ConnectMe - May 2017

12 July 2017

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Commentary:

Monetary Policy and Financial Stability

For Kiwi manufacturers who are working hard to stay competitive, monetary policy and financial stability are not always a concern day to day – there are bigger immediate issues that define your businesses success.  However, all have felt the effects of monetary policy settings, through the high exchange rate and interest rate levels, and the threat of financial instability on a global scale during the GFC.  

With an election approaching and a number of parties discussing changes to Monetary Policy, as well as the stepping down of the Reserve Bank Governor, it’s a good time to consider what improvements could be made.

In recent years, one of the biggest issues in this space for manufacturers and exporters has been a significantly overvalued exchange rate, directly hitting margins and competiveness of exporters and our import competing manufacturers.  Despite continued vocal calls from the Reverse Bank of New Zealand (RBNZ) that it is overvalued, and the drastic falls in dairy prices (of which the exchange rate often somewhat follows), it remained high.

The other side of this issue is how the RBNZ works to protect financial stability.  This definitely does not feel top of mind when things are going well, but our experience during the GFC showed how financial instability can hit our manufacturers hard, even when most of the damage occurs offshore.  With continued risks highlighted in our housing market, paired with high private debt, it is an issue we need to be proactive about.

In recent years, there have been some positive developments in this area, particularly in the area of macro-prudential tools, specifically the introduction of Loan to Value Ratios (LVR).  There remains more opportunities in this area to sure up financial stability, taking some lessons from around the world.  Doing more in this space could also help free the Reserve Bank up to take more action on interest rates and the exchange rate – we can’t have the RBNZ held hostage by risks and pressures in an overvalued housing market to act on other issues.

So what do we propose be changed?

In general, we believe the Government needs tobroaden monetary policy targetsand needs to update the Reserve Bank Act and the RBNZ’s Policy Targets Agreement, for example, including a more explicit focus on the exchange rate level and volatility, as well as wider measures/ targets of economic success to achieve that.

We would like to see more research on what targets could be added to provide better and more consistent outcomes for the productive sectors of New Zealand. This could inform the Government needs to better define other targets into the RBNZ’s mandate, such as the employment rate and level of the exchange rate, while keeping flexibility and judgement to the RBNZ in the short and medium term.

We believe there should also be an exploration on how to broadening decision making within the RBNZ in terms of policy decisions.  For example, moving to a Board decision making structure, as is used in some other countries. 

The last change, relating to financial stability should be giving the RBNZ flexibility to research and implement additional macro-prudential tools to help protect financial stability. Specifically, Debt-to-Income ratios should be added back into the Memorandum of Understanding (MoU) to allow the RBNZ to implement these when and if they see it as appropriate.

It is positive to see that it has been requested by Government that the RBNZ provide a cost-benefit analysis of DTI’s be completed with public consultation, and we would encourage them to add these specifically to the MoU following this. 

By Dr Dieter Adam, CE of the NZMEA