The Government’s new arrangements with the Reserve Bank represent an explicit acknowledgement of a major shift in theoretical underpinnings; whether it makes much change to the Bank’s operations is another matter.

One of the residuals of Rogernomics (neoliberalism) that the Clark-Cullen Government left unfinished was monetary policy. The Ardern-Peters Government seems to have taken on the challenge.

We can see this from the critics of the new arrangements. An exceptionally important one was economist Arthur Grimes who in the late 1980s had been involved in developing the then-new policy framework and was appointed by the Clark-Cullen Government to the board of the RBNZ and later chaired the board. Grimes was a major critic of the recent announcement, which I will explain shortly, defending the old regime.

But first, one element introduced in 1989, where there seems little disagreement, is that the RBNZ retains sole responsibility for the implementation of monetary policy. In the old days, the Minister of Finance was able to ring up the Governor of the Reserve Bank and direct, say, the level of the base interest rate – that happened under Robert Muldoon. It was secret, except the Governor had to tell various persons and, um, it eventually leaked (economists can be gossipy people),

The current arrangements allow a government to direct the RBNZ but it has to be in writing and tabled in a parliament so there is no secrecy. The claim that the Governor of the RBNZ has unlimited power is nonsense. Not only is he or she subject to the law but the democratically elected government can say (and does say) what the general shape of monetary policy is. The RBNZ then implements it to the best of its ability.

The main way the government tells the RBNZ what it wants is through a Policy Target Agreement (PTA) signed between the Minister of Finance and the Governor of the Reserve Bank. For three decades it has specified an inflation range with the expectation that the RBNZ will operate monetary policy to stay within it.

So what is changing? The 1989 Reserve Bank Act was passed when monetarist thinking was fashionable and intolerant of alternative approaches. (‘Monetarism’ is used here in the technical sense which gives great significance to money supply in the way the economy works, that changes in it determine the rate of inflation and that it should be at the centre of macroeconomic policy.) Thus Section 8 of the 1989 RBNZ Act states ‘[t]he primary function of the Bank is to formulate and implement monetary policy directed to the economic objective of achieving and maintaining stability in the general level of prices.’ Nothing here about a contribution to broader economic objectives, which the previous legislation mentioned and which are often referenced in the frameworks of central banks overseas.

In fact, in Section 1A there is a secondary purpose which is that the Bank should ‘promot[e] the maintenance of a sound and efficient financial system.’ That was introduced as a 2008 amendment by the Clark-Cullen Government although the notion was sort of implicit in the original 1989 Act.

It harks back to an earlier tradition – before Keynesianism actually – that the function of a central bank was to maintain order in the monetary system. (‘Soundness’ and ‘stability’ are other terms for this order.) If the system becomes disorderly, the means of payment breaks down (as almost happened in the early stages of the GFC) and a money-based economy can hardly function.

This was a British tradition. Americans have been less enamoured with it. In the nineteenth century they relied on private funders for bailouts during their financial panics (with less success). They have had a strong ideology arguing that governments should not get involved. Even so they would have been grateful for the actions of the American Fed(eral Reserve Bank) and the US Treasury during the recent GFC.

I have never been sure whether those who designed the Reserve Bank Act in 1989 were ideological or whether they were too narrowly trained. Whatever, the Act seems to have been designed on monetarist lines. Initially there was money stock targeting – as a good monetarist would advocate – but that quickly proved unworkable and the RBNZ switched to operating through interest rate channels (how Keynesian). However, the notion of inflation targeting has been retained for almost thirty years.

This government has weakened the sole focus on inflation. The latest Policy Targets Agreement signed between the Finance Minister and the Reserve Bank Governor still sets out specific targets for maintaining price stability but it also states that monetary policy is to be conducted so that it contributes to supporting maximum levels of sustainable employment within the economy.

Monetarists reacted critically. The rest saw this as an acknowledgement that monetary policy was no longer run solely on monetarist lines. But, we puzzled, would it make any practical difference to the way the RBNZ actually operates?

