Adrian Orr and Grant Robertson were careful this week to ensure their talk of monetary policy reforms didn’t scare the horses in the economy and markets. Bernard Hickey analyses their ‘horse whispering’ and the reforms.

Finance Minister Grant Robertson and incoming Reserve Bank Governor Adrian Orr were cautious this week to paint their first Policy Targets Agreement (PTA) and planned reforms to the 1989 Reserve Bank Act as evolutionary and unlikely to either endanger low inflation or the bank’s independence. The jury remains out on both of those aspects because a lot will depend on how the new Governor interprets his new semi-dual mandate and whether a new committee structure for official cash rate decisions castrates the power of the bank.

Their talk this week was soothing and may indeed lead to little real change, but it may also disguise a more fundamental disruption to a bank that has been an operationally independent and strict inflation-targeting pioneer for nearly 30 years. A lot will depend on Orr’s approach, which is unclear, and his chemistry with Robertson. So far, their whispering has been in tune, but Orr is known for his strong views and taking stances that can conflict with the orthodox. Robertson was thrilled to announce Orr’s appointment before Christmas, but has no guarantee Orr will take the Government’s preferred approach of running the economy hot enough to drag unemployment below four percent.

Orr’s very early comments suggested he sees few problems to solve in an economy that still has 122,000 people who want a job (4.5 percent of the workforce) and another 122,000 people who are categorised as working part time but wanting more work. That under-utilisation rate, which includes people not immediate seeking a job but available for work, is still at 12.1 percent of the workforce. Under-utilisation fell to 9.0 percent in late 2007 and unemployment fell to 3.3 percent. That previous low is well below the current 4.5 percent rate and below the 4.0 percent that the Government has said it wants to push unemployment.

Orr was particularly cagey when asked about his views on whether monetary policy had been run too tightly in recent years and whether the new maximum employment language in the PTA would necessarily mean looser policy to try to drag unemployment lower.

Orr said he was happy with where the economy was at the moment.

“I’d say that we are running a very, very healthy economy at the moment,” he said.

He said that most of the time, the new employment mandate should not make too much of a difference to the bank’s decision.

“It’s always going to be conditional on the issues,” he said, “in general times it shouldn’t make too much of a difference”.

What the horse whisperers said

In summary, they kept the two percent mid-point of the bank’s target range for inflation, did not indicate any imminent loosening of policy to ramp up employment growth, and made no comments suggesting they thought full employment was much lower than the current 4.5 percent unemployment rate. Their vagueness about what the new guidance about ‘supporting maximum levels of sustainable employment’ meant, and Orr’s comments about the economy being “very, very healthy at the moment,” suggested he was disinterested in heating it up any further at the moment.

They also stuck with plans to not allow independent members of a monetary policy committee to talk publicly or to identify their votes in any minutes. That assuages Reserve Bank concerns the public debate would create a “circus.”

Somewhat surprisingly after years of an over-valued currency, they made no mention of the currency’s value, although it remained as one of things mentioned in the ‘avoiding instability’ section of their Policy Targets Agreement.

There was one change though that could suggest an ‘easier’ approach to running monetary policy. The section in the PTA referring to monitoring asset prices was removed, which in theory would reduce the pressure on the Reserve Bank to hike interest rates in response to another house price boom.

The Reserve Bank has been careful in the past not to directly link interest rate hikes directly to house price booms or preventing more booms, but has said it was a factor the bank watched, particularly in the days when home owners were withdrawing a lot of equity. The bank’s focus on house prices has been more closely linked to its operation of macro-prudential policy, which is aimed at protecting the stability of the banking system in the event of any price crash.

However, if there was either a slump or another boom, then the Reserve Bank would be free not to take it into account under this PTA.

Finally, they downplayed the changes planned for later this year in the current internal committee system for deciding interest rates to including an observer from Treasury on the committee. This has been seen as something of power nudge rather than a power grab. The Treasury official won’t be able to vote, although they would be able to report back to the Minister on the nuances and detail of the board meeting. The public would get a blander version of the minutes that did not include detail that identified the different views expressed. The decisions not to allow independent member comment, named votes and only an observing Treasury official would have mostly pleased the Reserve Bank’s officials, who argued against any moves for external appointees or debate. The only wrinkle was the Treasury observer.

Orr pointedly thanked his Reserve Bank colleagues at the beginning of the announcement, including his most senior deputies Geoff Bascand and John McDermott.

Why Labour doesn’t want scared horses

If there’s one theme of this Government when dealing with the economy and business since its formation in late October it has been: ‘don’t scare the horses’.

Prime Minister Jacinda Ardern and Robertson, who are very much the double act on the economy, have been very conscious of avoiding another of 1999/2000 style ‘winter of discontent’.

