are anchored the Bank can and does use monetary policy to limit the impact of any unavoidable issues that occur in the economic cycle. Truly, monetary policy has been a great success around the world during the crisis (even if foreign policy was partially to blame for the crisis coming about – something foreign central banks can hopefully address).

    By TELLING the RBNZ to focus on growth, the exchange rate, the temperature, and the size of the Beehive lawn Labour is talking about compromising RBNZ independence.

    Why?

    Independence is about the Bank’s ability to say “We will keep inflation down”. If the Bank is independent, then people believe this, people expect low inflation, and this low inflation expectations provide low inflation.

    Once we muddy the waters, inflation expectations are harder to pin down, and it becomes more costly to achieve any policy goals.

  • Andrew Coleman

    Hey Matt, calm down

    It is perfectly reasonable for opposition politicians to raise questions about the monetary policy framework. In fact it is much better that they do it while in opposition – can you imagine the fuss if they tried this trick while in Government? After all, it has been 20 years since the Reserve Bank Act was passed, not 20 months. It is responsible to ask whether the country’s institutions are working properly – no less an economist than Douglas North continually emphasises that a country’s institutions (rules, customs, and regulations) are not necessarily efficient, and that the large differences in standards of living around the world can be traced to differences in the way the institutions work.
    We now have 20 years experience under the RBA, under several Governments and two Governors. Why not ask some hard questions, particularly as there are several areas of legitimate concern.

    eg
    (a) Why is inflation so high in New Zealand, despite having more or less the highest real interest rates in the world for 20 years? Can we claim monetary policy has been successful when the value of the currency (in terms of the local price level) has been debased by a third? Could price stability be achieved more efficiently if the Reserve Bank behaved differently – other countries (eg Singapore) use a different model with some success, is it not at least possible that there could be better alternatives?

    (b) Why has no-one tried to sue the Minister of Finance for not signing a policy targets agreement which is consistent with Section 8 of the Act: ” 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.”
    Two percent inflation for an average lifetime of 80 years means a five-fold increase in the price level – something which is scarcely consistent with the phrase “stability in the general level of prices(except in a Bill Clintonesque sense.) While academics may debate whether a 2% inflation target is a better goal than “stability in the general level of prices,” surely the law should either be applied as is or changed to reflect a consensus that moderate inflation is acceptable. (Not that I agree with this consensus: because of the way the tax sytem is applied to nominal capital income, I would much prefer lower inflation. It is my view that the interaction of inflation and the tax system induce significant distortions in saving and investment behaviour.)

    (c) The Hon Goff’s comments on the exchange rate echo those of Dr Bollard, who not only has expressed concern that the dollar is over-valued on many occasions in the last three years, but has intervened in the currency markets because of these views. The Bank has a well publicized policy governing when it believes interventions are justified – so the Hon. Goff can hardly be accused of being economically ileterate for suggesting that a floating exchange rate may possibly cause some economic problems. Indeed, there is a large and respectable economic literature arguing that floating exchange rates are excessively volatile, and this excess volatility may reduce welfare.

    It is hard to believe that all has been well with the way that monetary policy has been implemented in NZ in the last decades. In fact we know that not all was well in the first decade, because the Bank changed its operating procedures. It is at least possible that not all has been well in the last decade either, and that further changes could be welfare enhancing. So why not look at the experiences of other countries and see if there isn’t scope for some improvement.

    Andrew

  • @Andrew Coleman

    “Hey Matt, calm down”

    😀

    On points a), b), and c) I heartily agree with you.

    My dispute is with the idea that monetary policy itself needs to broaden its set of aims. The purpose of monetary policy is solely to anchor inflation expectations, and for Labour to say that this consensus has broken down is painful.

    However, I do see scope for significant changes in fiscal and prudential policy on the basis of perceived imbalances. I think sitting down and discussing the real reasons for these imbalances is important – and that changes to the tax system and prudential regulation could strongly improve New Zealand’s situation and social welfare.

    My concern is that structural issues that stem from fiscal and prudential channels are being blamed on monetary policy.

    Personally I believe that prudential regulation should be taken off the RBNZ and given to another independent organisation – so that the monetary policy and prudential roles can be split cleanly.

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  • really don’t make any sense.

    the world always change
    the price always raise up

    they just think about them selves
    they don’t want to experience any hard life.