Measured monetary policy

As election year really starts to heat up, National and Labour are starting to talk about reviewing or changing the Reserve Bank Act, the legislation designed to keep inflation under control.

The Government has announced the Treasury has appointed former State Services Commissioner Iain Rennie to review two aspects of Reserve Bank governance. But first, the review will look at the Reserve Bank's process for making official cash rate decisions - the decisions which influence lending and borrowing rates in the country.

The Reserve Bank follows a voluntary committee process when deciding to raise or lower the OCR but, under the legislation, the Reserve Bank governor has sole power to make those calls.

This is different from many other central banks where the power is spread among a committee rather than residing in the hands of one appointed official.

Labour wants to incorporate full employment into the decision-making process, something many people probably believed was already being considered.

There are some difficulties with the changes proposed by Labour finance spokesman Grant Robertson, and one of them is the idea of full employment being in tandem with low inflation.

Full employment is an economic situation in which all available labour resources are being used in the most efficient way possible. Full employment embodies the highest amount of skilled and unskilled labour that can be employed within an economy at any given time. Any remaining unemployment is considered to be frictional, structural or voluntary.

Breaking that down further, full employment is usually considered to be any acceptable level of unemployment above 0%. Full employment is seen as the ideal employment rate within an economy and is normally represented by a range of rates specific to regions, time periods and political climates.

A government or economy often defines full employment as any rate of unemployment below a defined number. If, for example, a country sets full employment at a 5% unemployment rate, any level of unemployment below 5% is considered acceptable. Full employment, once attained, often results in an inflationary period as a result of workers having more disposable income, driving prices up.

New Zealand has one of the lowest unemployment rates in the OECD and is suffering a skill shortage because of the extra work created by natural disasters, such as the Christchurch and Kaikoura earthquakes, but also through the Government's ambitious infrastructure programme of building roads and bridges.

Currently, the Reserve Bank has a mandate to keep inflation between a target range of 1% and 3%, with the 2% mid-point being the optimum. When it comes to monetary policy, the central bank has the OCR as its one tool for its sole target of inflation.

The Reserve Bank has asked for different macroeconomic tools and introduced loan-to-value ratios to try to cool the Auckland housing market.

Labour wants to institute a voting committee made up of the Reserve Bank governor, two deputy governors and chief economist, along with three external appointees.

If this was to happen, then it would be ideal if the minutes of the meetings were released to the public, as happens in the United States when the Federal Reserve meets to discuss interest-rate decisions. There will be a lot of interest in New Zealand on how people voted.

Reserve Bank governor Graeme Wheeler is leaving the role this year and his replacement will only be in an acting capacity until March next year when a full-time replacement is appointed.

Mr Wheeler's departure will give ample time for the next government to consider what changes it wants to introduce.

Full employment is a laudable but unreachable goal. Rather than use election year to push tinkering changes to the Reserve Bank Act, National, Labour and their prospective coalition partners should hold a measured conversation about how monetary policy should be conducted in this country.


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