No QE “free lunch” for NZ

As a general rule of thumb, whenever someone offers you something for nothing they aren’t telling you the full story – and that is exactly what we have with the Greens stating the Reserve Bank should start rebuilding Christchurch themselves by printing money.

Now, in order to come to this conclusion a bunch of points are being mashed together.  So in order to understand what this entails, and why does it in this way isn’t the best way forward, we need to have a think about what such a policy really means by splitting it into “monetary” and “fiscal” policy.

Monetary policy, fiscal policy

Having the RBNZ buy up a bunch of government debt which has been taken on to rebuild Christchurch works through two channels we need to think about distinctly:

  1. Monetary policy – by “increasing the money stock” in this example, they are loosening monetary conditions.
  2. Fiscal policy – by getting the RBNZ to go and fund the rebuild by printing money, we are in essence transferring resources for the rebuild.  They don’t appear from nowhere.

Now here Ganesh Nana states that he thinks RBNZ monetary policy is distinctly wrong – and that we will face deflation.  If that is the case, they should cut interest rates first.  However, he may believe that there is even more risk than that, and that cutting rates towards zero AND putting in place QE is required.  Viewing QE as a form of monetary policy this could make sense.

But, this is far from the consensus view, it is a long way away from households and firms expectations of what we will experience (which determine much of what usually happens with inflation) – and it is far from the way the Greens described it.  In truth, the RBNZ has policy about where it should be – and if it should be looser then it probably shouldn’t be by much.  As a result, we cannot use the monetary policy argument … and QE will increase inflationary pressures.  So from here, I’ll assume that the RBNZ is currently meeting its inflation mandate – a view that is held up by the evidence.

Russel Norman is completely misrepresenting QE by saying that the recent crisis is “evidence it isn’t inflationary”.  QE was put in place to fight the fact that policy was too tight overseas, and they were trying to fight deflation – in essence the fact that inflation stayed near the “target band” in these countries is evidence that QE is indeed inflationary as you would expect … just in the way they were intending.

Fiscal policy

Furthermore, choosing to do QE that is premised on an extension of government borrowing funded by the RBNZ is different to what is being done overseas!  Overseas, much of QE has been the Fed buying existing long-dated Treasury bonds from the private sector.  They haven’t been “financing deficits” persee per se, they have been trying to increase the amount of high powered money in the general economy.

The form of policy being suggested by the Greens is effectively full scale fiscal policy being fully accommodated by the RBNZ, or monetizing debt – it is saying that the government will borrow and the RBNZ will then print money to pay for it, thereby increasing inflation as a tax to pay for it.  Resources do not appear from the ether – no matter how many people inside and outside New Zealand want to pretend this is the case – this is a straight transfer of resources towards rebuilding in Christchurch and away from other places.  [Note:  This view comes from the presumption that the Greens are saying the RBNZ should buy the bonds and then write them off - if the RBNZ is just holding the bonds and expecting repayment, then you are still running a "deficit" it is just being hidden on the RBNZ's balance sheet instead ... in this case we are again easing monetary policy, we have a larger deficit which will need to be paid for with future taxes, and given monetary policy is currently sufficient this will lead to excess inflation].

Now you may believe we should fund the rebuild with a one-off tax – that’s fine, in that case get the government to put a tax in place directly (or to directly cut spending from other place).  However, taxation by stealth of this sort is likely to be worse in multiple ways:

  1. We have betrayed RBNZ independence for virtually no reason … understandably a sneak tax by the RBNZ would make people less likely to believe them in the future about holding to their inflation mandate.  As a result, we run into the time-consistency issue in monetary policy again, and it will become more painful for economy when the RBNZ tries to commit to its inflation mandate again.
  2. We have a relatively rough redistribution of resources due to this.  By putting in our sneak tax through QE, we transfer resources to those with assets, those doing the rebuild, and those who can easily adjust prices/wages – while hurting those on fixed income, and those who have saved.  It is an inflation tax – pure and simple – and as a result, it will initially transfer resources from those who can’t protect themselves (generally the poor) to those who can (generally the rich).  If we introduce the tax through fiscal policy instead we can sort out these distributional issues a little better.
  3. A country that is willing to introduce QE as a clear fiscal transfer – when there is no monetary policy reason – will destroy its credibility with international lenders.  People will scoff at this, but such a policy will increase the level of “inflation insurance” lenders ask for – increasing the cost of credit in New Zealand.