The then new Labour Government of late 1999 launched into an aggressive re-write of labour laws and was openly scornful of the involvement of big business in the political and economic convulsions of the late 1980s and early 1990s that rewrote the DNA of the economy and tore the Labour Party apart.

That triggered a slump in business confidence going into the winter of 2000 and sparked what some described as an investment strike. Eventually, then Prime Minister Helen Clark and Finance Minister Michael Cullen dialled back on the anti-business rhetoric and brokered a peace of sorts as economic growth surged. But Ardern and Robertson, who both worked in Clark’s office, were wary of triggering a repeat this time around that might hurt economic growth and confirm any preconceptions that a Labour-New Zealand First coalition was not a good economic manager.

So their economic moves and comments since October have been focused on ‘not scaring the horses’, particularly in the wake of the November publication of ANZ’s monthly business confidence survey showing a slump in confidence about the wider economy to a nine year low.

One of many soothing noises

So far, the Government has softened its plans to remove the 90 day trial period by leaving it in place for employers with less than 20 staff, it has stuck to its fiscal responsibility rules rigorously, and has taken a softly, softly approach to tighter immigration rules.

But arguably the biggest soothing noises to keep the horses calm has been around proposed changes to the Reserve Bank Act, which has underpinned our economic landscape since 1989.

On the face of it, the planned move to a dual mandate that includes maximising employment and a committee-style system for official cash rate decisions is a complete break with the 1989 Act that removes the single inflation focus and the complete independence of the Governor.

The Government’s aim to reduce unemployment from 4.5 percent currently to under four percent has raised fears among some that this Labour Government will sanction an over-heating of the economy that drives inflation towards the upper end or over the 1-3 percent range.

Many believe that’s what happened in the final two or three years of the last Labour Government when Alan Bollard was the Reserve Bank Governor and when unemployment got down to 3.3 percent in the December quarter of 2007. Underlying inflation (the Reserve Bank’s sectoral core inflation is one proxy) averaged 2.7 percent through the 1999-2008 Labour-led Government and averaged 3.2 percent in the last three years.

One consequence was the decision by then Finance Minister Bill English and his then-new Reserve Bank Governor Graeme Wheeler to specifically focus in their 2012 Policy Targets Agreement on the 2 percent midpoint of the 1 to 3 percent range to effectively drag inflation from the highs Wheeler inherited.

Wheeler then ran a more hawkish monetary policy than Bollard, hiking rates in 2014 to ‘get ahead of the curve’. In retrospect, that move was premature as inflation failed to materialise and he had to reverse the hike from 2.5 percent to 3.5 percent through 2015. He had to go even further to the current 1.75 percent through 2016. Core inflation averaged 1.4 percent during Wheeler’s term, meaning he ran monetary policy in a way that effectively halved the inflation rate.

The concern is that Orr, with the approval and help of Labour, would look to reverse that move and drag inflation up by heating up the economy to push unemployment lower.

New Zealand First has also talked repeatedly about a much wider reform of the Reserve Bank to a Singaporean-style central bank that targets the currency rather than interest rates. The coalition agreement eventually included a much vaguer reference to reforming the Act and including a employment mandate alongside the price stability target.

Inflation ‘more equal’ than employment

Orr and Robertson described their Policy Targets Agreement as a bridge to the dual mandate situation after the Reserve Bank Act changes, but it’s clear that the employment part of the dual mandate is not yet as strong as the inflation part of the mandate.

The key phrase gives employment secondary priority to employment, as specified in the current act. The exact make-up of the reformed Reserve Bank Act will specify just how ‘dual and equal’ the next PTA will be.

Their first PTA makes clear that the inflation target is more equal than the others. The bolding is mine.

“The conduct of monetary policy will maintain a stable general level of prices, and contribute to supporting maximum sustainable employment within the economy,” according to clause 1a of the agreement.

The second section also continues to give much more specific meaning to the inflation target than the employment target.

“The policy target shall be to keep future annual CPI inflation between 1 and 3 percent over the medium-term, with a focus on keeping future inflation near the 2 percent mid-point,” according to clause 2b.

There is no such specific target for unemployment or employment.

No ‘genius of hindsight analysis’

We asked Orr and Robertson what they thought maximum sustainable employment meant, or if there was a level that could be targeted. Both were cagey, although Robertson repeated the Government’s pre-election view that it wanted to get unemployment under 4 percent. Orr did not repeat Robertson’s 4 percent view specifically, but did express broad agreement with Robertson around the Government’s view.

They both referred to maximum employment as a ‘dynamic’ indicator that could be shunted around by all sorts of things outside the Reserve Bank’s control, including technology change and government policies around education and welfare.

He would not say whether he thought monetary policy had been too tight in the last five years.

“I haven’t done any of that genius of hindsight analysis,” he said.

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