I agree with you in a descriptive sense – however, I think the waters get a bit muddier if we expand things out a bit.

Moving away to the medium term, and to the short term, we need to think about how responsive the interest rate “needs to be” to deal with a fundamental shift of government spending in this way. If the central bank lacks the appropriate ability, or knowledge of tools, to do this in the short term (they would likely be the first ones to say this) trying to keep a budget close to balance at all times is a dangerous path.

Furthermore, there are distributional issues which you touch on when you look at the housing market. The RBNZ would let a bubble develop in the housing market, even if they actively didn’t want to, because they (in fact no-one) don’t have the precision or foresight to deal with that. Now if we “replaced” short-term monetary stimulus with a short-term budget deficit the liability would fall on the government side rather than with the private sector – and the type of investment and spending made would differ.

And finally, the way we “deal with spending” helps to determine the response of the “real exchange rate and competitiveness”. Lower government consumption and transfers will lower the real exchange rate. Lower government investment has an ambiguous impact – and as a result, we need to be careful.

Overall, the principle that we run a “cyclically adjusted balance budget” which goes into deficit when unemployment is elevated etc works pretty well for us while we have a positive cash rate.

With regards to the cash rate, it probably didn’t need to be as much higher as it was through 2012, but that is behind us now. An important point to remember is that we are about to have an “investment boom” – if it wasn’t for the rebuild, the RBNZ would have cut rates a fair amount from here. It is upcoming investment holding up interest rates relative to other nations at the current point in time.

It would be possible to go even further though, and construct an argument that tight fiscal policy is actually optimal for NZ in May 2013. Hypothetically, for example, what would happen if the government targeted a fiscal position that was consistent with the RBNZ lowering its overnight rate to 0.5%, to maintain aggregate demand? The heat would come out of the NZD, creating an immediate boost to demand through exports, domestic holidays, import-competing manufactures and services etc. Resources would be freed up by government to flow to these sectors, Christchurch etc. Asset prices would rise, boosting household and corporate balance sheets and creating a good environment for investment. There would be even stronger pressure to do something about the supply of housing in Auckland, although a runaway bubble in house prices wouldn’t develop as the RBNZ wouldn’t allow it. Government debt would reduce quickly. The effect on private debt would be ambiguous, as both savings and investment would increase. However, in my view, it would decrease as a percentage of GDP.

What’s not to like? Well, it’s probably not healthy for interest rates to be below trend NGDP growth for extended periods. But I think you could run this strategy for a few years quite comfortably. (BTW I consider myself a Keynesian, but when you are in a world of inflation targeting and your interest rates are 3% higher than most of your lower-rated trading partners you need to think outside the box).

Indeed. Let’s hope the RB steers a path safely positioned at a neutral point that lies somewhere between ‘scary’ and ‘folly’, and we do not go anywhere near ‘gruesome’!

Monetary policy is set over the economy as a whole, not for specific regions. I think saying that the rest of the country will recover more slowly due to the fact that Canterbury is sucking in capital and labour is true – but saying it is a “scary ride” is an exageration.

Of course I think the RBNZ should look past “relative price shifts” due to Canterbury, but ignoring its impact on capacity entirely would be folly. In fact, I would venture the opinion that we are saying the same thing from different directions 😉

(From the Statistics NZ press release)

” Excluding Canterbury from the national estimates shows a much weaker labour market, with both the employment rate and labour force participation rate falling over the year.”

We are going to be in for a scary ride if the “Canterbury Effect” is ignored when setting policy for the vast majority of us who live outside that region.