New Zealand. Economic and political structure in brief

Financial University

Under the Government of the Russian Federation

Chair of Macroeconomics

 

 

 

 

 

 

 

Laboratory work on Macroeconomics

Monetary Policy of Reserve Bank of New Zealand

 

 

 

 

Prepared by:

Stopnikov Nikita the student of

Finance University under the government of the Russian Federation

IFF the 2nd course student group 2-1

 

Tutor:

Vladimir Skalkin

Finance University under the government of the RF

Chair of Macroeconomics

Candidate of Economics

 

 

 

 

Plan:

 

1. Introduction…………………………………………………………...3
2. Literature review………………...……………………………………6
3. New Zealand. Economic and political structure in brief………….…..9
4. The Reserve Bank of New Zealand………………………………….11
5. Analysis and interpretation of data……………………….………….16
6. Conclusion and a look forward…….………………………………...45
7. List of References……………………………………………………48
1. Anti-plagiarism………………………………………………………49 
   Introduction

In today’s world, the Governments, the business and investment community, and the general public have no doubts about the importance of the role of policy makers in shaping the financial and economic events. If successful, the policies can make a significant contribution to the nation’s prosperity. If not, the effect of the wrong policies can be to ruin the economy, even with a lot of potential. The effect of the wrong policies can sometimes be compared to the effects of a destructive war. Monetary policy is the set of tools that are used mainly by the Governments or central banks if these are independent of Governments.

What is noticeable, each country has quite distinctive features of monetary policy compared with other countries. For instance, in Russia, monetary policy has been for a long time aimed at managing the Ruble exchange rate. In the United States of America, monetary policy tools are frequently used when GDP growth or unemployment is a matter of concern for the US administration. In Europe, Australia and New Zealand the central banks’ primary concern is the level of inflation1. However, in almost all counties (Russia being perhaps the only exception among the G8 nations), monetary policy was also aimed at controlling the economic cycle. In Russia the monetary policy until recently had little reference to what was happening in real economic life. The refinancing rate of the Central Bank of Russia was set and changed more or less regularly2. However, the effect of these changes on the economic events (which is the reason monetary policy steps are taken in the first place – to change the course of events) had been minimal. It is encouraging that recently the Central Bank of Russia has been taking a firm position on its role as the principal regulator of the economic environment. It is also encouraging that the Central Bank is moving towards realization of the fact that it should have the primary responsibility in maintaining the overall level of prices with the help of monetary policy instruments.

In my opinion, it would do much good for the Russian economy if the Russian Central Bank kept an open mind and was willing to use the policy instruments, which have proved to work well in other countries with open economies. In addition, it would also be beneficial if the administrative environment of such open economies was examined and some elements perhaps even copied directly into the Russian banking and financial system, and the economy in general.

New Zealand, despite being a very small country, serves as an excellent example in many areas, for other countries to follow:

• It is an economy open to the world, i.e. the country is not an autarky, it actively engages in foreign trade;
• The institutions and laws in New Zealand are among the best in the world, where businesses and households have confidence in the system’s ability to self-correct and self-regulate;
• Government intervention in the economy is minimal, but when it is required, the Government and the Reserve Bank of New Zealand are ready to step in with policy initiatives, which could help the markets;
• The country is so respected in the international community that it regularly shows in the Top 10 of the Doing Business ranking. In 2011 New Zealand was awarded the Most Peaceful Nation title, and the World Bank placed New Zealand at overall No 3 position in its 2014 assessment for the second consecutive year3.
• The Reserve Bank of New Zealand is openly accountable for its policy decisions4. On the other hand, the Bank never engages in anything, which would take its attention and effort away from the main policy goal – overall price stability as measured by the rate of inflation. The Bank of course keeps track of all the major economic indicators, including GDP growth and unemployment levels, but it openly states that it is outside the Bank’s competence to influence the unemployment levels, for example, or the long-term GDP growth5, because these indicators depend on factors largely outside its control.

 

Overall, the country’s position in the world is determined, among other things, by how truthful the actual policies were, compared to the declarations, and how successful the declared policies have been, when time comes to consider the actual policy results. Here, again, New Zealand offers an example to follow.

