Post quake OCR cut

The Reserve Bank cut the OCR 50 basis points today, primarily on the back of the Canterbury earthquake.  Their justification was based on a negative national confidence hit, on top of an already weak national economy.  This framework was consistent with the thinking of many economists – so even with all this uncertainty, it appears that policy was relatively pick-able this time.

I suspect that they waited to cut at the meeting instead of doing it prior to the earthquake so that they could indicate this was “one-off”, and prevent a sharper drop in the currency and expected rates.  However, no-one said that so I’m just guessing 😉

Demand is a nebulous concept, and they cut today as there is uncertainty regarding how heavily “demand” around the economy will drop following the earthquake.  Economists will not have a good idea what is going on here for some time – so the Bank should be ready to respond once it is clear that this demand shock has worked through.  We will see what happens.

  • andrew coleman

    Hmmm
    Section 8 of the Reserve bank of New Zealand Act (1989) states

    ” 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.”

    This Monetary Policy Statement shows the extent that the Bank feels free to ignore their Act, by choosing to follow a policy target of 1 – 3 percent that is not consistent with the Act: inflation of 2% per annum implies a five-fold increase in prices over a lifetime, which is hardly consistent with stability in the general level of prices. At the end of the MPS they justify the cut partly on the basis that underlying inflation of 1.6 percent is now seen as modest. Laws, it appears, are just for little people, not ministers and their important bureaucrats.

    The MPS is also notable for saying that monetary policy is likely to be more effective in the future than the past because there is a positive yield curve, so that most people with mortgages are on floating rates that will rise quickly when tightening occurs in the future. One wonders if the bank is starting to suspect that its extreme inverted yield curve policy of most of the last decade was a failure. This would be an interesting development; perhaps the bank is wishing to fess up that its conduct of monetary policy in 2006 – 2008 (highest short term real interest rates inthe world from January to June 2008 despite being in recession, remember) may have been a contributing factor to the depth of the recession.

    Andrew

  • “This Monetary Policy Statement shows the extent that the Bank feels free to ignore their Act, by choosing to follow a policy target of 1 – 3 percent that is not consistent with the Act: inflation of 2% per annum implies a five-fold increase in prices over a lifetime, which is hardly consistent with stability in the general level of prices.”

    This is a point where a lot of economists strongly agree with you IMO. However, I’d lay the blame at the feet of political pressure for setting that rate in the PTA – not on the Bank for following their PTA.

    “One wonders if the bank is starting to suspect that its extreme inverted yield curve policy of most of the last decade was a failure.”

    There is an undeniable issue with a strongly inverted yield curve. In one sense this should be telling us that people expect the economy to slow – that is definitely how people felt in 2006 (and as a result the Bank might have felt this track was appropriate to smooth economic activity).

    But of course, by setting the 90 bank bill track the RBNZ has some control over the shape of the yield curve, and on top of this we knew inflationary pressures were not slowing during this period – so policy would need to be tight (in this case they focused on the current bill rate as an indicator of the tightness of policy – which may have been mistaken). A massive export price spike, with the associated TOT increase, made policy a lot more difficult in this case.

    There are two things here:

    1) Should the Bank have forecast an upward sloping 90 bill rate track
    2) Did the Bank need to introduce prudential regulation to reduce the impact of lower international rates on the domestic yield curve.

    There may have been mistakes in how they performed this type of policy here – that is hopefully something they will analyse and discuss as you say.

  • It’s remarkable what impact natural disasters can have on the economy. It will be worth following how Japan, the worlds third largest economy will cope in rebuilding after the earth quake and tsunami.

  • Natural disasters have higher impact on our every day lives than we think. Droughts and floods may affect the harvest of agricultural crops, the cotton or coffee beans. We have to learn how to predict this kind of occurrences more precisely and in sufficient advance.