Is the Reserve Bank’s blunt tool fit for purpose?

Time for a rethink on the mandate for taming inflation, argues Bernard Hickey.

The last couple of rate decisions by the Reserve Bank have attracted unusual heat, with economists differing on whether it is time to lift the base rate. 

In May, the Monetary Policy Committee itself was split down the middle, with the official cash rate ultimately being held thanks to the casting vote of governor Anna Breman. Economists including Shamubeel Eaqub of Simplicity and KiwiBank’s Jarrod Kerr urged a repeat last week, but the MPC was not for holding, with the first rise in three years nudging the rate up to 2.5%. 

In doing so, the decision makers were acting with inflation in mind. Their objective, which they are tasked to pursue independently from the government of the day, is to target inflation at 2%, within a bracket of 1% to 3%, with an eye on the medium term.

The mechanism, which has evolved since the enactment of the Reserve Bank Act in 1989 – a pioneering push to independence in monetary policy, as driven by Roger Douglas and championed by Ruth Richardson – is not without its trade-offs. It has meant, as one former governor acknowledged, the need to sometimes engineer a recession. 

And it can mean the jobless queue grows. 

The reason this most recent rates increase is controversial, said Bernard Hickey, speaking to The Spinoff for the podcast At Large with Toby Manhire, is because “the economy feels like it’s still flat on its back. And the idea that you’re putting up interest rates when unemployment is 5.4% and youth unemployment is in some areas over 20% … It’s quite a thing to be putting up interest rates when a whole bunch of young people are unemployed.”

The central bank acknowledges the difficulty of such decisions, but, as Breman put it, “in the long run it will make growth come back and also give us a stronger labour market”.

For Hickey, however, there is something broken in the architecture of the rules that sit beneath. “I think the Reserve Bank Act should be repealed and replaced with something that acknowledges the Reserve Bank can’t shift inflation that much, and that responsibility for low inflation should be with a government,” he said. 

“There are lots of things the government can do to lower inflation and to improve the productive capacity of the economy, and it should be the government’s responsibility, and therefore ultimately voters’ responsibility,” said Hickey, who writes the Kākā newsletter on Substack. 

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“There’s a whole bunch of people have been quite happy to shove the responsibility for low inflation off to the Reserve Bank, who’ve then used that blunt tool to hit some other people, and there’s a whole bunch of people who’ve done quite well out of this situation, but the ones who haven’t are the ones who don’t have assets and have been young and have missed out on the asset price explosions of the last 20 or 30 years, driven partly by falling interest rates, falling inflation, and the controls on the number of houses that we could build, and that’s a problem.”

The Reserve Bank Act, together with its cousin, the Public Finance Act, had delivered “intergenerational unfairness”, said Hickey. It was time to look at replacing them with “legislation that specifically prioritises the interests of the youngest and those who are struggling the most, and you can do that with inflation, with investment in infrastructure, investment in training, all sorts of ways. But I just don’t think that the model created by Douglas and Richardson has actually worked.”

Hickey lays out his case in more depth on At Large with Toby Manhire, available, which you can find on your podcast feed: follow here for Spotify, or here for Apple. It’s all on YouTube, too. Subscribe to the Spinoff here and find all the episodes here. ...