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Dr Muriel Newman

Strange ideas on managing the economy

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Despite political sideshows, the economy remains the key issue of concern for most voters. It’s also top of the agenda for most political parties – for their own self-serving reasons.

Surprisingly, it’s the Green Party that is gaining the most traction on the issue – this is despite advocating policies that lack credibility and realism. The economy is high on their agenda because they want to broaden their constituency into Labour’s left flank.

Labour, of course, sees the tough economic times as an opportunity to undermine National’s credibility.

Much of what opposition parties are promoting does not stand up to scrutiny. Between them, Labour, the Greens and New Zealand First are trying to persuade the public to believe that the Reserve Bank Act and the other economic reforms implemented in the 1980s – are outdated and inadequate. But if the public were to look past the scaremongering, all they would find is political posturing and gross exaggeration.

The Labour Party is trying to claim that National’s economic approach is responsible for job losses in the manufacturing sector. Yet, it is the same approach they supported during the nine years that they were in government. During that time they were supported by the Green Party and New Zealand First. Neither raised serious concerns, even though the country was slipping into recession. Additionally, of course, Winston Peters spent time as the country’s first Treasurer in 1996, and failed to introduce reforms back then.

The Labour Party’s mantra is that the high exchange rate is damaging exporters and the manufacturing sector. Although our dollar is nudging US$0.82, it is worth remembering that movements in the exchange rate are cyclical. The value of our dollar usually has more to do with what is happening in other countries, than what is happening here. Back in 1979, our dollar was on par with the US, and only six years earlier, the New Zealand dollar was worth almost US$1.50.

Labour would like to broaden the Reserve Bank’s mandate to include a focus on jobs, the exchange rate and growth. At present, the Reserve Bank is charged with maintaining price stability by keeping inflation near the 2 percent midpoint of the 1 to 3 percent range. In addition, it has prudential responsibilities with regards to promoting the maintenance of a sound and efficient financial system.

With Labour’s main economic policy initiative being the introduction of a capital gains tax, it is hard to rationalise their approach, since a capital gains tax would be a new tax on business that would have a negative impact on jobs and growth – including in the manufacturing sector. In addition, Labour wants to raise tax rates even though there is overwhelming evidence from New Zealand and overseas that lower taxes encourage enterprise and initiative which increases the tax take.

The Greens, meanwhile, have called for the Reserve Bank to start printing money in a mutant version of “quantitative easing” that would be very damaging.

Quantitative easing is a tool of last resort used by central banks when they have run out of options. Normally central banks cut interest rates to encourage more lending and spending, but when rates are close to zero they may “print money” as their only other option. This new money is then used to buy Treasury bonds or long term securities from commercial banks in order to pump money into the economy. This drives down commercial interest rates and gives banks more money to lend. The theory is that the ready availability of cheaper money will boost borrowing, spending and growth.

In a speech on Friday, the new Governor of the Reserve Bank, Graeme Wheeler, explained, “We do not see any reason to adopt quantitative easing in New Zealand. Quantitative easing is being adopted by central banks that have little or no scope to lower interest rates in economies experiencing major deleveraging, and where deep concerns exist about generating and sustaining economic growth. It is a sign of desperate times for central banks, who in some instances are shouldering the burden of domestic policy paralysis over fiscal policy. Since the onset of the global financial crisis, the Federal Reserve has expanded its balance sheet by 13 percent of GDP, the European Central Bank by 16 percent of GDP, the Bank of Japan by 10 percent of GDP, and the Bank of England by around 20 percent of GDP. In all four cases the official cash rate is 0.75 percent or less. In all four cases there is little evidence of any appreciable impact on economic growth.”1

The Green Party’s quantitative easing plan would involve the Reserve Bank printing a massive $14 billion of new money all up – $7 billion to buy earthquake recovery bonds from the government to fund the rebuilding of Christchurch, and a further $7b to buy overseas assets to restore the Earthquake Commission’s Natural Disaster Fund.

But Shamubeel Eaqub, the principle economist of the New Zealand Institute for Economic Research, points out that what the Greens are proposing is not quantitative easing aimed at “trying to provide liquidity to banks to promote credit growth in the economy through the private sector”. They are proposing the “monetisation of government debt” by forcing the Reserve Bank to print money to give to the government so it can “monetise its liabilities through higher inflation”. He explains that, “A policy like that suggested by the Green Party would see the Reserve Bank’s independence thrown out the window…That kind of stuff is very much a tool used by despot autocrats around the world. It’s just one of the slippery slopes to becoming Robert Mugabe. That’s what they do: ‘We’re going to borrow all this money, and essentially we’ll get the central bank to monetise it’.  It’s tax by stealth.”2

Apart from wanting to print money, the Green Party also supports a capital gains tax, higher progressive taxes, and a range of new eco taxes – again it is difficult to see how these polices can possibly boost jobs and growth.

