Reserve Bank is at the center of a political struggle it never wanted to have

ANALYSIS: The Reserve Bank has found itself at the center of an unlikely political storm, with politicians of all stripes debating the extent to which central bank independence gives it absolute freedom to set monetary policy independently.

The Reserve Bank has been operationally independent since 1989, but as the economic trauma of the past decade, and in particular the past year, pushed it to deploy more of its unconventional monetary policy tools, politicians have begun to question whether they have the right to tell the bank what to do.

That uproar came to a head on Monday, when new shadow National Party treasurer Andrew Bayly said the government should write to the bank to tell it to divert some of its money printing from the housing market.

The central bank has said it would create up to $ 28 billion in cheap funds for banks to stimulate the economy, encouraging banks to lend more. This is in addition to the $ 100 billion it has said it could print to stimulate the economy.

READ MORE:
* James Shaw says it’s time to tax capital gains and wealth to cool down the housing market.
* Reserve Bank says it is not responsible for the housing crisis, as it reveals $ 28 billion of cheap funds for banks destined for housing
* Judith Collins flirts with the ACT Reserve Bank’s house price policy

Prime Minister Jacinda Ardern, when asked about intervening in the independence of the Reserve Bank, said that this would be “like Muldoon”, referring to Sir Robert Muldoon, the prime minister from 1975 to 1984, who oversaw a period of rampant inflation that hit double digits. .

It represents a sea change in New Zealand policy, which has generally stayed very far from the independent right of the Reserve Bank to set monetary policy (which the bank does mainly in the form of adjusting the official cash rate towards up or down).

Even now, politicians worry they are venturing into dangerous territory. Some at National say privately that Bayly is playing a high-risk opening tactic on his new portfolio, especially after the party’s financial reputation took a hit in the 2017 election.

Essentially, Bayly wants the government to tell the central bank to keep doing what it is doing, but to direct more of its financing schemes to commercial loans.

Bayly, for his part, denies that writing a letter to the bank violates his independence. In fact, so do most of the politicians currently criticizing the bank.

David Seymour of ACT was one of the first. In the closing days of the election campaign, he suggested that the Reserve Bank should make sure to take house price inflation into account when making its decisions. Currently, the bank is targeting stable prices measured by the consumer price index, which largely ignores house prices.

Technically, this would not be playing with the independence of the Reserve Bank, it would simply be giving the bank another objective. The current government has done much the same. It took the Reserve Bank mandate to target price stability and added another goal: maximum sustainable employment.

Where this would become controversial is in a situation like the one we are in today, where those goals would rub against each other. Getting the bank to control home price inflation could mean higher rates and slower growth. This could lead to deflation. If the bank was in that position, it would have to determine which of its objectives it prioritized.

Green Party co-leader James Shaw, known for supporting the work of Reserve Bank Governor Adrian Orr, has taken a different tack. Rather than target the bank, Shaw says the government should do more to eliminate some of the unintended consequences of its monetary policy.

Orr himself has said that monetary policy is a blunt tool and fiscal policy – taxes and spending by governments – can be more surgical.

The consequence of the Reserve Bank’s printing of money, aimed at lowering interest rates, has been runaway house price inflation.

Shaw said the government needs to “implement measures to soften the impact of these measures.”

He suggested that this could be a tax on assets, either in the form of a capital gains tax, which would tax the income earned when those assets were sold, or a tax on wealth.

This makes sense, but the extent to which house price inflation is an unintended consequence is up for debate. Households that benefit from rising house prices tend to spend more because they feel richer. Mitigating that wealth effect could undermine the only positive consequence of what the Reserve Bank is doing: keeping the economy alive.

Shaw’s intervention acknowledges that the Reserve Bank’s all-or-nothing actions have truly helped it achieve its mandate of price stability and maximum sustainable unemployment during an immensely difficult time in the economy.

House prices, unless they threaten the overall stability of the financial system, are not really a problem for the central bank. In fact, the bank is right to be upset when politicians, who have failed to increase the supply of homes, turn against the bank and blame it for the rise in prices.

A surprise intervention in the debate came from former finance minister Sir Michael Cullen, who said Things that the bank should start buying government debt directly.

He said this would help the government achieve political goals such as building more homes and transitioning to a greener economy.

It is something the first Labor government did after nationalizing the Reserve Bank in 1936. It had an account with the central bank and borrowed money to build state housing and pay the guaranteed prices it offered to farmers for its produce.

Cullen’s comments go one step closer to what is known as modern monetary theory (MMT), which would involve the Reserve Bank printing money for the government to spend. The theory goes that large amounts of money could be created to solve urgent problems, to the point where the creation of money caused problematic inflation.

MMT is the logical end point in arguments about the level of independence the bank should have. Politics is likely to act as a block on any serious move in that direction.

To some extent, circumstances have led this debate to the Reserve Bank itself. Bonds purchased through its money printing program have to be indemnified by Finance Minister Grant Robertson, who gives the government at least some voice on policy, although the bank will most likely proceed with or without Robertson’s approval.

Regardless, with the official cash rate essentially depleted as a monetary policy tool, the bank will have to think of increasingly creative ways to carry out its policy.

This will drag the government into the world of monetary policy, whether it wants to go there or not.