Friday, 14 September 2012

The BERL/NZ First report on the PTA (updated)

Matt Nolan has a piece up at the Infometrics website on Not a time to muddy the water: a rebuttal to the BERL/NZ First report on the PTA Matt writes,
Sifting through the report, BERL and NZ First's recommendation to scrap inflation targeting is based on a fear of "hot money". As they say, between 2002 and 2007, New Zealand saw a significant lift in private borrowing, much of which was sourced from overseas. They state that the lift in foreign lending was due to the higher interest rates in New Zealand.

However, this is only part of the story - a loan only appears when there is both a lender and a borrower. To understand the sharp increase in private debt levels, we need to ask what was driving up private sector demand for credit during this period. When we approach the issue in this way, we can recognise that the demand for credit was not the fault of interest rates being "too high".

As the Reserve Bank and, more recently, the NZIER have stated, the key issue in New Zealand over the past 40 years has been the high real exchange rate (the exchange rate adjusting for changes in prices between countries). Our persistent current account deficits and high level of net liabilities indicate that there is a significant issue in the New Zealand economy that needs to be addressed - but this is not a consequence of the PTA, inflation targeting, or interest rate setting.

The purpose of inflation targeting is to help wage and price setters set expectations of what will happen to the price of goods and services over time. The Reserve Bank controls inflation by announcing its target and adjusting the official cash rate in a way that is consistent with changes in saving and investment behaviour within the economy. The reason interest rates have had to be higher in New Zealand is due to the economic fundamentals that have driven up debt - blaming the Reserve Bank involves getting the explanation the wrong way around!
I note that in the BERL/NZ First report they say
The present Act’s primary function of controlling rising price inflation was critical when it was enacted in 1989. The world has since successfully beaten inflation. Therefore the Act is redundant.
Let us assume, for the sake of the argument, that the world has in fact beaten inflation. But so what? It may have beaten inflation now but what about the future? Isn't the point of the RB's focus on inflation that it remains beaten and we don't get any future periods of inflation?

The BERL/NZ Frist report goes on to say,
To grow the economy, the Reserve Bank actions could be used to encourage efficient production of more goods and services. This will ensure our businesses and workers are world-competitive.
How can the RB make firms efficient? What can the bank do to encourage efficient production? What does "ensure our businesses and workers are world-competitive" mean and why do we want it? This looks like more of the mercantilist "exports good, imports bad" line of (non)thinking.

Tellingly there is also no indication in the report as to how the RB's function should be changed. But it must be changed and these unknown changes would, apparently,  have great benefits for New Zealand.

Matt Nolan has additional comments on the report at the TVHE blog under the title BERL report on changing the PTA.

Update: Eric Crampton also comments here. The ODT has an article here.


paul scott said...

I am completely out of my depth here, but NZ First and others claim that $NZ is seriously overvalued.
Does this mean that they are arguing that the $NZ should be tagged in value at say 55 cents Australia.
That is along with the package of new objectives for the reserve Bank.
Is there merit in this business of getting the Bank to take an active role.

Paul Walker said...

The exchange rate is just a price. In what sense is any price overvalued? How would you tell if the price of bread is overvalued? The whole overvalued thing is thought about only in terms of exporters, but what about importers and NZ consumers who gain from a "high exchange rate"?