New Zealand innovates again: Supplementary Monetary Policy Instruments

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.

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    2024 years ago

    I have rather liked the idea of one-off narrowly-targeted taxes on consumer credit. These could have sunset clauses or be removed earlier once they have had their desired effect.

    These could be one-off taxes on new debts or percentage taxes on existing debts.

    For example:

    – All applications for new credit cards require a $1000 up front tax before the card will be granted.

    – A similar up-front tax for personal loans, interest free deals and (possibly) use of home equity.

    – Applicants for any form of consumer credit shall be required to give their tax file number on their application. Consumer debt could be taxed at a rate similar to the GST (eg 10%).

    – Taxes on multiple credit cards that rise exponentially with the number of different cards.

    During the late 80s it might have been possible to have one or more of these measures combined with much lower (and less recessionary) interest rates to successfully achieve Paul Keating’s desired ‘soft landing’ (rather than the recession we had to have) without the hardship that ensued.

    Stephen Bounds
    2024 years ago

    Peter – your proposals seem rather extreme. Unless I’m missing something, these would seem to simultaneously greatly reduce low- to middle-income earners’ access to credit while making those in debt quickly spiral into bankruptcy.

    I assume you’re trying to discourage people spending money they don’t have, but wouldn’t you achieve the same aims rather more simply just by banning the granting of credit altogether?

    Nicholas Gruen
    2024 years ago

    Yes, and Peter’s proposal is very tenuously related to monetary policy or even prudential supervision. I have very little sympathy for the pretty widespread view that we should make people’s borrowing decisions for them. I commented on it tangentially here.

    derrida derider
    derrida derider
    2024 years ago

    “It has a yawning current account deficit, employment shortages producing some inflationary pressure, labour keeps heading across the Tasman, and housing credit keeps growing”

    And you still admire NZ’s economic management?

    Lets face it, two decades of free-market zealotry has seen NZ living standards go steadily backwards relative to every other developed country in the world. I know they started from a pretty unenviable position, but really they oughtta have done better.

    Hugh Pavletich
    Hugh Pavletich
    2024 years ago

    Dr Michael Cullen, the New Zealand Finance Minister and Dr Alan Bollard, the Reserve Bank Governor, will be heartened by the support from Troppo Armadillo !

    Alas – there is no support within New Zealand for this “initiative”.

    Nicholas Gruen
    2024 years ago

    DD, I admire their recent economic management – or at least innovations like their Super fund, default super and now their exploration of these issues. Their earlier reform looked OK to me on paper, but Australia’s was better because it was more gradual and fairer. Now those who saw the NZ reform as too ideological, too radical and too unconcerned about inequality can take comfort in NZ’s economic woes, but I have to admit (and I’d like to see some of them admit) that it remains quite a mystery as to why they did so much worse than us. After all the reform agendas in Oz and NZ were similar, and if we went for more equality than them (which I support) it’s still not immediately apparent why they should have had so much less growth.

    My only hypothesis is that Australia is sucking a fair bit of the life out of the place – pinching it’s best and brightest. A gravity model explanation.

    As an additional ‘two bob’s worth’, I’d add that when I started learning about the NZ economy, I was shocked to learn that this country that has the best GST in the world, the country that is supposed to have done it all by the textbook has introduced neither capital gains tax nor (I think) means tests on old age pensions. A pretty poor set of reform priorities if you ask me, but still not enough to explain the difference between NZ’s and Australia’s economic performance.

    John Humphreys
    2024 years ago

    I know people get sick of libertarians saying “tax is bad mmm-kay”, but NZ has higher tax/GDP than Australia.

    As for “It has a yawning current account deficit, employment shortages producing some inflationary pressure, labour keeps heading across the Tasman, and housing credit keeps growing”

    I don’t think the CAD, employment shortages or rising credit necessarily represent a problem. Indeed, so-called employment shortages seem to me like a good thing.

    derrida derider
    derrida derider
    2024 years ago

    Not taxing capital is received wisdom amongst strict econrats – the stuff’s internationally mobile, you know (as though NZ labour isn’t!), and taxing capital anyway has higher deadweight costs than taxing labour.

    The means test on NZ’s age pension has an interesting story. Way back when it used to be means tested. They got rid of the means test but imposed a special aged tax surcharge that had the effect of clawing the whole lot back from upper income people – this had the same effect in income terms as means testing but carried some big administrative advantages.

    Predictably, taxing someone extra “just because they were old” was unpopular (though of course it wasn’t just because they were old – it was because they were getting a pension they didn’t need). Winston Peters, in populist style, campaigned against the tax surcharge and had it removed.

    FWIW, I think there is an excellent case for progressively removing the means test from the Australian age pension and paying for it by winding back tax concessions on superannuation. It would actually boost household savings (the means test on the pension is a big barrier to voluntary saving for retirement, and pushes what saving there is into investment in the principal residence), would be far easier to administer, would encourage late retirement, is eminently affordable (the extra government outlay is about 0.5% of GDP now, rising to 1.5% in 2050) and would be distributionally fairer.

    Hugh Pavletich
    Hugh Pavletich
    2024 years ago

    Regarding the difference in economic performance between Australia and New zealand – I would suspect, as a New Zealander – that much of it has to do with culture. In a sense – Australia is more entreprenerial like the United States, whilst New Zealand is somewhat more European.

    Much of this goes back to the late 1800’s when under the Premiership of Richard John Seddon – we New Zealanders saw ourselves as the “social justice laboratory of the world”.

    In 1900 – according to the OECD figures – New Zealand had the highest GDP per capita of Australia, Canada, the United States and Japan. Today – New Zealand is lower than all of them – and some 30% behind Australia. I will send this data to Nicholas.

    Now on the rugby front………….

    Cameron Riley
    2024 years ago

    John, The diff between Au and NZ in total tax as a percentage of GDP isnt much different. For 2004, Au is 36.6% and NZ is 38.3%. It should be noted that in 1993 Au’s tax as a percent of GDP was 27.4%. No wonder Howard has a name, deservedly, as the most taxatious Prime Minister EVAR.

    That data on NZ was from this interesting PDF comparing NZ with the OECD;

    derrida derider
    derrida derider
    2024 years ago

    So Kiwis would rather play rugby than make a quid. But the Aussie sterotype was always that we’d rather play sport (any sport) and bet on it than make said quid. I don’t reckon the “culture” explanation will really fly – we’re too alike, and anyway in the long run culture changes in response to economic changes.

    Nicholas’ point about no-one – supporter or critic alike – having a good explanation of WHY the NZ experiment failed is a good one. I suspect poor macro, rather than micro, economic management may be part of the answer, as it is in Europe. But I’ll have to think about it.


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