Monday, 25 Oct 2021

Liam Dann: Is central bank independence under attack?


Everyone liked Star Wars when Luke Skywalker and Darth Vader used the Force to do somersaults and twirl their lightsabers.

People were less fond of later movies where Liam Neeson’s impossibly named character delivered lengthy biology lectures about how the Force was made of midichlorians.

So it is with columns about central banking.

People like to debate house prices or food prices or what’s going to happen to with interest rates.

And there’s nothing boring about a bank collapsing.

But reform of the 1989 Reserve Bank Act? Or, more specifically, the Deposit Takers Act’s place in the wider review.

Well, sorry, here goes.

The mass appeal may be low but (like it does for Star Wars nerds) the passion runs high.

Right now there’s an intense battle raging about how the government manages the Reserve Bank.

While it gets very technical, it also goes to the heart of a bigger debate, playing out globally, about the extent of government involvement in the economy.

There is concern from many in the financial community that central bank independence is under attack.

Viewed through the orthodox, monetarist framework of the past 35 years it’s easy to see it that way.

The nature of the Reserve Bank’s relationship with government shoud be dynamic.

The act has been tweaked many times under many different governments.

But lately it’s been changing fast.

In his first term, Finance Minister Grant Robertson formalised a committee-based structurefor monetary policy decisions.

He added employment to the monetary policy mandate’s previously sole focus on inflation.

Then, in February, he added a house-price considerations to the Reserve Bank’s monetary policy remit.

Now – as part of a more thorough overhaul of the 1989 act -he is proposing a new process for setting lending restrictions, such as the loan-to-value ratios which restrict how much banks can lend to homeowners with small deposits.

In essence, it shifts the direction from which calls about lending restrictions and regulations are made.

Instead of being proposed by the Reserve Bank and approved by the minister, they’d be proposed by the minister though still formulated and implemented by the Bank.

Is this a power grab by the minister, a step on the slippery slope to “Muldoonist” government intervention?

Or is it, as Robertson argues, the tidying of an unstructured regulatory process?

He says this leaves Reserve Bank independence intact to determine the timing and extent to which any new lending measures are applied.

To understand the debate, it might help to look at the strengths and weaknesses of central bank policy over the past 30 or 40 years.

There’s no question that by the end of the 1970s the economy was tied up in regulatory knots of interventionist policy and overburdened with debt.

A series of central bank reforms through the 1980s culminated the 1989 act.

That created a fiercely independent Reserve Bank focused on doing one thing well.

That thing was targeting inflation, which had been out of control since the 1970s.

The lack of price stability was making us poorer, undermining efforts to generate real economic growth.

New Zealand’s efforts on this front were so successful that our policy became a blueprint for central bank reform around the world.

That has been a point of pride in New Zealand financial circles for many years.

And rightly so.

But times have changed.

By 1989, trust in governments to run economies was at a historically low ebb.

Governments didn’t even trust themselves.

Like an alcoholic asking the publican to ban them from the premises, the act was structured to keep politics out of monetary policy.

Thirty years later, inflation is tamed and social inequality is rising off the back of asset price inflation.

It’s not surprising that critics would question whether a lack of political influence might equate to a lack of democratic control.

It’s especially unsurprising that a left-leaning finance minister, with a large electoral mandate, might see it that way.

I’m confident that Robertson remains committed to the independence of Reserve Bank decision-making – if not what we’ve come to see as the orthodox framework for those decisions.

Despite his youthful looks, he turns 50 this year and that is old enough (the same age as me) to recall the woeful mess that the country was in by 1984.

His concern for fiscal responsibility and respect for the Public Finance Act (also birthed in 1989) reassures on that front.

Robertson understands that debt has to be repaid and has resisted calls from his colleagues on the left to abandon self-imposed spending constraints

But he also firmly believes that the failures of the 1970s provoked an overly harsh reaction which has had social consequences.

He will see opportunity now in the post-Covid, Bidenomics era for a reset of some the fundamentals.

If that’s the case he’ll have a battle on his hands with traditionalists.

And he will need to be careful to keep the Reserve Bank onside.

Reserve Bank Governor Adrian Orr’s response the February’s housing remit was lukewarm to say the least.

Orr will naturally be wary of anything that he feels undermines the strength of the institution he leads.

But Orr is also the most reformist Governor the Bank has seen in living memory.

He’s largely on the same page as Robertson on numerous liberal issues, including the importance of the Reserve Bank embracing Māori Tikanga and climate change considerations.

It just may be that Robertson has history on his side here.

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