Central banking in a post-crisis world

Pursuing price stability and financial system stability is the best way that the Reserve Bank can bolster New Zealand’s long-term economic growth, Reserve Bank Governor Graeme Wheeler said today.

In a speech to the Admirals’ Breakfast Club in Auckland, Mr Wheeler said New Zealand should be capable of better economic growth given its tremendous assets. But as a small open economy, it is continually buffeted by external economic and financial shocks.

“New Zealand needs to reverse the slow-down in multifactor productivity growth and the decline in value-added in our tradables sector, and reverse the shift of resources into the public sector and non-traded activities,” Mr Wheeler said.

He noted that large central banks in many advanced countries are operating in new territory with unprecedented policy settings.

“Price stability and financial stability remain the Reserve Bank’s central objectives for monetary policy and prudential policy. These provide the best framework for achieving stronger growth in output and employment in the longer term,” Mr Wheeler said.

“The recent Policy Targets Agreement (PTA) reinforces the importance of price stability, and introduces the goal of keeping future average CPI inflation near the 2 percent mid-point of the 1 percent to 3 percent target range. Over time, attaining this outcome should help to anchor inflation expectations around the mid-point.”

In the wake of the Global Financial Crisis, central bankers and fiscal authorities are now more conscious of potential risks and possible flow-on effects to the banking sector. Mr Wheeler said the Reserve Bank has placed a high priority on strengthening New Zealand’s prudential regime, including introducing macro-prudential instruments and having an Open Bank Resolution capability in place.

He said New Zealand does not require quantitative easing: the economy is growing at an annual rate of around 2 percent, and the Reserve Bank has scope to lower interest rates if needed.

“New Zealand is one of several countries that have experienced upward pressure on its exchange rate in recent years. Ultimately it is the relative rates of return between New Zealand and the rest of the world that explains the strength of the New Zealand dollar,” he said.

The Reserve Bank would like to see a lower exchange rate “provided it can be achieved without damaging price and financial stability”.

Mr Wheeler said that foreign currency intervention is unlikely to have a sustainable effect on the NZ dollar, although it can have an impact in the short term.  The Bank will remain vigilant on its criteria for intervention, and will be prepared to intervene if all its conditions are met.

“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.”

“Monetary policy by itself cannot deliver quick fixes to achieve and sustain more rapid economic growth, lower unemployment, or maintain a lower exchange rate.  Other policies are central for achieving these outcomes but when they are applied monetary policy can be supportive of them.”

A copy of the speech is available on the Reserve Bank website at http://www.rbnz.govt.nz/speeches/5005204.html