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Will the RBNZ’s doom and gloom be self-fulfilling?

Who or what is the greatest threat to the well-being of New Zealanders? Who would have thought it? None other than the Reserve Bank of New Zealand, says Auckland University macroeconomics professor Robert MacCulloch.

Not content with scaring the pants off practically every investor and consumer in NZ with its dire predictions of our economic downfall, the Reserve Bank has now unleashed a scathing comment accusing the Chief Executive of Business New Zealand of not understanding how the Official Cash Rate is being set.

All Kirk Hope had said was that: "Last week's OCR cut was less predictable because it did not seem to relate to current inflation or unemployment data".

This innocuous line, in particular, has appeared to raise the ire of the RBNZ’s governor, whose formal response, published on the Bank's website on 16th August, is that: "We cannot, and do not, set the OCR based on current or historical inflation and employment outcomes”.

But the Head of Business NZ got it right. The above statement by the governor got it wrong. I hereby call upon the governor to retract his words. Moreover, why does the RBNZ publish this kind of stuff that only serves to damage its credibility and reputation? An own goal, for sure.

The RBNZ statement, in a rambling justification of its non-focus on the current and past state of the economy, argues: "We scan the horizon and chart for the journey. We look ahead - not behind".

The argument appears to be that the Bank needs to act pre-emptively.

Let us hope that the RBNZ’s “shock and awe” slashing of interest rates, when it was not called for, has also been based on a mis-prediction, one stemming from the Bank’s increasingly mysterious in-house crystal-ball gazing.

However, this same metaphor can also be used to explain why the current and historical path of the economy IS so very important when it comes to forecasting the future. Voyagers on the high seas have no idea how to chart their journey, unless they know their current and past position.

More formally, a large body of work by eminent authorities on this subject, using huge amounts of data, has shown that most interest rate decisions by central banks around the world are HEAVILY influenced by the current state of the economy. The most important indicators include the current unemployment rate, current employment rate, current inflation rate and current level of output.

The former Chair of the US Federal Reserve, Ben Bernanke, describes how the predictions coming from only these above variables and “actual Fed policy” have been “generally quite close over the past two decades”.

What is even worse, a former Chair of the US President’s Council of Economic Advisers and writer of the world’s most popular textbook in economics destroys the RBNZ governor’s argument that central banks look “ahead”, “not behind”, when he argues that looking ahead makes sense, but only “if forecasting is good enough to make the task feasible”.

However the US numbers suggest strongly that it is not. He shows how the “strong contemporaneous correlation” between US Federal Reserve cash interest rate movements and current rates of inflation and unemployment suggest that US monetary policy has not, in fact, been “pre-emptive at all”.

This observation is linked to the old joke frequently made about economists, namely that they have successfully predicted nine of the last three recessions.

Let us hope that the RBNZ’s “shock and awe” slashing of interest rates, when it was not called for, has also been based on a mis-prediction, one stemming from the Bank’s increasingly mysterious in-house crystal-ball gazing.

Put another way, we can only hope that the joke will be on the RBNZ, and not on our economy.

Strangely, even the Bank’s own research explains the importance of using current and historical outcomes of the state of the economy if one does try to make an attempt to chart a future path.

One of their own analytical notes written in 2017 says that "forecasts constructed using measures of past inflation have been more accurate than using survey measures of inflation expectations, including the 2-year ahead survey measure previously used by the Bank".

The problem our country now faces, unfortunately, is that the RBNZ’s tales of doom and gloom may become self-fulfilling, leading to a full-on collapse in confidence.

Those of us who sit on the side-lines as observers have also been left to wonder to what extent the RBNZ’s statement on 16th August, which is referred to as “a comment from Reserve Bank governor, Adrian Orr” fully reflects the views of each and every member of the Monetary Policy Committee. The point of that committee was, in the words of the Minister of Finance, to bring “a wide range of experience” to the decision-making process.

Is the governor speaking for the whole committee when he says that the setting of the OCR is not based on current or historical inflation and employment outcomes? The interest rate decision is not up to the governor to make on his own. How do we know that the current state of the economy and its recent trends are not indeed playing a role in the minds of the other committee members when making their decisions? Did anyone ask them?

More generally, what we appear to be witnessing is a whole new RBNZ, completely different from the world-class one that existed a couple of years ago. Fresh from the departure of its top talent, including one who had a doctorate from Yale University, the Bank now speaks a different kind of language.

It seems to crave the limelight and be known for advocacy of new causes, far beyond its previous justly narrow focus on price stability. The Bank talks the talk of quantitative easing, negative interest rates, talk more typically found in countries like Greece or Brexit Britain. Will it walk the walk and take us there?

How did the RBNZ send us on this kind of journey in such a short time?

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