Monetary policy 2.0?

Labour wants to upgrade monetary policy, preserving inflation targeting but asking the Reserve Bank to reduce persistent external deficits. To help, the Reserve Bank might get to vary contributions to an enhanced Kiwisaver scheme and go a little further with macro-prudential policy. Getting kiwis to save more is probably a good thing. If successful, interest rates would be lower and ease the exchange rate a little. But the evidence-base is weak and there are many leaks since implementation and accountability frameworks are not clear. Better to leave the Reserve Bank to do what they do best – implementing flexible inflation targeting.

The problem as defined

Many commentators point out that New Zealand has high real interest rates and that the exchange rate is overvalued relative to an economy less reliant on borrowing from abroad (see below). That makes our exports less competitive and promotes consumption of imported goods over domestically manufactured goods.

The problem: high interest rates and an overvalued exchange rate

The problem: high interest rates and an overvalued exchange rate


Our persistent negative external balance – that nets our borrowing and imports from overseas against exports – largely reflects our savings choices. Of course, an external balance can also reflect imports of capital equipment for investment in the real economy but most likely reducing the external balance would reflect a useful rebalancing of economic conditions for New Zealand.


What’s on the table?

Labour is proposing to preserve the core of the current regime:

  • central bank independence
  • the flexible exchange rate
  • unimpeded capital flows into and out of New Zealand
  • the inflation target that sits at the heart of the monetary policy regime

but innovate on the framework by introducing an additional tool. That tool, a Variable Savings Rate (VSR), changes the rate of contribution into a compulsory Kiwisaver account, raising contribution in good times and lowering contributions in bad times.

The quid pro quo is an additional objective for monetary policy:

“…maintaining stability in the general level of prices in a manner which best assists in achieving a         positive external balance over the cycle…”

Making Kiwisaver compulsory

Labour’s proposals contain policies aimed at both the structure of the economy and policies to better manage the economic cycle.

The key structural proposal is to make Kiwisaver compulsory and increase the contribution to 9 percent over time. On paper this is really nice. Policies that help kiwis save – if effective – are probably good, reducing the real interest rate and the exchange rate a little.

However, a compulsory Kiwisaver has costs. Many workers would rather spend superannuation contributions on their children, going to university or reducing their mortgage.It’s simply irrational to save much if income is low and the microeconomic data suggests New Zealanders have sufficient savings for retirement.

Many of the other proposals are helpful, establishing a sufficiently flexible economy where resources respond quickly to price signals and are allocated effectively across the economy.

A variable savings rate to manage the cycle?

One of the key policies is introducing a Variable Savings Rate, which increases compulsory contributions to Kiwisaver in boom times and reduces contributions in recessions.

Changing the price of credit – the interest rate –– “gets in all the cracks” of the economy, changing the cost of spending today rather than tomorrow for businesses, exporters and households.

Trying to influence the quantity of credit – by varying the contributions to Kiwisaver – affects only some households, a much smaller fraction of the economy. Interest rates will still have to do the heavy lifting to manage the economic cycle.

And there will be many leaks. For example:

  • First-home buyers with large mortgages forego Kiwisaver payments to pay off mortgages Under a VSR they will reduce mortgage payments, borrowing more to offset increased Kiwisaver contributions. Net savings are unchanged.
  • Leveraged up property speculators are largely unaffected by outgoings to Kiwisaver. Lower interest rates would mean cheaper access to credit, encouraging speculators to leverage up further.
  • Low-income earners are stretched. Inevitably, they would require exemptions but these are messy and set up odd incentives.

Increasing the Kiwisaver contribution rate would not have the same impact as increasing interest rates on reducing inflationary pressure and increasing savings.

Implementation needs tidying

Labour clearly notes that more work needs to be done to investigate a variable savings rate while preserving the independence of the Reserve Bank.

Requiring the Reserve Bank ask the Government every six weeks to reset the VSR would undermine its independence and would be practically unworkable, forcing the Reserve Bank to second-guess the Government view in their Monetary Policy Statement. That leaves two unpleasant choices:

  1. the Government sets the savings contributions or
  2. license the Reserve Bank to set the savings rate.

Option 1 leaves the Reserve Bank one tool short of too many objectives: who then carries the can for the external balance? Option 2 allows the Reserve Bank to implement savings policy. It seems difficult to retain the same consensus across the political spectrum and constituency for the Reserve Bank to set this rate.

Accountability also needs tidying – actually a lot of tidying

Back in much simpler times, there was a very clear objective for the Governor of the Reserve Bank – pin inflation to a defined target. Maybe the Governor couldn’t in practice be fired for missing the target but it was reasonably clear when the Governor was doing a good job with monetary policy and when things were out of hand.

Appropriately, as the monetary policy regime matured, the objectives for inflation targeting expanded to include dampening cycles in output, the exchange rate and interest rates. That makes it harder to assess performance but at least the metric is clear.

Holding a central bank to account for the external balance is entirely different. The external balance nets both our external borrowing and saving and trade in goods and services (exports and imports). The current account (see below) moves for a wide array of reasons. So should the Governor be praised for the improvement in the current account from the Canterbury rebuild or the booming demand for our dairy products? Should the Governor be castigated for our individual decisions to borrow to buy or build a home for our families? It’s pretty unclear what can be signed up to.