In this paper, I will begin with a brief review of the literature, which has been covered during preparation of this paper. I will continue with a brief outline of New Zealand economic and political structure. The next section will deal with some analysis and interpretation of data for different periods of time, and explain what the monetary policy decisions were, and why they were taken. The analysis will be supported by official statistics modified where appropriate and presented in graphical form so that it is easy for the reader to visualize. I will conclude with an opinion as to the success of the policies, and with some projections which have been developed in respect of New Zealand for the future.

 

 

 

Literature review

Paul Krugman and Robin Wells in “Macroeconomics” (second edition) outline the consensus thinking in monetary policy theory. That is, in the long run, changes in the money supply do not affect real GDP or the interest rate, and ultimately, monetary policy is ineffectual in the long term. But in the short run, monetary policy can successfully address output–demand imbalance through monetary policy instruments, such as inflation targeting and the use of central banks’ power to affect interest rates.

Mr Alan Bollard, who was the Governor of the Reserve Bank of New Zealand until September 2012, wrote in that month for The Banker magazine in his article “New Zealand learns from the sidelines of the crisis”. On the whole, he subscribes to the above traditional view. “The crisis experience has raised questions around whether we can still rely on orthodox monetary policy to work in the traditional way. In New Zealand’s case, we think so”6.

Thomas I. Palley with the German Macroeconomic Policy Institute, challenges this view. His “Monetary Policy and Central Banking after the Crisis: The Implications of Rethinking Macroeconomic Theory.” states that “The financial crisis and the Great Recession have prompted a rethink of monetary policy and central banking… The insider reform makes no changes to macroeconomic theory and is uncritical of the central banks’ pas actions… The outsider program fundamentally challenges existing macroeconomic theory and is also highly critical of the central banks. They should have a duty to shape the allocation of credit and the financial system in ways that ensure growth, full employment and a fair shake for all”7. “The paper’s critique of existing monetary policy and central bank practice and it recommended reforms are focused on the US Federal Reserve. However, the principles that are articulated and many of the proposed reforms carry over to monetary policy and central banking everywhere, including the Bank of England and the European Central Bank”8. For the Reserve Bank of New Zealand, which has been following the traditional line of thinking, this means that it is also subject to the same criticism.

The Bank’s Board of Directors in its ”Explaining New Zealand’s Monetary Policy” naturally disagrees with such a radical proposal and states that “Growth in an economy is driven by many factors, most of which have nothing to do with monetary policy… Over the long run, an economy’s performance is ultimately determined by productivity… Employment is maximised by having the economy operate as productively as possible. Price stability can assist, but it is far from the only factor affecting employment. For example, educational standards, skill levels, labour laws, and social policies can all increase employment levels, and these things have nothing to do with the Bank’s operation of monetary policy”9. The Bank’s position is that its primary concern is as stated in the Reserve Bank of New Zealand Act 1989 – to maintain the price stability with low inflation.

The Board of Directors of the Reserve Bank of New Zealand had also agreed on the place and role of the Bank in a wider context, that is, in macro-prudential regulation. The Board thinks that “When selecting an appropriate instrument, an important consideration will be the effectiveness of the instrument in meeting the policy objectives given the particular risks facing the financial system at that time… In some cases, the optimum response might involve using more than one instrument…”10

Rebecca Jackson-Young (lead analyst) and Fung Siu (analyst) of the Economist Intelligence Unit have provided an outlook for the New Zealand Economy in their November 2013 overview of political, social and economic risk assessment for the country for the foreseeable future.

Alan S. Blinder, Michael Ehrmann, Marcel Fratzscher, Jakob De Haan and David-Jan Jansen of the European Central Bank in “Central Bank Communication and Monetary Policy: A Survey of Theory and Evidence” maintain that on the whole, transparency and clarity in communication by the Central Banks could not only dispel public fear or misunderstanding of what central banks do and why they do it, but also make the monetary policy more effective11. New Zealand is commented on by the ECB as an enthusiastic pioneer and an example to follow.