These are obvious and true costs, that have been seen from similar policies around the world for hundreds of years.  QE really isn’t anything new, and if we want a fiscal transfer of this sort just say it (as the Greens previously have to be fair), and do it through fiscal policy – it has nothing to do with the RBNZ.

But the exchange rate, it will get that down!

The constant banging on about the exchange rate and the RBNZ shows a fundamental misunderstanding of the “issues” NZ faces.

The Greens, and Ganesh Nana, are wrong in stating that the RBNZ has failed.  Distinctly and totally wrong.  Things like this:

”No system of monetary policy is perfect and New Zealand cannot remain the last devotee to a failed monetary theory while the rest of the world moves on,” Norman said.

Paint a complete and utter misrepresentation about the lessons from the Global Financial Crisis.  Our flexible inflation targeting framework saved us from a massive crisis at home – while the rest of the world fell apart.  We have learnt that there are issues of financial stability we should have looked at – issues we have discussed for a while – but this is definitely not a reason to start “fine tuning” the economy through the RBNZ.  That is exactly what Labour, the Greens, and NZ First are trying to do … and its something that has been shown time and again as folly!

We can easily make the case for the exchange rate having been persistently too high – the key word there is persistently – and the key point that comes out is that, as a result, our real exchange rate is too high.

The high real exchange rate is not due to monetary policy – which is cyclical in nature – it is due to persistent structural factors.  Things related to government policy and competition policy.

The confusion stems from the fact that the combination of the current nominal exchange rate, inflation rate, and nominal interest rate are the indicators that move around with monetary policy.  They do, and they tell us things about the stance of monetary policy – but the RBNZ only makes up one part of the determinant of these factors.  The RBNZ works to achieve its inflation mandate while other institutions in the economy run around and do what they do.

So what happens to the real exchange rate when we print money to do some building in Christchurch?  Well if this activity persists it will likely go up as we are funding more government activity through an “inflation tax”.  If it is indeed a one-off tax, then the outcome is more uncertain.

Lets stop dwelling on the exchange rate like it is some shackle holding us back, and that we have a silver bullet to shoot it down.  The macroeconomy is not, and never will be that simple.  Instead lets us “why” NZ keeps running current account deficits and why our discount rates are so high – is it because we treat investments differently, is it because we have higher growth expectations, is it because government spending is too distortionary, is it because we have issues with competitiveness in the non-tradable sector, is it because we are naturally impatient people?  The one thing we know, is that it is not because of monetary policy – that does not follow.


To summarise I’m saying:

  1. We don’t need QE in NZ, as we have enough monetary stimulus (and if not we can cut interest rates further).
  2. What is being suggested isn’t even QE – its the monetization of government debt, effectively a inflation tax to pay for the rebuild in Canterbury.
  3. It is unlikely that such a tax is the “best” way of raising the revenue to rebuild Christchurch – which should be the primary question.

This is the main gist of what is going on here.

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  • SBW

    Matt, I really like your blog, but one thing you do really annoys me.  You always write “persee.” First, it is two words.  Second, it is “se”. 
    The phrase is “per se”.

    • Matt Nolan

       I do always do that.  I’ll make more of an effort to fix that ;)

  • Adamsmith1922

    An excellent explanation, could not agree more. A profound shame that the MSM seem intent on promulgating mistruths and misleading views and only one perspective.

    There is littel reasoned discussion in the MSM of this major issue.


    • Matt Nolan

       To be fair, the media works from the information available – and I have noticed the quality of discussion improving. 

      I am sure that soon enough there will be people writing things that are more insightful, and clearer, than whatever I’ve said here.

      • Crikey Coxy

         I have my doubts about this but lets hope so. To most people all this is a big yawn. They like to complain about ‘inflation’ and ‘the exchange rate is too high’ etc. but won’t take the time to actually try to understand what’s going on. We’re rather lucky in the UK I suppose. At least we have the BBC who make some effort to explain these things but their approach often seems to me to be a bit frivilous and shallow, possibly on the basis ‘most people won’t understand it anyway so let’slighten it up a bit’ – even say the radio 4 programs today and PM, to which some 4 million people listen. Thank you for the explanations which were of help to me for one. I by the way agree with the Green Policy suggestions. Seems rather low risk to me and would possibly bring down the exchange rate, make Chinese products (particularly) more expensive, plus motor vehicles, a plus, and encourage more ‘home manufacture’ of a lot of the simpler goods and maybe more of the ‘high end ‘ too.