New Zealand First has been championing a change to the Reserve Bank Act as a way of boosting export growth. The drawing from the ballot of Winston Peters’ private members bill, “The Reserve Bank of New Zealand (Amending Primary function of Bank) Amendment Bill”, provided an opportunity to debate the proposal. I asked Dr Don Brash, the former Governor of the Reserve Bank for his reaction. In his NZCPR Guest Commentary, How many times do we have to learn what monetary policy can and can’t do, he explains that the changes being proposed would not produce the benefits claimed:

“While the Reserve Bank’s monetary policy can undoubtedly influence the nominal exchange rate it can have no … enduring effect on employment. Yes, an unexpected burst of inflation can reduce unemployment – it does that by temporarily depressing real wages.  But as soon as workers realise that their wages are rising more slowly than prices, they take steps to rectify that situation, and unemployment returns to its previous level.

“The reality is that monetary policy has an enduring effect only on prices.  Its best contribution to real economic growth and employment creation is to keep the price system operating free from the distortions caused by generalised inflation. Yes, it would be desirable if New Zealand’s real exchange rate were lower.  The best and quickest way to achieve that would be for the Government to further tighten fiscal policy by cutting government spending or increasing taxes.  This would dampen economic activity and enable the Reserve Bank to ease monetary policy without fear of inflation taking off.  The harsh reality is that a depreciation of the exchange rate only works if it effectively reduces New Zealand real wages, though neither Mr Peters nor the others who supported his bill were keen to acknowledge that.”

In their six weekly review of the Official Cash Rate (OCR) last Thursday, the Reserve Bank left the rate at 2.5 percent, where it has been since March last year. With inflation running at 0.8 percent – below the bottom of the Reserve Bank’s target band of 1 per cent to 3 per cent – the rate is expected to stay on hold until September of next year.

The crucial point it that if the New Zealand economy stalls and needs a boost, with the OCR at 2.5 percent, the Reserve Bank has 10 unused notches for reducing interest rates. In other words, the call by the Green Party to print money is needless and reckless.

Compared with many other countries, New Zealand is not doing too badly.  While many of our trading partners are still battling recession, our economy is growing at an annual rate of 2 percent. In the year to June growth averaged 2.6 percent, but is expected to fall back in the second half of the year. We also have a number of other major advantages. According to the World Bank, we rank eighth in the world for natural capital – which includes our farmlands and forests – with only oil-producing countries ahead of us. New Zealand is regarded as the least corrupt country in the world according to Transparency international, and the World Economic Forum ranks us among the best for the quality of our institutions and the efficiency of our product and financial markets.

The government also appears to be serious about growth, with many new measures aimed at that outcome. The grievance-free 90 day trial period is making it easier for businesses to employ new workers. The 6-month youth wage will help younger workers to get their foot on the first rung of the employment ladder. The planned reforms of the Resource Management Act are meant to speed up consent processes to encourage local development and jobs. If new mining and mineral exploration ventures go ahead, they will lead to new export opportunities and jobs. The changes to improve home affordability should lower the cost of building and encourage more families into home ownership. The infrastructure development programme, which includes roads and ultra-fast broadband, will not only help businesses to become more productive and the economy to grow, but is also providing thousands of additional jobs. And if the government’s focus on lifting New Zealand’s productivity is successful, it could significantly improve our long-term prospects.

The reality is that New Zealand is a small country located far from our larger trading partners. The more the government can remove bureaucratic constraints on growth, the better businesses will be positioned to compete and grow – and adapt to the global economic forces that buffet us.

Finally, a touch of realism. To bring down the dollar, the Reserve Bank Governor explains what is needed – and it doesn’t include a capital gains tax, an increase in the top tax rate, a reduction in wages and living standards, nor printing money: “In order to achieve a sustained reduction in the New Zealand dollar it would be necessary to alter the overall level and pattern of saving and investment in the economy. In particular, it will be necessary to tackle our addiction of depending on foreign savings to finance our consumption and investment. This dependency means that we have persistently needed interest rates above those in most developed economies to maintain inflation at target levels similar to those being followed elsewhere. Policies that increase domestic savings, including reducing the government’s fiscal deficit, and to reduce the flow of resources into the public sector and other non-tradables sectors, would help to achieve a sustainable reduction in the exchange rate.”

  1. Graeme Wheeler, Central banking in a post-crisis world
  2. Alex Tarrant, NZIER’s Eaqub: Greens’ quake bond buying policy not QE; It’s the sort of ‘debt monetisation’ practised by Mugabe; Will see poor pay for quake rebuild via inflation