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A new Governor with an extra target

After almost 30 years the Reserve Bank has abandoned its pioneering approach of focusing solely on inflation to also focus on maximise employment.  It's not yet clear whether that is more than window-dressing. 

Reserve Bank Governor Adrian Orr and Finance Minister Grant Robertson talked in public together yesterday for the first time about the new-look monetary policy as they unveiled their first Policy Targets Agreement and previewed changes to the 1989 Reserve Bank Act.

The Reserve Bank led the developed world in the late 1980s by focusing solely on lowering inflation, an approach that was adopted by some other central banks. The popularity of this pure inflation targeting has waned because inflation has been so low as to spark fears of deflation.

Robertson and Orr took the stage of the Beehive Theatrette to discuss the outcomes of Phase One of the Reserve Bank reform while signing of the Policy Targets Agreement between the pair.

With the inflation target of 1-3 percent over the mid-term and 2 percent over the long term left unchanged, the big story was the announcement the Bank would in future look at “supporting maximum levels of sustainable employment” alongside its traditional mandate of maintaining price stability. 

There has long been criticism on the left that the Reserve Bank’s inflation target has come at the expense of targeting employment. If inflation rises, as it did in the 1980s, it erodes spending power and savings as wealth loses value. But if the Bank increases its Official Cash Rate to calm inflation it can have the effect of cooling the economy and increasing unemployment. 

Countries like the United States, Australia and Norway have central banks with a dual mandate to consider both inflation and unemployment and Robertson’s victory in securing the dual mandate here will be applauded by those who argue the current mandate gives precedence to maintaining the purchasing power of capital and wages over decreasing unemployment.

A bold move or simply window-dressing? 

Orr  said on Monday that, “in general times, it shouldn’t make too much of a difference,” but added that towards the extremes of an economic cycle it might change policy outcomes.

Infometrics economist Hilary Parker agrees that in the short term we are unlikely to see the mandate lead to massive policy changes, but she could foresee a scenario when the dual mandate might change outcomes.

“There might be higher unemployment and high inflation at the same time so what does the Reserve Bank do?” she said. 

“If they raise rates to curb high inflation that means unemployment could increase, so they might actually tolerate high inflation for a little bit longer to see unemployment go down,” she said. 

She pointed to the Reserve Bank’s decision to raise interest rates in 2010 as an example. 

“We had high inflation and high unemployment, they increased the interest rate by about half a percentage point within a couple of months so maybe if we’d had this dual mandate in place they might not have increased that,” she said. 

Bill Rosenberg, chief economist at the Council of Trade Unions, said an example of when the mandate might have had effect was in the 2000s.

“The Reserve Bank was ramping up interest rates in order to try and put a lid on house prices. That would have had an effect on employment because it would have been heading off, making investment much more difficult,” he said. 

Parker said the Reserve Bank already factors employment into its decision-making as employment has a significant effect on inflation, which the Bank targets. 

“If unemployment falls below expectations there will be a situation where employers are having a tough time trying to find staff which means they’ll have to put up their wages to attract better staff which means their costs increase, which flows into general prices as companies try to maintain their margins. And that would result in inflation rising and they need to target that inflation anyway, so in effect they actually already consider unemployment,” she said. 

Cameron Bagrie of Bagrie Economics agreed monetary policy is not likely to change a great deal under the new targets in the short-term, but the wording of the new employment target “made a lot of sense”.

“You get into problems if you phrase that such as maximising growth in employment  — you need that term sustainable,” Bagrie said. 

“The Reserve Bank’s only got so much influence over the labour market. [Its] hands are a little bit tied there so you need that sustainable term,” he said. 

He said the key to the employment mandate was the word “sustainable”. 

“It would have been tempting to put in, ‘maximise growth in employment,’ but that’s a bit like going to a cricket match and trying to win it by hitting each ball for six. You want to give it a damn good nudge if the ball is there to be hit, but only if the odds are good,” he said.

He said the most likely times the lever would be used would be at the top or the bottom of an economic cycle, but it is unlikely there would be an impact over the course of a cycle. Other levers like improving the workforce through education would be more effective in reducing unemployment.

“The Reserve Bank controls a couple of levers, but most of the levers in regard to driving labour market outcomes are actual government levers,” he said. 

One of the most significant parts of the policy agreement was an omission. The statement did not include a reference to asset price stability. The stability of asset prices had been part of the Policy Targets Agreement Robertson signed with Acting Governor Grant Spencer and is traditionally mentioned in the PTA.

Christina Leung, principal economist at NZIER told Newsroom this indicated there would be an increased focus on CPI as the measure of price stability. 

Bagrie said the omission could indicate bigger changes to come.  

“I’d have thought that asset prices are still a consideration for monetary policy. I think it’s a little bit surprising to have that little piece taken out."

The omission might gesture at Government policy that could have an impact on asset prices.

“I guess the glass-half-full interpretation of that is you’ve got a Government that is pretty gung-ho in getting the supply of housing up and they’re looking at pulling that lever pretty hard,” Bagrie said. 

“Maybe they think they can get the housing market under control and leave the Reserve Bank focused first and foremost on the inflation objective and maximising growth and sustainable employment,” he said. 

The omission might also flag some big reforms that could come from the review of the bank.

“That might flag something else might be happening like potentially the Reserve Bank might be split up and then we end up with an RBA model,” Bagrie said. 

In Australia, the Reserve Bank has a mandate for monetary policy, while the  Australian Prudential Regulation Authority handles bank regulation. 

Robertson hopes to introduce legislation to amend the Reserve Bank Act by the middle of the year. 

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