  • Kominsens

    The politicians of the left that are pushing for devaluation keep quoting so called respected global economists. They also state that we are the only country in the OECD going against the trend of QE which does not take into account that most other countries are in the Troika of global trade currencies being US dollar,Euro and the Yen.The lenders to this group are doing so from reserves of the national currencies of the borrowers. Simply put any fall of these currencies will effect the lenders net worth and have little effect on the borrower.
    NZ is well out of this ring fence and we would have to borrow these currencies which we do now but as our own exchange rate on the Kiwi falls our debt increases accordingly having a double whammy on the populace. As we already import some 80% of all finished goods and raw materials that are converted here including an enormous quantum of food the increased cost to the consumer could be a tax greater than the devaluation percentage.
    A possible solution that satisfies keeping a strong dollar and an aid to exporters is the introduction of export credits as a relative deduction against a theoretical exchange rate.
    Parker,Norman,Peters and Shearer need some real world applied economic lessons.

    • Matt Nolan

      My preference would be for everyone to sit down and figure out why the real exchange rate is doing what it doing – and whether we are happy with that “cost to competitiveness” given whatever the cause is.

      For example, if the cause was solely a “large government” (note I don’t think it is – it is just an example) we may say that is what we want as a society, and accept that we will be persistent borrowers (which is sustainable with persistent nominal growth).

      • Crikey Coxy

         I wonder about the ‘persistent nominal growth’ bit.

        • Matt Nolan

           Note if we have a positive inflation target we will get persistent nominal growth even if you don’t expect real growth/technological improvements … so its a pretty fair assumption right ;)

      • Alistair Connor

         Indeed. The current model with an “independent central bank” is an ideological choice — and we’re way out on a limb with respect to modern central-banking practice internationally (inflation the only target, interest rate the only tool in the box). The Greens challenge this, yet in this discussion you persist in trying to discredit them on *technical* grounds, as if they were obliged to work within the ideological strait-jacket imposed in the Douglas era.

        But at last, in your reply to Kominsens, you are acknowledging the real issues. In particular, that it’s a valid political choice to maintain nominal growth through moderate inflation (though actual growth is even better).

        Let’s look at what the Greens are saying about the exchange rate :

        “In the four years to June 2012, exports from manufacturing have fallen by 12.4%, or $1.7 billion.1 Output from manufacturing in GDP terms has reduced by 9.1%, or $2.8 billion.2 In the same period, nearly 40,000 manufacturing jobs have been lost, a 16.7% reduction in the manufacturing workforce.”

        To me, this clearly implies that there is a *huge* output gap! If you, and the RB, claim the contrary, I assume the reasoning is something like “this lost industrial output is gone for good, because it’s not competitive at the current exchange rate. And the exchange rate is not within our brief, so we’ll ignore it”.

        But since the Greens are claiming that the exchange rate is a fixable problem, then the output gap reappears … at a lower exchange rate.

        So yeah, I don’t see how you can write off the Greens’ proposals without examining the benefits (and explaining the costs) of lowering the exchange rate. Which involves understanding why it’s so high.

        I see that elsewhere you have posted an analysis which implies that the high exchange rate follows high resource prices, and accompanies (cause/effect?) a real-estate bubble. The Greens claim that it is also fuelled by a carry trade, driven by excessive interest rates (this should be easily quantifiable, at least).

        The emphasis of the Green policy release is on lowering the exchange rate, for which they propose several policy instruments that go well beyond monetary policy (including tackling the persistent housing bubble). It would be interesting to analyse that in more detail.

  • Crikey Coxy

    There are several fallacies in this argument but let me concentrate on one glaring one. The Governor of the B of E has publicly admitted, if not in so many words, that no one really knows whether QE has ‘worked’, or more importantly what real effects it has had in the real economy of the UK. You are right that QE is not new but each time it is applied in a different way, so the term is a ‘catch all’ anyway. Many of the statements you make are assertions only, based on the way you understand any real economy works. There are almost as many opinions among economists about the subject of QE as there are leaves in a tree, which surely indicates that no one really konws how it works or will turn out in each new sitution. This also therefore makes it obvious that your opinions are just that, assertions, nothing more or less. 

    • Kimble

      Whoa… if “no one really knows how it works” then how can it be justified? You didnt think about that, did you?

      Do you want to go ahead and list which of Matt’s points are assertions? Save a little time and let the discussion hit the ground running when Matt gets back online?

      Besides, at the moment all we have is your assertion that Matt’s points are mere assertions.