The Reserve Bank of New Zealand Act 1989 governs the activities of the Reserve Bank through legal provisions. They concern different areas, such as the purpose – to establish that the Reserve Bank of New Zealand (RBNZ) has the overall responsibility for monetary policy, maintenance of a sound and efficient financial system, and carrying out other functions, appropriate to the nation’s Central Bank12. The Act also defines the principal terminology, the internal structure of the Bank, the role of officials and such functions such as the principal executor of the monetary policy, regulator in the macroeconomic area, foreign exchange, issuing of currency, and banking supervision.

The official data and announcements from the Reserve Bank of New Zealand, such as Monetary Policy Statements and supporting downloads on the website provide first-hand information on New Zealand economy and its main indicators over historically significant period of time, of which five such announcements are covered in the paper. Graphical support, prepared by the author of this paper, enable better visualization of economic trends in the country over the last ten years.

 

2. New Zealand. Economic and political structure in brief.

Background: New Zealand is a small country of only 4.5 million people (that is less than one half of the Moscow city). It relies in large part on agriculture, which is also its main export item. New Zealand is actively trading with the USA, Australia, UK, Japan and China, as well as with other East and South-East Asian countries. Some economic statistics are given in the table below13:

GDP in 2012 (USD billion)	169.7
GDP per head (USD at market exchange rates)	37,869
Historic average GDP growth (2008-2012)	1.0%
Inflation	2.7%
Public debt (USD billion)	71.2
Public debt as % of GDP	46.5%

The country is focusing on reconstruction efforts after the devastating Christchurch (Canterbury region) in February 2011. There was a significant loss of life and a lot of damage to property caused by this earthquake. The Government sees its job in strengthening the state finances, improving the country’s economic performance and productivity and the environment of regulation. Many previously state-owned assets are now being privatized. The taxation level is relatively low, with personal income taxes starting at 10.5% and the top rate of 33%. This is similar to the United States, but lower than the top marginal tax rates in the Continental Europe (over 50%) or the United Kingdom (45%). The indirect taxation is represented by GST (Goods and Services Tax, the equivalent of VAT) at the standard rate of 15% on final purchases of goods and services. This level is above the sales taxes in most states of the USA, but lower than the Value-Added Tax in most European Countries and Russia.

Major exports are dairy products (25%), meat products (11%) and forestry items (9%). The leading export markets are Australia, China and the USA. Major imports are machinery (20%), mineral fuels (18%) and transport equipment (12%), and the country mainly imports from the same partners, although in imports China takes first place, Australia second, and the US – third. 

Political structure: New Zealand is part of the Commonwealth of Nations and is a democratic state. The latest government was formed following the November 2011 general election, by the Prime Minister, John Key. The political and social environment is stable with no major turmoil expected over the foreseeable future. The Prime Minister is widely expected to hold on to his job at the next general elections, although, as with many other countries, the Government regularly faces criticism from the Opposition.

 

3. The Reserve Bank of New Zealand

The Reserve Bank of New Zealand (RBNZ as it may be referred to hereafter in this work) will be 90 years old in 2014. It operates under the Reserve Bank of New Zealand Act of 1989. It is owned by the Government but is independent from the Government in making the monetary policy decisions.

The Bank’s current Governor is Mr. Graeme Wheeler. He replaced the previous Governor, Mr. Alan Bollard, in September 2012.

It is written in the law that “…the primary function of the Bank is to formulate and implement monetary policy directed to the economic objective of achieving and maintaining stability in the general level of prices”14. The main mechanism through which the bank conducts the monetary policy is the Official Cash Rate (OCR). This rate is set to influence the interest rates in the market in the short term. The Bank can lend overnight funds at 0.25 per cent above the OCR to banks, and on the other hand, the Reserve Bank can take deposits from banks at OCR less 0.25 per cent. The Bank has no limit on how much it can borrow or lend in the market at these rates. This creates a good mechanism to ensure that the level of the interest rates in the market is as close to the OCR as possible.

Adjustments to the official cash rate are made eight times a year. There is no obligation on the Bank to change the Official Cash Rate at any time. On the other hand, the Reserve Bank of New Zealand can make unscheduled adjustments, but does not usually do so unless in really exceptional circumstances.