What KPI for Graeme Wheeler?

What KPI for Graeme Wheeler?


My overall assessment

Labour’s proposal is clever, preserving the core of central banking but teasing with sufficient innovation to warrant the upgrade tag. And compulsory Kiwisaver probably pushes in the right direction.

Labour’s key innovation – a variable savings rate – also holds promise on paper. But running through the details suggests very limited effectiveness. There would be leaks, so interest rates would have to do almost all the legwork.

Moreover, implementing the variable savings rate raises real questions about what the central bank should do and what it can realistically be held accountable for. Worth remembering that manufacturing has been on a secular decline well before inflation targeting was implemented (see below).

Don’t expect miracles

Don’t expect miracles



11 replies
  1. James
    James says:

    Nice post. I saw some of the same problems in this, which made me wonder whether the VSR could be collected by banks via mortgage interest. That is, interest rates would go up, but part of the increase would be increased compulsory savings as a function of the size of your lending. The immediate problem I see in this is that it would encourage property speculators to use non-person entities (trusts, companies).

  2. Seamus Hogan
    Seamus Hogan says:

    Kirdan, I am puzzled by your statement that making kiwisaver compulsory pushes in the right direction, and that encouraging New Zealanders to save more is probably a good thing. Saving means forgoing one good thing (consumption today) in order to get a different good thing (consumption tomorrow for yourself or your heirs). What is the welfare framework for thinking that people are making the wrong decision on that margin? Note that Investment is an intermediate good into the production of future output. If we did proper intertemporal accounting of GDP we would consider future discounted consumption as part of GDP, but deduct Investment spending as an intermediate good. Having one-period measures of GDP means that we double count investment twice: I is included in current GDP and future C is included in future GDP, but mis-measurement is not a reason to favour one consumption path over another.

    • kirdanlees
      kirdanlees says:

      On balance I have enough sympathy with macroeconomic balance models – which show lower real interest rates and exchange rates from a better savings-investment balance – to favour promoting savings a bit more.

      I used the phrase “probably pushes in the right direction” since most microeconomic studies suggest sufficient savings while the macro evidence suggests New Zealanders have a way to go.

      Both the micro studies and the macro data are pretty fraught though. The revisions to GDP and the savings track in the UK show just how fragile the conclusions economists draw in this space can be.

      The Treasury, the Reserve Bank and the IMF all suggest the exchange rate is 5-15 percent “overvalued” and point to savings being an issue. So some savings imbalance seems a reasonable problem definition for the Labour Party to start from.

      I don’t see GDP as the discounted sum of current and future consumption.

        • kirdanlees
          kirdanlees says:

          Hi Seamus,

          Was going to write something up on exchange rate models and macroeconomic imbalances but this analytical note from the RB fits the bill:

          Worth noting their up-front assumption that the exchange rate is overvalued relative to either a pre-specified current account (like the Pederson Institute who assume the long-run current account position is three percent, well, negative three percent, for New Zealand), a long-run current account position based on an estimated cross-country regresssion based on demographics and trend growth, or an assumption about the NIIP position – which seems like an assumption on the CA to me.

          Bottom line: this framework assumes the exchange rate is overvalued relative to a world where New Zealanders save more. One can easily get pretty cynical then about this kind of analysis – particularly given New Zealands track record with essentially no debt defaults

  3. Jim Rose
    Jim Rose says:

    The new savings tool is a regulatory policy.

    How can a positive productivity shock slow the economy down?

    If compulsory savings is a negative productivity shock, then it might slow the economy down.

  4. C Thoenissen
    C Thoenissen says:

    Making kiwisaver compulsory assumes that
    household savings are both low and sub-optimally low at that. Furthermore, it
    assumes that the reason savings are sub-optimally low has to do with household’s
    inherent preferences. New Zealanders are, according to Labour, an impatient
    lot, incapable of looking after themselves.

    If the aim of this policy is to raise the
    aggregate savings rate, then I doubt that this policy will work. The bulk of
    saving is done by households who are not borrowing constrained and who can
    therefore easily off set any increase in kiwisaver rates by dissaving elsewhere
    – leaving total savings largely unchanged.

    If the policy maker wants to increase the
    savings rate, they should take a good look at the tax treatment of savings.
    Where are the tax free ISAs (individual savings accounts popular in the UK) in
    New Zealand? My guess is that savings are not low because households are
    impatient, but because saving is penalized in the tax system.

    The proposal to turn the kiwisaver
    contribution rate into a monetary policy tool is truly bizarre and only
    marginally less baffling than the a proposal once floated by a Treasury
    official to use GST rates to target the exchange rate. If, as I argued before,
    households can offset increases in kiwisaver rates through dissaving elsewhere,
    then this is going to be a pretty useless policy tool. Worse still, it will be
    borrowing constrained households (those with poor credit ratings or those who
    have already borrowed up to the limit) who will have to do the ‘heavy lifting’
    for this policy tool to work. Let’s not even get into the relative effects on
    different age cohorts.

    How and why this would affect the real
    interest rate or the exchange rate, is anything but clear.

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