      • Crikey Coxy

        How about these for starters -

        …the RBNZ has policy about where it should be…’ , a lot of people would disagree.

        ”…and QE will increase inflationary pressures….’ , where’s the proof ?

        ‘…in essence the fact that inflation stayed near the target band is evidence that QE is indeed inflationary as you would expect….’   UK inflation rates have been off by a mile from B of E forecasts for many quarters now. Many of these have been during the QE phase. This shows inmo that the probable result of QE were not understood at the outset.

        ‘…and the RBNZ will then print money to pay for it, thereby increasing inflation as a tax to pay for it…’  It is by no means certain that inflation would result to any significant extent. i.e that which could reasonably be ascribed solely to QE.

        • Matt Nolan

          Lets head through these:

          “…the RBNZ has policy about where it should be…’ , a lot of people would disagree.”A lot of people also think that we should tighten conditions as well as ease them – the balance of evidence suggests monetary conditions are right.  So it is a fair starting point.  If it wasn’t, we can cut interest rates.

          “”…and QE will increase inflationary pressures….’ , where’s the proof ?”

          Go to the Fed working papers that estimate the economic impact of QE – or look up the literature on how open market operations, and/or seniorage (depending on how the greens do the policy) works.

          “There are many who agree that no one really knows how it works – not least the Governor of the B of E.”He was stating that we are unsure about the dynamics involved with QE – we have more idea about how changes in interest rates influence the domestic economy in the short term than changes in “high powered money” or “balance sheet effects”.Woodford stated at Jackson Hole that QE would have absolutely no impact – as in not only would it not create inflation, but it wouldn’t change the borrowing profile of anything.  His argument helped to illustrate how unclear things are with “real QE”, due to a bunch of important economic modeling concepts.  I more than accept this.Now the Greens aren’t suggesting that form of “QE” – they are suggesting the monetization of debt and “calling it QE”.  Given that it is the policy, rather than the name of the policy, that determines what it will do we know what this means – and I have described it in the post.

          Look – my post clearly differentiated between the monetary policy impact (the full effect of standard QE) and the fiscal policy view (the impact that comes from the specific monetization that comes from the Greens policy).  There is no free lunch here, and no amount of mixing up these two issues will make one appear :)

      • Crikey Coxy

        There are many who agree that no one really knows how it works – not least the Governor of the B of E.

        • Kimble

          Then by all means, lets embark on that course of action as soon as humanly possible. If no one knows how it works, then the outcome can only be good right?

    • Matt Nolan

      Of course we don’t know anything – at the moment this view of QE is the best understanding we have until additional research has been done.  Furthermore, even if we aren’t sure of the impact of actual QE what is being suggested isn’t just QE – its the direct monetization of debt, which we do have a lot more experience with.

      I’m also unsure why we would ever think a policy would be a good idea if we didn’t know what it did.  That would be a better argument against it than anything I’ve written.

  • Alistair Connor

    “by getting the RBNZ to go and fund the rebuild by printing money, we are in essence transferring resources for the rebuild.”

    This claim, and the claim that monetary financing of the rebuild is necessarily inflationary, seem to ignore a certain number of facts on the ground in the real world. In two words : “output gap”.

    For example: is the labour market overheated in NZ? No unemployed in or around Christchurch who could usefully work in reconstruction? The cement works are already running at full production?… I think not.

    i.e. if money is printed to mobilize these unused resources for reconstruction, then this is neither diverting resources nor feeding inflation. OK both of these effects may occur marginally, but you’d have to close the output gap quite substantially before they could really bite.

    But Russel Norman should not despair : NZ is not the last place in the world to stick to discredited monetary doctrine. Sure, the US and Japan are printing money, but the European Union are keeping the faith : unemployment is rocketing, the output gap is huge and growing, and the European central bank is determined to shrink the economy to some sustainable size … maybe they are the true ecologists eh?

    • Matt Nolan

      Output gap you say.  So you are just saying that monetary policy is insufficent?  So the RBNZ should cut rates?

      If you reread my post, I state that if monetary policy is so insufficient that we could cut rates to zero and still have a problem we could justify QE – I just decided to go a little further and discuss exactly what the policy actually meant.

      Also I’m not sure you are entirely clear on what the US, Japan, and European are doing. They are all performing QE, and they are all doing it in order to reach an inflation target – during the crisis both the US and Japan tried to improve monetary policy by announcing a target. And it was hailed around the world as an improvement.

