Adrian Orr started yesterday as the new Governor of the RBNZ, and earlier this week, signed a Policy Targets Agreement (PTA) with the Minister of Finance, Grant Robertson. As widely expected, the announcement included many of the outcomes of Phase 1 of the Government’s RBNZ Review; reaffirming the RBNZ’s position as a flexible inflation targetter; adding a dual mandate of “supporting maximum sustainable employment”; and, shifting the RBNZ away from the Governor being the sole-decision maker for setting the Official Cash Rate (OCR).
We believe that these changes will have a minimal impact on New Zealand’s monetary policy settings, but it could take the market a little while to adjust to the new framework. Broader changes to the RBNZ’s functions may also await in Phase 2 of the Government’s RBNZ Review, which will come into focus in the second half of 2018.
The RBNZ’s PTA tends to be amended with each new incoming government. While inflation targeting was always expected to remain front and centre, there had been some speculation that the new PTA may revert to an earlier formulation, specifying the target as anywhere in the 1% to 3% range, dropping the reference to focusing on keeping future inflation near the 2% mid-point. However, this reference to the 2% mid-point has been retained and should help reinforce to the public that they should expect CPI inflation to be well anchored in the future around 2%. While the challenge through the 1990s and 2000s was to lower inflation down to this target level, since the GFC the challenge has been to stop inflation expectations getting stuck below 2%.
Introducing a dual mandate for the RBNZ of price stability and full employment has been a flagship policy of the Labour Party since the election campaign, bringing its practice into line with other countries like the US and Australia.[1]
We believe this should have only a marginal impact on interest rate settings. First, the RBNZ has always focused on measures of spare capacity (like the output gap and unemployment rate), when setting interest rates, given they act as a guide to future inflation pressures. Second, the current NZ unemployment rate of 4.5% is very close to the RBNZ’s estimate of maximum sustainable employment. We do not think the dual mandate provides a signal to set monetary policy materially looser or tighter.[2] Finally, monetary policy can only “contribute” to supporting the labour market amongst a broader government policy agenda. As noted by Governor Orr in the press release, “maximum sustainable employment is determined by a wide range of economic factors beyond monetary policy.”
That said, we believe that the PTA will put the RBNZ under a higher level of scrutiny to be transparent about its analysis of the labour market, and to justify its decisions based on the impact on employment. So, expect the Governor to field a disproportionate number of questions about jobs at Finance and Expenditure Select Committee hearings, and see if the political pressure rubs off on decision making over time.
The shift to a committee decision-making structure for setting the OCR was also well flagged. In an international context, New Zealand has been unusual for some time for having a sole decision maker (the Governor) setting monetary policy – something that made sense 30 years ago, when strong accountability was needed to get NZ inflation down to target from double digits. In the announcement yesterday, we learnt that there will be a new formal voting Monetary Policy Committee (MPC), with 5 to 7 members, with a minimum of 2 external members and maximum of 4 internal members (including the Governor), as well as a Treasury observer.
External members will be selected on the basis of having knowledge and experience in economics, finance, banking, or public policy, without having conflicts of interest. The challenge of moving to a committee-based structure is balancing the broader wisdom of a group with the potential for greater noise for markets and the public to deal with, from voting members with diverging views and opinions.
The new arrangements seek to deal with this by publishing MPC minutes without attributing comments or votes to individual members. The idea is that the Governor will remain the sole spokesperson for the MPC, with Monetary Policy Statements and Governor speeches continuing to be the main anchor for markets. This should help reduce mixed messages on the monetary policy created in other countries, like the UK and the US. However, it is a framework that could get tested if external members have strong independent views during periods in the economic cycle when OCR decisions are highly contentious.
While the introduction of a dual mandate including employment is captured in the new PTA as part of Phase 1 of the RBNZ Review, it will need to be also changed in the RBNZ Act along with the introduction of a committee structure. The process for changing the RBNZ Act is expected to start in mid-2018, with the new MPC only coming into force during 2019.
Adrian Orr’s first Monetary Policy Statement is in two weeks, on 10 May. But before then, expect a speech from the new Governor setting out his interpretation of the RBNZ’s role and objectives looking forward. We are expecting the OCR to remain on hold in the months ahead, not because of a new Governor or new PTA, but because inflation pressures remain subdued for now and more evidence will be required for the RBNZ to change its tune on the OCR remaining on hold for a considerable time.
Further ahead, it is important not to lose sight of Phase 2 of the RBNZ Review through the second half of 2018, which covers the financial stability functions of the RBNZ. This could span a much broader canvas than Phase 1, including financial regulation, financial supervision, lender of last resort, crisis management, liquidity provision, the use of macroprudential tools, and many other aspects of financial stability. These are potentially more complex and contentious areas of central banking and regulation. While markets are naturally focusing on whether the new Governor is a hawk or a dove on inflation, it may turn out that it is financial stability where Adrian Orr looks to make his mark on the RBNZ.
[1] Harbour Navigator: “Labour’s mainstream monetary policy proposals”, April 2017.
[2] Harbour Investment Horizon: “Dispelling the myth that a dual mandate implies easier monetary policy”, November 2017.
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