Is the economy too tough?
You’ll have seen that an attempt in Parliament to change what the Reserve Bank (RBNZ) is meant to do and make it take more heed of exporters’ competitiveness has got the thumbs down.
Good thing, too. It might have sounded reasonable, but there were at least three things wrong. One, it’s simply not true that the rest of the world has a shiny new monetary policy model while we’re still riding around in a clapped out one.
Yes, some of the big central banks overseas have had to do unusual things to cope with the GFC and Eurozone debts, but no major central bank has walked from its day job of keeping inflation low.
Two, the Reserve Bank is not blind to what’s happening to business. It takes the overall state of business activity into account. Probably the biggest factor it looks at is the ‘output gap’ — whether the economy has spare capacity or is going gangbusters.
If the economy is weak on this measure, inflation pressures are weak and the bank will be easing policy in difficult times, as proponents wanted.
Three, high inflation used to be ingrained into how we acted. That made it a big ask to get low inflation into Kiwis’ thinking and behaviour and to establish the credibility of our central bank.
We’ve spent over 20 years getting inflation down, keeping it down and trusting the bank to keep it down in the future. It makes no sense to junk what we’ve achieved.
All that said, the proponents of change were channelling a genuine and better founded concern: current monetary conditions are making life arguably too tough for business. How do I know? Because I’ve resurrected the Monetary Conditions Index (MCI).
It is a formula that combines interest rates and the overall value of the Kiwi dollar into a single number, the aim being to measure the combined impact of interest rates and the Kiwi dollar on companies. High MCI numbers mean either high interest rates or a high Kiwi dollar, or both, indicating tough monetary conditions. So what does the MCI tell us? Here, we hit a bijou problemette.
The RBNZ hasn’t published the MCI since November 2000. So I’ve had to bring it back to life. With a bit of spreadsheet manipulation it’s telling an interesting story: policy is too tight. Interest rates are very low, but the exchange rate is very high and the combination works out as too tough for present economic conditions.
Currently the economy is on the weak side: the RBNZ’s measure of the output gap, for example, signals spare capacity in the economy. You could have figured it out without the RBNZ’s help, by looking at our 6.8% unemployment rate.
But the MCI says monetary policy, overall, is at the sort of level you would expect when the economy is humming. In 2006-2007, for example, when the economy was performing quite strongly, the MCI averaged around 1100.
Today, despite the sub-par state of the economy, it’s within cooee of that at around 1000. Before the GFC, the biggest financial turmoil we’d experienced was the ‘Asia crisis’ of 1998. You’d be inclined to believe overall monetary conditions in the post-GFC economy ought to be at least as easy as they were in the wake of the lesser Asian turmoil.
They’re significantly tougher. To get to the levels of late 1998, interest rates would have to go to zero and the Kiwi dollar would need to be 15 per cent lower than it currently is.
As that calculation indicates, by far the biggest moving part in generating our uncomfortable monetary conditions has been the exchange rate.
There’s no guarantee that cutting interest rates to even lower levels would get the Kiwi dollar lower — but in the current global environment, when even small positive yields on Kiwi dollar deposits are attracting international buying, it’s worth a go.