      Seriously, we don’t know how lucky we are with monetary policy and the fact we don’t “need” to take the risk with QE.

      • Alistair Connor

         I’m just saying that the two objections you assert to printing money : resource transfer and inflation : need to be tested against the fact of the considerable output gap in NZ’s economy. I note that you don’t address this.

        The US is doing QE to target both inflation and employment. It has been doing that for a while now : Bernanke made it explicit in September, and hey, the world kept turning!

        Japan is printing money to stay afloat, they are in a pretty desperate situation. But hey, they are staying afloat.

        Europe is sitting on its hands, which is why it’s in a death spiral. It provides liquidity to banks to stop them collapsing, but its economy is shrinking, whereas it’s growing in the US and Japan.

        NZ, to your apparent satisfaction, is following the discredited European, or more precisely, Aust(er)ian prescription. Because hey, we don’t “need” to increase employment, nor rebuild Christchurch.

        • Miguel Sanchez

          Are you suggesting that Christchurch won’t be rebuilt if we don’t start printing money? I wonder then what will happen to the $17bn or so of foreign reinsurance payments that are making their way into the country? If we’re not building new houses then I suppose it will be ploughed into the values of existing ones… But don’t worry because that’s not “inflation”.

          • Alistair Connor

             OK I withdraw the snark about rebuilding Christchurch. But I’m interested in Matt’s reply about the output gap.

            But your question leads to an interesting question : is the $17bn of foreign money being injected by reinsurance companies inflationary? Does it lead to transferring resources rather than creating economic activity?  i.e. in what respects is this influx functionally different from printing money to finance rebuilding? This is perhaps a naive question.

            • Matt Nolan

              As a starting point I deal with the output gap issue in the post – I just don’t use the word output gap as I’m trying to discuss this as simply as possible. I deal with it my saying that monetary policy is “right” at the moment. The RBNZ is forecasting that the output gap smallish and closing and will be closed pretty soon.

              I think it is important to differentiate between QE and monetizing debt.

              With QE, the Fed is buying up some bonds based on government debt already being X – and it will sell those bonds again in the future.  It is buying the bonds so it can ease monetary conditions now, while it needs to.

              With the Greens suggestion there are many ways to interpret it.  I took the view that the RBNZ would buy the bonds and destroy them – in which case it would be lead to an inflation tax.  We would still “borrow” to build in so far as we import, but it would also involve a tax on domestic citizens through inflation.  

              If the RBNZ didn’t destroy them, and sold them again later – they are just moving around when the debt takes place.  However, since they are easing monetary conditions like the Fed is it will still cause excess inflation now … and it won’t do anything about the “borrowing”.

              • Alistair Connor

                 The Fed is kicking the can down the road, in other words, based on the notion (or fiction) that they will sell bonds in the future at some time when there will be excess liquidity to mop up (good luck to them!).

                How this can have a *different* effect than simply “printing money” (monetizing debt) is, I confess, beyond me : I can see only two possibilities. In your opinion, Matt, is the difference to do with “market perceptions”, or is it a purely philosophical difference? Or something else?

                On inflation : OK, so opinions differ among economists as to whether monetizing debt is necessarily inflationary in NZ’s current context. You trust the RBNZ; good for you. The Greens are not obliged to.

                In any case, it seems likely that however the reconstruction of Christchurch is funded, it will cause inflationary pressures. If there aren’t enough builders because they’ve all gone to Australia because there were no jobs in NZ, then they may need an incentive to come back…

                To repeat a question I posed higher up : is the $17bn of foreign money being injected by reinsurance companies
                inflationary? Does it lead to transferring resources rather than
                creating economic activity?  i.e. in what respects is this influx
                functionally different from printing money to finance rebuilding?

                • Matt Nolan

                   ”OK, so opinions differ among economists as to whether monetizing debt is
                  necessarily inflationary in NZ’s current context. You trust the RBNZ;
                  good for you. The Greens are not obliged to.”

                  I’m sorry but the RBNZ does research and analysis to understand what is going on – the Greens just “say things”.  I will trust the RBNZ any day of the week above that :)

                  “To repeat a question I posed higher up : is the $17bn of foreign money being injected by reinsurance companies
                  inflationary? Does it lead to transferring resources rather than
                  creating economic activity?  i.e. in what respects is this influx
                  functionally different from printing money to finance rebuilding?”

                  Don’t get me wrong, the fact there is a rebuild means there is more inflationary pressures than there would be.  However, having the RBNZ loosen monetary policy to deal with this is more inflationary again. 

