Readers of this blog will know that I am an admirer of the way in which New Zealand seems to be innovating in economic policy. I’ve drawn attention to the way in which they’ve been the first country in the world to build the ideas about ‘potent defaults’ into savings policy, how aggressive their government surpluses have been at a time when the economy desperately needs savings.
Now they’re considering something that I’ve thought for many years is worth considering. In Australia whenever the economy is running too strongly there is much gnashing of teeth about what a ‘blunt instrument’ monetary policy is. Inevitably we think some of the effects of monetary policy suit our short and medium term macro-economic circumstances, while other effects don’t.
The mother of all dilemmas was in 1989 and 1990 when we desperately wanted to slow the economy (to contain the current account deficit, the threat of rising inflation and prevent a feared wage breakout). At the same time at least some of us were anxious that high interest rates and the high exchange rate that went with them were quite inconsistent both with the medium to long term micro-economic strategy of moving from import replacement to export orientation and indeed with one of the central stated objectives of high interest rates which was to bear down on the current account deficit.
High interest rates did indeed bear down on the current account, but only in the short term, and the price of bearing down on it in the short term was a worse current account deficit later as the high exchange rate helped to hollow out the traded sector and thus reduced its contribution to the recovery.
I argued at the time and subsequently that a better policy was to increase compulsory super (it would have been better as salary sacrifice rather than notionally employer funded). I still think that was the ‘first best’ policy at the time (to use a somewhat misleading expression).
But there remains the more general question. If we agonise so much about how blunt an instrument monetary policy is might there be a case to have monetary policy instruments that enable monetary authorities to target their actions more specifically to where they see imbalances occurring.
These instruments would still be broad ones, but would target specific markets. Thus in addition to manipulating the cash rate as they felt appropriate, the RBA would be able to broadly tighten monetary conditions (or loosen them) for specific sectors if they were particularly the subject of concern.
One can argue this in a pragmatic way. The argument is that textbook efficient capital markets wouldn’t need these kind of instruments just the cash rate – to establish price stability. (Then again textbook efficient capital markets might not need any instruments at all.) But actual markets aren’t like that and imbalances that concern us appear in particular parts of the market or may do in which case it’s best to try to use policies targeted to the issue.
But one can also argue the case in a more principled way it seems to me by tying in the monetary authority’s responsibilities (in most countries but not in Australia) for prudential supervision. According to such a view, as property prices, or equities prices rise, one might adjust one’s view as to how much it would be prudent to lend against property or equities. If so, then when the property market appears depressed one might consider banks could prudently borrow say – 85% of the value of residential property and require mortgage insurance over that figure. But as a boom gets under way one might want to pull that back to some lower figure 75%.
It surprises me that private banks do this so little on their own. They’ve done it a bit with the highest risk residential property (particularly inner city high rise) but that’s about it otherwise it’s been business as usual.
Anyway, the New Zealand Reserve Bank has been mulling over similar issues. New Zealand’s economy is in a state that looks very tricky to manage. (Indeed to borrow something someone said after the 1974 Australian election, the winner of the last election should have bagsed Opposition).
It has a yawning current account deficit, employment shortages producing some inflationary pressure, labour keeps heading across the Tasman, and housing credit keeps growing. New Zealand interest rates are now well above Australia (and every other developed country I can think of).
This situation has similarities with the situation Australia faced in the late 1980s when the RBA sent housing interest rates to 20% to immediate alarm and subsequent despondency. But NZ reformers have already put compulsory saving to their electorate only to have it overwhelmingly rejected, so that’s not an option (and my proposal that we coudl ‘walk and chew gum’ and occasionally use compulsory savings as a macro instrument – as they have in Singapore – is unorthodox in any event).
So what’s to be done? The New Zealand Reserve Bank has announced an inquiry into “Supplementary Stabilisation Instruments”.
Two classes of options will be explored:
One-off measures, eg:
The removal or restriction of structures that facilitate tax reduction through property investment, such as Loss Attributing Qualifying Companies (LAQCs) Factors that may be incorporated into the prudential framework which could reduce the amplitude of housing credit cycles
Discretionary stabilisation measures, eg:
A limit on loan-to-value ratios for mortgages, that could be managed by the Reserve Bank as a macro-stabilisation instrument Other direct interventions that might be used by the Reserve Bank to influence the quantity and or price of mortgage lending
It all seems very sensible to me, but a New Zealander who keeps in close touch with me says few kind words are being said about it over there.
I’d be interested in others’ views.