Liam Dann: An idiot's guide to the Official Cash Rate

You don't need to be the top student in class to get the OCR. Photo / Getty Images

Next Wednesday at 2pm, the nation’s media will pause briefly for the Reserve Bank’s call on the Official Cash Rate or, as we say in the game, the OCR.

But what is the OCR and why does it matter?

It's a good question and one that I was asked to answer for an "explainer" video last week.

Nothing makes you feel more like an idiot than writing an idiot's guide.

What is the OCR? What is an interest rate? What is money ... Ahhh!

It's easy to tie yourself in knots with ever-deeper definitions.

After 3000 years, philosophers still argue about how to define an argument.

There's always another level you can go to in explaining the mechanics of things.

But at the other end of the scale is the idea of a workable definition - a non-specific, collective understanding we use to just get on with things.

As a working definition, I like the idea that the OCR is the wholesale price for lending and borrowing money.

Most people get that the OCR is an interest rate.

It's the baseline interest rate, the starting point for banks before they add their margins.

How the Reserve Bank controls that rate is where is gets more technical.

The big retail banks hold accounts with the Reserve Bank and these accounts are used to settle transactions at the end of the day.

When you buy something electronically or with cheque there's usually a transaction between two banks that needs to be settled.

The accounts with the Reserve Bank are used to cover transactions that haven't yet been matched up at the end of the day.

By fulfilling that function, the Reserve Bank is able to both charge and pay interest. And by doing that, at the lowest available domestic rate, it effectively sets the floor for all other domestic interest rates.

Why is it so important for the Reserve Bank to have that control?

Well, primarily, the Bank's job is to keep inflation under control. In other words, to maintain price stability.

It's hard to do business, or even run a household, if you can't be sure what a dollar will buy next month.

In extreme cases - like the hyper-inflation that hit Germany in the 1930s - things spiral out of control and the public loses confidence in the value of money.

This seldom ends well.

Since 2018, the Reserve Bank has had a dual mandate; it now also has to keep an eye on unemployment and ensure monetary conditions aren't so tight they are costing jobs.

But given that both inflation and unemployment levels are relatively benign these days, why do why do we still care so much?

Obviously there is the impact on our back pockets.

If the OCR drops, mortgage rates usually follow. That's good news for homeowners - it effectively puts cash back in their pockets.

But it's bad news for savers.

Another reason we care is the effect on the international value of our currency.

Investors who can move money around the world tend to prefer countries with higher interest rates - as long as they're politically stable.

So when the OCR goes up so does our dollar, and when it goes down the dollar generally follows.

For an export-led economy like New Zealand, this can be very important (not to mention your upcoming overseas holiday).

But the Reserve Bank's control is pretty limited. International currency markets are vast and influenced by many factors.

So, for me, it's as a barometer of the economy that an OCR decision gets really interesting.

It sends a clear message to the world about where New Zealand is at in the circle of economic life.

If the economy is slowing or stalling, the Reserve Bank will cut the rate to try and increase the flow of money.

If it is overheating, rates will go up.

Unlike the forecasts that most economists and journalists make, it is a forward-looking judgement call with real impacts.

And next Wednesday is shaping up as a big one. It could go either way.

Well, spoiler alert: It won't go up.

The rate will either be cut or stay the same.

With so much conflicting data out there right now, how bad is the economic outlook really?

There is certainly room for interpretation.

Economists currently are split (about 60-40 per cent) in favour of a cut.

If you don't think that sounds exciting then I'm guessing you probably didn't cover the 24 OCR decisions between April 2011 and January 2014 - for which no change was expected and no change was made.

Former Reserve Bank Governor Alan Bollard announces the Official Cash Rate will remain the same during a press conference in June 2012. Photo / Mark Mitchell

Like watching test match cricket play out to a draw, that was a good time for the purists.

All the tension hung on subtle wording changes in the Governor's statement ... usually in the second-to-last line.

"He said 'for some time' instead of 'the foreseeable future'," we'd shout to our editors.

Much of the impact of an OCR call is tied to expectations. Governors have to tread a fine line between predictability and inconsistency.

Current Governor Adrian Orr has shown he's not afraid to surprise markets with both words and actions (the Reserve Bank made a double 0.5 per cent cut to the OCR in August).

Which raises the prospect a fascinating show next week. Tune in.