Gossipy economists will tell you that the RBNZ has long abandoned a strictly monetarist approach. Rather, it uses a pragmatic mixture of the various forms of monetarism and Keynesianism (including traditional Keynesianism, modern monetary theory, neo-Keynesianism, open Keynesianism, post-Keynesianism and so on).

The RBNZ may now feel it can weigh into public discussion on the determinants of sustainable levels of employment – I would welcome that – and it is likely to consider employment issues more explicitly when it makes its decisions – or at least more explicitly mention them in its analysis. But what else? It may well be that the new PTA does not result in outcomes at all different from the previous one.

My view is that the RBNZ has even less discretion about what it can do than the conventional wisdom says. It has two elements:

First, whatever its legislation, the RBNZ will operate to maintain order in New Zealand money markets. Second, those markets are not isolated from the far-larger international ones despite most public discussion pretending that they are. (In particular, monetarist and closed Keynesians use analytic models which have no overseas sector; oh that the world was so simple.)

What that means is that the RBNZ is limited as to what it can do by what is happening offshore. It is not entirely without some discretion in the short run but in the medium run its responses are shaped by overseas developments. If international interest rates are generally rising, then you would expect local ones to follow; if – heaven helps us – the world economy enters a period of high inflation then our inflation rate goes up too, whatever the PTA promises.

 This may not be the conventional wisdom, but today it may be openly expressed without the discussant being accused of a heinous crime. The revised version of the PTA allows us to have a more free-flowing and less ideological debate about how New Zealand’s monetary system works. That is to be welcomed.


For a damning critique by an outstanding economic theorist of macroeconomics as it is practised with inattention to the underlying economic theory  see my account of Joseph Stiglitz’s ‘Where Modern Macroeconomics Went Wrong’.


Comments (5)

by Ian MacKay on April 10, 2018
Ian MacKay

So that is what it was all about. Thanks Brian.

Have all NZ Governments wanted unemployment to be very low?

by Brian Easton on April 13, 2018
Brian Easton

I cannot think of New Zealand government, Ian, which would not have said that  they wanted unemployment to be as low as possible. (The language of nineteenth century would have been different but the sentiment would have been much the same.) Some were unable to succeed in their objective (e.g. the Coalition Government on the early 1930s), others would not have given the objective a very high priority and a few pursued  policies which proved not to work. But the simple answer to your question, is 'yes -- all of them.'

by Moz on April 13, 2018

I think that's debateable, a pool of unemployed is useful to prevent wage breakouts which lead to  inflation. It definitely seems to have been the case that neoliberal governments are comfortable with much higher levels of unemployment than most of their subjects. They tend to focus on keeping people off benefits via punishment rather than creating jobs.

In fact one of the primary justifications for privatising and enterprising thngs was to reduce headcount, and it was something of a point of pride that the "new SOE" employed far fewer people than the previous state-controlled incarnation.

by Brian Easton on April 15, 2018
Brian Easton

It is worth remembering, Moz, that the neoliberals promised lower unemployment. They said that the abandonment of compulsory unionisation (the ECA), the lowering of benefit levels and the reducing of minimum wages would increase employment. I have a memory of one promising that were his policies introduced there would be near zero unemployment. The neoliberal promises failed. My point is that they were concerned about a low unemployment objective even if their policies to attain it did not work. 


by Moz on April 15, 2018

The neoliberal promises failed. My point is that they were concerned about a low unemployment objective even if their policies to attain it did not work.

You're arguing that it was incompetance rather than malice?

Coz I was there, and most of what was done seemed designed to produce a surplus of unemployed to help drive wages down and increase profits. Forcing people off benefits was a useful way to hide the actual level of unemployment (like the notorious "worked more than one hour in the last week" definition of "employed"). 30 years later we have at-will casual employment and Uber... no-one need be unemployed at all, you just need the app (oh, and an income, but that's unrelated. We have unpaid trial periods and internships, plus little-to-no enforcement of laws against wage theft and outright slavery).

When the whole history of neoliberalism shows a project to transfer wealth and power from the poor and formerly not-poor to the very wealthy, I think you need stronger evidence than "I heard a guy talking once" when trying to deny that.

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