                  Think of it this way, we accept that cutting interest rates would increase inflationary pressure – buying government bonds with an estimated zero interest rates is cutting interest rates (when the RBNZ goes to sell them, they will have to accept a discount on the bond that represents this).  Writnig them off is an interest rate of -100%!  In this context, we can accept there will be inflationary pressure – the purpose of my post was to also focus on the distributional implications, and how just popping in a tax would be a better solution if we do want to fund the rebuild domestically :)

                • Alistair Connor

                   OK, so we’ve established that rebuilding Christchurch will be inflationary… Given the RB’s brief, are we going to see them step in to tighten monetary policy when this happens?

                • Matt Nolan

                   The RBNZ sets a time path of interest rates – their current monetary policy settings are already taking the rebuild into account.

            • Miguel Sanchez

              Alistair: holy heck, did I just win an argument on the internet using sarcasm?  *does chair dance*

              Matt: I’m not sure I follow your distinction between QE and monetising debt. Quantitative easing, as the name suggests, is about directly increasing the quantity of money; whether it’s for the benefit of the public or private sector seems like a separate issue. Are you thinking of it in terms of whether it’s temporary or permanent?

              • Matt Nolan

                 Hey Miguel,

                Fair point.  I was trying to make the idea of a “inflation tax” easy to understand by splitting the issue into monetary policy considerations and fiscal policy. 

                So with QE, the goal is to buy bonds and stimulate AD to the point where the inflation mandate is met – but if we go to implement QE when we’ve already got monetary policy settings at their “right” level we are merely transfering resources.

                I would also note another thing here – when foriegn central banks do QE they are admiting that it could have distributional consequences which should be determined by a democratic government.  And so they focus on buying govt bonds … and where they have a mandate mortgage debt.  If we needed QE in NZ for monetary policy reasons, then the RBNZ would buy govt bonds, and that would be that – I’m not really arguing against that area of what the Greens have said :)

                In terms of “monetization”, my view from that comes from when a central bank pushes inflation past inflation expectations – where their inflation target defines inflation expectations as a starting point.  That is why when I separate “fiscal” and “monetary” in the post I call the fiscal side monetization – and just point out that this is akin to a tax.

                The temporary vs permanent issue is pretty damned important when we think about the size of the impact – and I assumed permanent when discussing it.  Even if the purchase is temporary, what also matter is of course the price of the bond.

  • Maxamillian

    Whenever the government spends, it is effectively printing money, and whenever the government taxes, it is effectively “unprinting” or destroying money (from the private sector perspective). It doesn’t change the net financial assets in the system whether or not the government “borrows” – it’s simply an asset swap of two very liquid government liabilities (cash vs govt debt instrument). The government has to “borrow” when spending is more than taxation because otherwise its Crown account at the RBNZ would go into overdraft. Its a self-imposed constraint.

    The RBNZ works closely with the Government to ensure that the right levels of cash are available in the banks’ settlement accounts (their deposits at the RBNZ) so that the OCR works most effectively. If no one wants to borrow in the interbank market (i.e. too much cash), then the OCR doesn’t work. However, when the government is about to issue debt, the RBNZ ensures that their is enough cash in the system to purchase the bonds or bills, by buying existing govt debt in the market (that is agrees to sell back in a short amount of time). Once the new govt debt is issued, the government starts spending the proceeds of its debt issue, and the cash goes back into the banks’ settlement system! In the end, the amount of cash in the banking system hasn’t changed! However, net financial assets have increased because we have an additional IOU from the government: a highly liquid trade-able government security.

    Ok, so if the RBNZ did allow the Crown to go into overdraft indefinitely, then the RBNZ would have to do more work to drain the commercial banks’ settlement accounts so that the OCR actually worked. It would have to do this by issuing its own debt instruments (RB bills have been done before at certain times). 

    In any case, nothing would really change. EXCEPT, that the government would be free of a silly fiscal constraint (that being the level of government debt). 

    That is not to say, let’s spend away without a care. But at least spend to the point of dealing with the output gap as Alistair Connor mentions earlier. That is, targeted spending in productive areas that fully utilises unused resources – one of those resources is the unemployed! Not much inflationary pressure if spending produces more goods and services…

    • Matt Nolan

       ”That is not to say, let’s spend away without a care. But at least spend
      to the point of dealing with the output gap as Alistair Connor mentions
      earlier. That is, targeted spending in productive areas that fully
      utilises unused resources – one of those resources is the unemployed!
      Not much inflationary pressure if spending produces more goods and

      That is the monetary policy argument – and the RBNZ is of the view that the output gap is getting close to closing due to their monetary policy actions. As a result, additional bond purchases seem unnecessary no?

