Just briefly, RBNZ Chief Economist Paul Conway talks in the interview above about the central bank's meetings with politicians and how it remains "fiercely independent." Governments that interfere in monetary policy get higher inflation, he said.
Also, Conway said:
* The RBNZ was doing a ‘mini-review’ of whether it should have taken a more moderate approach to hiking interest rates in the current cycle, similar to that adopted by the Reserve Bank of Australia, which hiked 425 basis points in 2022 and 20223, while the RBNZ hiked 525 basis points between late 2021 and May 2023;
* He thought it was time for New Zealand to debate how to grow its economy in ways other than just increasing house prices;
* He thought the best way to grow the economy more sustainably was to improve productivity by investing more, connecting better internationally and improving domestic competition; and,
* the Monetary Policy Committee considered the potential long-term scarring effects on GDP growth and productivity from having a big output gap with higher unemployment for too long.
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‘We’re fiercely independent. And meddling just means higher inflation’
I interviewed Reserve Bank Chief Economist Paul Conway this week about last week’s 25 basis point rate cut decision and the bank’s latest quarterly Monetary Policy Statement.
Before our pre-arranged interview, PM Christopher Luxon said he had told Reserve Bank officials in a meeting before the decision that he wanted more rate cuts. He agreed with his interviewer Mike Hosking’s statement that the bank had been too slow. Luxon was then criticised for expressing an opinion in public that might damage perceptions the Reserve Bank was independent.
“It's very clear in the literature. If you look at central banks that do get exposed to political pressure, inflation's higher in those countries.” Paul Conway
I asked Paul about that risk at the 7:44 mark. Here’s the transcript of that part of the interview (bolding mine):
Bernard Hickey: In that political economy space, in the last few years all around the world, but also a little bit in Aotearoa, there's been some debate about Reserve Bank independence. Politicians from both sides have said things in the last couple of years. How is the landscape at the moment on Reserve Bank independence? Does the Reserve Bank feel independent? Does it feel like anyone's stepped out of their lane?
Paul Conway: There's been a bit of talk the last couple of days in our country on this topic of Reserve Bank independence. I go to meetings with the Minister of Finance and the Prime Minister a couple of days before we make a decision. Absolutely, we are independent. We are not influenced by either the Minister of Finance or the Prime Minister in terms of our OCR decisions.
We do kick around the economy. We learn from them what they're seeing and they sort of learn from us. We don't explicitly talk about what we are going to do with the official cash rate.
Firstly, the Monetary Policy Committee hasn't decided what we're going to do at that date. And secondly, we're fiercely independent. We guard our monetary policy independence. And the reason that we do that is if we do have politicians setting interest rates — we call it the time inconsistency problem — they tend to juice growth around elections.
It's just the fact of human nature. And it's very clear in the literature. If you look at central banks that do get exposed to political pressure, inflation's higher in those countries. So categorically, we are independent. Monetary policy is independent, and we are not influenced by the politicians when it comes to setting the official cash rate.
‘Should we have hiked by less, as the RBA did? We’re checking’
I then asked if the Reserve Bank had hiked too early and too much in 2021, 2022 and 2023, and had cut too little in 2024 and 2025. Here’s the full transcript from that exchange starting at the 15 second mark (bolding mine):
Bernard Hickey: We've just had the Reserve Bank's monetary policy decision, a 25 basis point cut. We've now seen the Reserve Bank cut the official cash rate 2.5 percentage points in the last year and a bit. Do you think the Reserve Bank, in retrospect, put up interest rates too much in 2021 and 2022 and then hasn't cut them enough in the last year or so?
Paul Conway: Retrospect is an important word there. The other thing I'll say on that is it takes a long time to sort of figure out a good articulate answer to that type of question. So we do our RAFIMP (Review and Assessment of the Formulation and Implementation of Monetary Policy) every five years (the next one isn’t due until 2027). We're sort of doing a mini RAFIMP at the moment and we'll be publishing a lot in that space.
I think the other really important aspect when answering that question is what's our mandate? We are the people that try to maintain low and stable inflation. So you really have to come at it from that perspective. And I would argue with inflation of 2.7% in the second quarter, we're looking at hitting 3% in the third quarter, so upper end of the target band, we understand why.
Inflation is up there and we do expect it to fall, but we expect it to fall back towards the midpoint of the target. So there's no hint of inflation sort of going south of 2%, much less out the bottom end of the target. So assessed from that perspective, even though I'm sort of saying it's a bit too early, there's a definitive sort of answer to that question. We think we're achieving our mandate and monetary policy settings over the last couple of years have been consistent with that.
Let's chat about this again in the future when we've been through the full cycle. We obviously want to learn from these types of things. So let's chat about this again, these types of things and how we did compared to the RBA, which took a slightly different approach. There's some really interesting questions in there and we need to come to a really good landing on all of those questions so that we get even better at monetary policy going forward.
‘Maybe we should invest in productivity, rather than house prices’
I also asked about the Reserve Bank’s comments in its MPS around housing wealth and its connection to consumer spending, and then about whether the economy could grow in the long run without rising housing wealth and a rising population.
“It has been house price inflation and strong population growth through migration have been key drivers of economic growth in this economy for a long time.” Paul Conway
Here’s a couple of charts from Pages 35 and 36 of the MPS.
Here’s the transcript of that exchange from the 2:50 mark (bolding mine):
Bernard Hickey: In the monetary policy statement and then in the discussion in the news conference after the decision, there was quite a focus on the role of wealth and the wealth effect on consumers in Aotearoa. Can New Zealand's economy grow when house prices are flat or falling?