The Reserve Bank of New Zealand is also responsible for, and engages in, macro-prudential regulation. This is a broader role and is aimed at taking measures to preserve wider economic stability (for example, to hold back economic risk-taking in good times, to prevent appearance of asset price bubbles, or to improve standards of performance by the country’s banks15.

The Bank has long subscribed to the view that its functions in the economic system should be limited to those, where it is naturally the most competent agent to provide direction and regulation – the financial and banking system. The policy tools which the Bank considers should be regularly used, are also standard – mainly the policy rate adjustments and general banking supervision. In other words, the Bank considers its role as specific.

This view and policy making attitude have been subject to a growing criticism from the group of economists who subscribe to alternative views. These views were recently restated by Thomas I. Palley in his Working Paper for the German Macroeconomic Policy Institute No 8/2011. The institution most criticized was the Federal Reserve of the United States, however, it is evident that most Central Banks (including the Reserve Bank of New Zealand, the European Central Bank and the Bank of England) and the monetarist theory in general are all targets of this criticism.

Mr. Palley’s and his colleagues’ view is that the current rethink of monetary policy and central banking (called the “insider rethink”) does not go far enough as it only scratches the surface of the problems which culminated in the Financial Crisis of the late 2000s. In particular, the argumentation is as follows:

1. There is already a reform proposal (the “insider rethink” mentioned just above), but this proposal does not mean a change in macroeconomic theory;
2. The actions of many of the Central Banks, including the Federal Reserve, during the crisis are justified16;
3. The focus of the “insider rethink” is narrow – namely, (a) monetary policy and asset price bubbles; (b) regulation in monetary policy; and (c) zero limit to the nominal interest rate17.
4. Finally, the scholars claim that the proof of the need for deeper reform is that actions of many of the Central Banks have been unsuccessful. They may have succeeded in preventing the new economic collapse similar to 1930s, but, on the other side, the social cost of this was too great in the form of budget cuts, and significantly higher unemployment than before the crisis. These unemployment levels are still high today.

What they propose is the “outsider reform program”, which would focus on the following:

1. Governance of central banks and their independence
2. Changing the economic philosophy of central banks;
3. Big reform of the monetary policy, which would include adoption of an inflation target equal to the minimum unemployment rate of Inflation (MURI)
4. Other measures of the technical nature, such as asset-based reserve requirements;
5. Regulatory reform18.

I would like to briefly describe only points 2) and 3) because point 1) has been subject of numerous debates for many years in many countries, and there is probably no right or wrong answer that can be stamped on any given economy. Point 4) deals more with central banks’ regulatory and supervision role in the financial system, and point 5) has been going on in different countries at different speeds in different directions since the Financial Crisis started.

Changing the economic philosophy of the central banks.

Mr. Palley argues that the current thinking makes the central bankers favour only one range of outcomes of the monetary policy – they have a “preference for low inflation to protect financial wealth”19. Meanwhile, industrial capital will have a preference for a stronger real economy and lower unemployment. Workers of course will want full employment and higher real wages. Central bankers tend to side with the interests of financial capital, so the central banks will tend to favour macroeconomic outcomes, which have higher unemployment and lower inflation. This is a point lower on the Phillips curve. It is claimed that a central bank will more likely choose too low inflation, and if the economy has a negatively sloped Phillips curve, this causes permanent output losses and permanently higher unemployment20.

Mr. Palley says that this bias of the central banks in favour of the financial capital interests should be reversed, and that the central banks must fully represent competing interests so that a socially optimum inflation – unemployment outcome can be achieved.

Monetary Policy Reform

Mr. Palley’s proposition is rather radical – central banks should adopt such inflation targets that a point can be reached where the sustainable rate of unemployment is minimal. In his view, the Phillips curve, showing the trade-off between unemployment and inflation, is backward bending and central banks should redirect their policies 180º. That is, to make inflation rate a subsidiary indicator, and the unemployment rate – the primary target. He also proposes a term for this level of inflation – the minimum unemployment rate of inflation – or MURI. This is the opposite of NAIRU – non-accelerating inflation rate of unemployment. The backward bending Phillips curve and the MURI are illustrated in the graph below21.