      And if this is the justification, why politicise it when the central bank already does this to an appropriate degree.

      • Maxamillian

        I would argue that the output gap is closing! Unless you make the outrageous claim that some economists have made which is that unemployment is voluntary.

        The RBNZ can continue what it is doing. I’m saying that the government can spend, without being constrained politically by the level of debt and being obsessed with balancing the books and reaching surplus.

        • Matt Nolan

          Ahh of course the government can spend – after all they “should” only aim for a balanced budget when the output gap is closed in of itself :)

          The only real point I’m making here is that forcing the RBNZ to ease monetary conditions more than it believes is warranted to close the output gap isn’t appropriate – which is really what telling the RBNZ to do additional bond purchases at present is.

      • Maxamillian

        Why do you claim that the RBNZ’s view is that the output gap is getting close to closing?

        • Matt Nolan


          Page 23.  The output gap is down to 0.5% of GDP by March 2013.  Monetary policy also closes the gap with a lag, so even if we thought we could incrementally close it more quickly – the central view would be that this time has passed :)

          • Maxamillian

            That output gap is bollocks to be frank. It’s based on a potential output that “avoids” inflation – but as the RBNZ’s definition will tell you it’s not an exact science. And it’s more of this obsession with inflation. 

            There is obviously an output gap. There are thousands of willing workers that are unemployed! If these people are employed, they make stuff or offer services, they spend, aggregate demand is increased. Increased spending = increased incomes in the aggregate, and we’re all better off…

            • Matt Nolan

              I’m sorry, but you can’t justify this on an output gap – and then ignore the output gap when it isn’t what you expected.  Yes it is involved with inflation, as when this “output gap” goes positive we know inflationary pressure will pick up – leading to exactly the inflation tax we’ve been talking about.

        • Matt Nolan

           As a side note to my reply – if the RBNZ wasn’t forecasting the output gap to close and inflationary pressures to be within the band, then they would be forecasting policy failure.  In that case, the first step would be to remind them of the PTA rather than trying to take over their actions directly.

          However, the RBNZ doesn’t need reminding, and so its all gravy and all that.

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  • Sdemler

    Slightly at a tangent to this debate; one of the interesting dynamics that I’ve never seen answered very well (at least from a lay persons perspective) is why is NZ’s propensity for inflation so high. More specifically The ratio of interest rate per inflation rate seems very high in NZ when compared with competitor nations. If we could tackle the causes of this dynamic then I think we would have some very positive benefits.

    So what are the causes of this phenomenon? Any ideas?

    • Matt Nolan

       That is the idea of a “high real interest rate” in New Zealand – which has been discussed as a concerning issue in policy circles for the past decade, as it doesn’t seem due to “higher real growth”.

      This comes back to understanding the same issues that could be causing our “high real exchange rate”.  We had a brief chat about those issues in the “persistent overvaluation” section of this post:

      The analysis by the tax and savings working groups dug into these issues in more detail, and suggested that changes to tax policy and potentially things like local government regulation could have an impact. 

      For example, if we tax assets very differently, or we treat assets very differently in the financial system, we are likely to see large inefficiencies – and potentially see these high real interest rates. 

      There is no real easy answer though, we just have to sit down, look at how all the different tax, spending, regulation, and competition policy settings have an impact on this, and try to figure out if there are some issues … or if New Zealanders are different … or if our data is wrong, or measured differently to the rest of the world :)

      All big important issues to be sure – but they are independent from monetary policy.  Which is why we are pointing out that trying to improve outcomes by blaming the RBNZ for these things is akin to looking for answers in the wrong place.

    • Matt Nolan

       Hmm, I didn’t really tell you why – let me try again … although that stuff is useful.

      Interest rates in NZ that “stabilise the price level” are higher because NZer’s are more willing to borrow are a higher interest rate than people in other countries.  There could be many reasons for that, we could expect more growth or a higher return on our assets for example.

      But for some reason this has occurred while the return on our assets on a social level hasn’t been that great – and one of the main reasons economists think this has happened is because of distortions in the economy, such as the tax system treating different investments differently.  So it might be in an individuals interest to borrow at a really high rate of interest – but it is because other people in society are implicitly subsudising them!  If this is the case, we have a policy failure that we should fix up, and we can really say that we have been borrowing too much.

