RB admits it has scant exchange rate control

Grant Robertson.
Grant Robertson.
The Reserve Bank admitted yesterday it had little control over the exchange rate, the comment taking on irony when the New Zealand dollar rose sharply in reaction.

In a speech written for the Otago Chamber of Commerce by Reserve Bank governor Graeme Wheeler and delivered by chief economist John McDermott, the central bank addressed monetary policy challenges in turbulent times.

Referring to the exchange rate, Mr Wheeler said the Reserve Bank had lowered the official cash rate six times since June last year and the trade-weighted index remained about 2.5% higher than it was at the start of the cuts.

''Central banks cannot persistently achieve a lower nominal exchange rate unless monetary policy is fully dedicated to that goal - and even then cannot permanently achieve a lower real exchange rate.''

Central banks might influence financial risk-taking through short-term interest rates, but other factors, such as regulation and taxation, would determine whether that flowed through into investments that enhanced productivity and real income growth, he said.

Also, the scope central banks had to influence short-run activity and wage and price-setting behaviour diminished as interest rates approached zero and the limits for quantitative easing were reached.

Central banks must make finely balanced judgements when setting monetary policy. The judgements were based on evidence, research and scenario analysis and there was a continual review of policy records and international experience, Mr Wheeler said.

The New Zealand central bank's position was flexible and inflation-targeting remained the most appropriate monetary policy framework for conducting monetary policy in New Zealand, he said.

Provided there was sufficient flexibility to accommodate the frequent and often severe impact of external shocks, the most important contribution monetary policy could make to promoting efficiency and the long-run growth of incomes, output and employment was the pursuit of price stability, he said.

The Reserve Bank has a policy target agreement with the Government to keep inflation between 1% and 3%, with the optimum being 2%. Inflation in New Zealand is running at 0.4% and has been under 2% since 2013.

Westpac economist Sarah Drought said the Reserve Bank noted much of the recent low inflation had been due to global factors beyond the control of local policy markets. They included low global inflation and loose monetary policy globally.

The bank also acknowledged such challenges could be long-lasting.

''Against this backdrop, the Reserve Bank views the current focus of the policy target agreement as appropriate. It allows them to pursue price stability and promote long-run growth of output while providing sufficient flexibility to accommodate the impact of external shocks on inflation in the short term.''

The central bank's forecasts assumed a further 0.35% reduction in the OCR from the current level of 2%, Ms Drought said. The aim was to gradually return headline inflation to 2% and limit the down-side risks of inflation expectations.

''They didn't give away anything in terms of bias, downplaying both the ideas interest rates should remain unchanged or that rates should be cut rapidly.''

Westpac continued to expect a 0.25% reduction in the OCR in November and there was a risk of a further cut next year, she said.

Labour finance spokesman Grant Robertson said whatever the future held for monetary policy, the current Policy Targets Agreement signed by the Government and the Reserve Bank had one priority: to ensure inflation was between 1% and 3%, with a focus on the midpoint 2%.

The failure to meet the target for an extended period, and forecasts that the midpoint would not be reached for seven years, seriously called into question the agreement.

Current interest rate settings were helping to push the dollar to nearly its highest point this year, hurting hard-pressed exporters and slowing the economy.

''It is time to review monetary policy to ensure it is relevant in the modern world. The Government's abject failure to manage the housing crisis is a major issue for the economy.''

The Reserve Bank Act was almost 30 years old, Mr Robertson said.

The world had changed hugely since then. It was clear from overseas evidence New Zealand's monetary policy targets needed to be updated to adapt to the ''new normal'' of low inflation and stalled growth.

A review needed to consider widening the focus of the bank to take factors such as the exchange rate, employment, wages and the overall health of the economy into account when setting the OCR and making its policy decisions, Mr Robertson said.

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