Don’t mess with Mr In-between
This article represents the end of Infometrics' association with the weekend business pages of the Dominion Post. We began this collaboration with the Dominion Post back in June 2007 and have prepared around 260 articles on a wide range of topics over this period. So on behalf of the current Infometrics team (Gareth Kiernan, Matt Nolan, Benje Patterson, Nigel Pinkerton, Adolf Stroombergen, and Andrew Whiteford), as well as past contributors (John Carran, Andrew Gawith, Susan Guthrie, Brent Oliver, Geoff Simmons, and Chris Worthington), I would like to thank our colleagues at the Dominion Post for hosting our articles. To readers, thank you for the many positive comments that we have received. We have also enjoyed the debate generated by readers that have challenged us on various issues.
In our first article Gareth Kiernan questioned the reappointment of Dr Bollard as Governor of the Reserve Bank for a second term. Dr Bollard is stepping down next month, and given our frequent articles questioning the operation of monetary policy, he may well be amused that his tenure outlasted our tenure with the Dominion Post.
Underpinning our concerns with the operation of monetary policy is an issue that pervades and disrupts the effective implementation of economic policy across a wide range of policy areas: the risk of intermediate targets usurping the achievement of the ultimate aims of economic policy. Too often the complexity of policy issues and the varied interests of different groups have resulted in the formation of policy that short change lifetime prospects for New Zealand citizens.
The Reserve Bank is charged under the Reserve Bank of New Zealand Act 1989 to, among other things, "formulate and implement monetary policy designed to promote stability in the general level of prices". The ultimate purpose of this responsibility is to enhance economic efficiency. Money is a medium of exchange, a store of value, and a metric for comparing the relative value of products and services. The invention of money in Lydia two and a half thousand years ago was important for further promoting the specialisation of economic activities and this specialisation is the bedrock of civilisation.
Specialisation requires co-operation and trust. And money provides a mechanism for promoting trust between people. But this only works if people have faith that the value of money is shared between people and across time.
The inflation targeting mandate that underpins the operation of monetary policy in New Zealand is simply a mechanism for providing protection for the value of money. It is a very important foundation for the New Zealand economy, but it must be remembered that price stability is just an intermediate target and that it is a mechanism for promoting the ultimate aims of promoting economic efficiency and wellbeing. Price stability only has value if it contributes to economic wellbeing.
Once this is recognised, it opens the way to debate the finer points of monetary policy. For example, should we have an inflation target (which lets bygones be bygones) or would a price level or even a nominal GDP target generate more beneficial outcomes? If one accepts inflation targeting, which prices should be included in the target measure? We use the CPI, but the target could plausibly be set in terms of the GDP deflator, non-tradeable prices or some measure of core inflation. Then comes issues about the implementation of monetary policy, such as the choice of policy instruments, the timing of changes in policy settings, the degree of any incremental changes in settings, and the wording of statements that might accompany any policy announcement.
What starts out as a seemingly simple mandate gets complicated very quickly. And with this increased complication comes a complex chain of inter-linkages and intermediate targets. This in turn results in increasing specialisation in the roles associated with the design and implementation of policy. Although the promotion of specialisation is one of the reasons for targeting price stability in the first place, this type of specialisation comes with the risk that intermediate targets take on an importance that masks the ultimate aims of policy, or worse encourage outcomes that are at odds with the overarching policy's ultimate aim. For example, one might imagine a situation where the inflation target is met, but only via wild swings in interest rates. The net result is that despite stable prices, one still has a high level of financial market instability – thus negating many of the aims of monetary policy in the first place.
This perhaps sounds like an endorsement of Winston Peters' private member's bill to widen the primary function of the Reserve Bank. It definitely is not, this ill-conceived bill will only further complicate the task of the Bank, as well as anyone trying to assess their performance. If there has been a problem with the evolution of monetary policy since 1989 it has been an excessive desire to have monetary policy address issues that it is ill equipped to do. Maintaining the value of the New Zealand dollar is a sufficiently important task, let's not make it any more difficult.