      At the moment we are trying to fully get our heads around how this is the case – and the changes we have seen to the tax system in recent years have been partially in response to this. 

      • Sdemler

        Reading between the lines here Matt. It certainly sounds that the desire for so many NZ’ers to try out the land lord business might be part of the pain here.

        Perhaps we should borrow a couple of billion, give it to housing NZ with a brief to build homes. That might reduce the willingness of NZ’ers to borrow if they can’t make the sums add up enough to become landlords! 

        • Matt Nolan

           We sort of need an idea about why things are happening, rather than just walking in and taking over the allocation ourselves :)

          Tax and competition policy are good places for us to start

        • Alistair Connor

           Taxing landlords so that they no longer get a free lunch isn’t hard. What is hard is the deflation in house prices that follows, and the honest hardworking people who find themselves upside down on their mortgages. It has to be done though, because the ongoing housing bubble is a colossal misallocation of resources that skews the whole economy. But it won’t be done because it isn’t exactly a vote winner…

          • Matt Nolan

             I don’t disagree regarding transitional effects from policy, and the fact that there is an allocative issue in the housing market.

            But I’m not sure what you are proposing here – landlords are taxed on rental income, so is it an issue of capital gains you are talking about?

  • HJC

    Matt, on the RBNZ website it says “The Reserve Bank pays interest on settlement account balances, and charges interest on overnight borrowing, at rates related to the OCR. The most crucial part of the system is the fact that the Reserve Bank sets no limit on the cash it will borrow or lend at these interest rates.” The monetary base is not used in to conduct monetary policy and is not a constraint on bank activities. The OCR is the only policy instrument. Pure QE (government bonds for settlement account balances) could be implemented without affecting the OCR and hence will not affect monetary policy. It cannot be said to be inflationary.

    • Matt Nolan

      Lets think about it in the most generous sense – the RBNZ buys government bonds at a zero interest rate.

      What happens here?  Well the RBNZ has to sell the bonds back at a loss in the future, implying that the borrowing still appears on the governments balance sheet and they still have to effectively pay the interest!

      Of course, we might say that markets have significant imperfections that would prevent this – but thats the kicker, in so far as there are credit market issues that cut the interest rate on government debt they will be inflationary.  So say the RBNZ increases the OCR to deal with this – we essentially have a transfer from the private to public sector in NZ.  Say they don’t increase the OCR, we have excess inflation which is a transfer of resources from the private to public sector.

      So we have interfered with the RBNZ in order to “fund” something – destroying the RBNZ’s credibility.  We have implemented an implicit tax on society, which is probably regressive.  I’m struggling to see how this is a good idea – compared to leaving the RBNZ with credibility and transparently introducing a tax which is set up to be “fair”.

      • HJC

        Sorry, you lost me at the first sentence. Why zero interest? The RBNZ exchanges the bonds for settlement funds on which it pays OCR. The coupons from the bonds can pay for this. The RBNZ’s ability to control monetary policy is not affected at all. Hence yields on government debt should not be affected either, market participants can be expected to be indifferent to two state assets with the same yield.

        • Matt Nolan

          That would be because I can’t write properly :)

          If we are just genuinely moving debt from one part of the governments balance sheet to the other the debt and borrowing still occurs – it is only in so far as we increases the quantity of credit that we will expect it to have any impact on “who bears the burden of paying for that government spending”.

          But even in the case when absolutely nothing happens, we are still politicising the RBNZ’s balance sheet – which will reduce the Bank’s credibility.  So we get no “benefit” with some cost.

          • HJC

            Do we (sort of) agree that shifting state assets around its balance sheet is not the issue? By the time it comes to start shifting state liabilities around, the spending has already occurred. So it’s actually about fiscal spending and appropriation of real resources. It comes back to whether there is a local output gap in Christchurch. I don’t know the answer to that, but it seems that perhaps some of the other commentators are sure there is. If there is though local government spending is probably not going to be inflationary.

            • Matt Nolan

              That’s fine – but if that was what the Greens are suggesting instead then there are two issues:

              1)  It still risks making the RBNZ seem politicised
              2)  It doesn’t actually do anything – so the policy “outcomes” they mentioned are wrong.

              When I wrote about the issue, I was trying to figure out what exactly they were suggesting as policy by figuring it out from where there policy outcome is coming from.  This other view of their policy implies there are costs to credibility and no other effects.

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