Paul Conway: Yeah, that's a really good question as well. And if you look at the correlation with house price changes, house price cycles, and if you compare that to the consumption cycle or the residential investment cycle, they're very close to each other. And that wealth effect coming through the housing market, it has been a source of growth, a growth engine, if I can use the term pretty lightly.
It has been house price inflation and strong population growth through migration have been key drivers of economic growth in this economy for a long time. We're talking decades here and for a few reasons it doesn't look like it's going to be the same going forward. I think we have made progress on the supply side of the housing market. There's been reasonable progress there, so that when we get an increase in demand for houses, we get more houses instead of just getting more expensive houses.
So I think it's a really interesting time in New Zealand's economic history. Can we sort of kick on from here? How do we spark this economy up without relying on house price inflation? Because of course the problem of sort of selling houses amongst ourselves at ever-increasing prices, pretending that we're creating prosperity, is important.
If you've got a house you're doing great And if you don't you're not and then your kids come along and they want a house and all of a sudden they cost a million dollars.
I do not subscribe to the view that the only way to sort of lift growth in this economy has to come through ever increasing house prices. I think it's time for us to really have the conversation on how do we grow in other ways, which as you know from my perspective is through productivity enhancements. (In a previous role Paul was the chief economist for the now-disbanded Productivity Commission) That's how a sort of normal developed economy would do it going forward and I think that's what we need to aim for.
Bernard Hickey: So the Reserve Bank obviously sort of runs the machine (the economy) rather than builds the machine or repairs the machine. So what sort of repairs would the machine need from your point of view?
Paul Conway: I think it's really important here to say what is the role of monetary policy in economic growth. The literature on that's very clear that the best contribution that we as the nation's central bank can make to our long-run economic performance is maintaining low and stable inflation.
We are the people that moderate the business cycle so that we can keep inflation well anchored within that 1 to 3 % target with a focus on the midpoint. So that's all we do basically in terms of monetary policy. So we're forecasting a recovery in the economy from the third quarter of this year. And what we're talking about there is what we call the output gap closing. So the business cycle sort of turning and it's not a spectacular sort of recovery and growth. It's just an uptick in the business cycle and that's all that we can affect.
If we want more impressive long run growth rates, that's not monetary policy. That's regulatory policy. It's tax. It's other bits of government policy.
There's no secret sauce about how we do that. I run the risk of being told to stick to my knitting and stay in my lane when I talk outside of monetary policy, that's fair actually, we don't want people knitting while they're driving. So I hear that.
But it's not a secret sauce how to improve our long run structural growth. It's about investing more. It's about connecting better internationally. It's about competing harder domestically. It's about doing innovation smarter.
I would actually argue, Bernard, that we know what to do, but are we up for the conversation and are we up for the challenge of just getting on and doing it? And can I just be very clear: this is not a critique of the current government because we've had these issues for decades going back into the past.
But does monetary policy actually hurt productivity & scar the economy?
I also asked Paul Conway about a debate that has arisen in Australia in recent months about whether central banks actually further reduce productivity growth by hiking interest rates to offset the inflationary effects of low productivity growth. Last week Westpac Group Chief Economist Luci Ellis wrote in this note about growing evidence tight monetary policy didn’t help productivity grow: it may actually harm it.
“Until recently, it was assumed in many quarters that weak productivity growth meant that demand had to be constrained – by monetary and other policies – to match the weak growth in supply. What if we have it all backwards? A growing body of research suggests that tight monetary policy can in fact reduce long-run growth. Westpac Group Chief Economist (and former RBA Governor) Luci Ellis
Here’s the transcript of our discussion, starting at the 12:10 mark (bolding mine):
Bernard Hickey: In Australia, there's been some interesting debates about productivity. Whether monetary policy, which generally is assumed to be independent from the engine rebuilding process, whether actually monetary policy, raising interest rates, can have a scarring effect to reduce productivity growth, because it's not so easy to borrow money to buy new machines or retrain staff and we all know about the scarring effect when you have higher unemployment. So is it possible that the Reserve Bank makes it more difficult to improve productivity with the way it runs monetary policy?
Paul Conway: I think these are interesting questions. So the idea if, for example, monetary conditions are restrictive, that's going to slow investment in the economy, which will equal a lower capital stock going forward, which can detract from what we call potential output growth. Or there's literature around suggesting that monetary policy type financial conditions again can reduce innovation in an economy.
Normally we think of monetary policy influencing demand in the economy. And regulatory settings, fiscal settings, have more of an impact on the supply side of the economy. But I do think there is potential for hysteresis or these scarring effects.
If you read the record of the meeting from our monetary policy decision last week carefully, we actually talk about it a bit in there, and at the margin, and I would argue it is just at the margin, there is a sense among the Monetary Policy Committee: we've had a negative output gap for some time; it sort of just keeps getting kicked into the future.
When’s that going to start to recover? And it's a concern. What sort of scarring effects, if any, that might have on the supply side of the economy. That was one of the many factors that went into the change in tone, more assertive approach, to interest rate easing that the committee did last week.
The section of the Monetary Policy Committee’s (MPC) record of meeting that Conway was referring to is here:
The Committee discussed slow growth in the productive capacity of New Zealand’s economy. Potential output growth has slowed, reflecting subdued investment, low productivity growth, and historically low population growth through net immigration. The Committee noted that appropriate monetary policy settings would support sustainable long-run investment and growth. MPC record of meeting in August MPS (page 4)
Conway is a member of the MPC.
Ka kite ano
Bernard
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