Monetary policy is a blunt instrument, writes Liam Dann. Photo / Getty Images
Monetary policy is a blunt instrument, writes Liam Dann. Photo / Getty Images
OPINION:
Monetary policy is a blunt instrument.
That's a line that central bankers - including Reserve Bank Governor Adrian Orr - often use to describe the limitations of interest rates as a tool for economic management.
When the Official Cash Rate is hiked hard and fast it can deliver aheavy blow to economic growth - to the point of tipping the economy into recession.
That's the big question facing Orr and the RBNZ monetary policy committee as they look to head off inflation in the coming months.
A 50-basis-point rate hike when the RBNZ delivers its Monetary Policy Statement on Wednesday is priced in as a near certainty.
Inflation (6.9 per cent) is so far outside the target zone (1-3 per cent) and unemployment (3.2 per cent) is so low that there is nothing holding the RBNZ back this month.
But from here it gets harder. And most of the focus this week will be on the RBNZ's language and forecasts - where it sees the OCR peaking in coming months.
The Reserve Bank's job is to apply just enough pressure to the money supply to cool demand in the economy and curb inflation, without killing demand and stalling growth.
It's a delicate balancing act requiring almost surgical precision - but they only have a hammer to work with.
For now there is plenty of leeway to deliver hefty blows.
But the monetary policy hammer is bigger and blunter than ever right now.
There will be a fine line between knocking the economy back on its heels and inflicting blunt force trauma in the form of recession
While a 50-basis-point hike on Wednesday only takes the official cash rate to 2 per cent, the impact will be more dramatic than in the past.
Median house prices are now double what they were the last time the country went through a significant cycle of rate hikes in 2014.
The Reserve Bank hiked the official cash rate three times in 2014 only to see oil prices collapse, deflating the global economy and forcing it to beat a retreat.
The OCR peaked then at 3.50 per cent - which is roughly where most economists now think it will peak in this cycle .
But the sheer scale of mortgage debt required means that same peak will cause more pain.
Compounding the imprecise nature of monetary policy is the delay between OCR hikes and mortgage holders feeling them.
Its data shows the average mortgage rate across the country's stock of fixed lending was only 3 per cent at the end of March.
Two-year fixed rates are already above five per cent and headed higher.
More than half the country's stock of fixed-rate mortgage lending is due for refixing this year.
That means most mortgage holders are still to feel the financial shock of rate hikes.
The other big problem with interest rates as a tool is that they only deal with one side of the economic equation - demand.
Supply-side problems - from war-ravaged energy prices to pandemic disrupted shipping costs - continue to be the primary driver of rising prices.
When these things ease is outside our local control.
How aggressively the RBNZ should beat demand out of the economy in the meantime is a politically charged issue.
Some argue that hammering the economy into recession with high rates is futile if inflation still hangs on supply pressure easing over the next year anyway.
Alternatively, others fear that if we let local inflation become embedded, we could be stuck with it even when global prices do ease.
Where does the Reserve Bank sit in the debate?
Reserve Bank Governor Adrian Orr. Photo / Mark Mitchell
Governor Orr's efforts to broaden the scope of the Reserve Bank, to address social issues like climate change and embrace te ao Māori, has seen critics portray him as a soft-focused liberal.
But when it comes to monetary policy, he remains firmly orthodox.
Moves made during the early stages of the pandemic were entirely in line with other central banks around the world.
Now the RBNZ has hiked rates sooner and more aggressively than any of its international peers.
I suspect that, like most Kiwis of his generation, Orr is hawkish on inflation and will be prepared to risk a hard landing to chase it down.
He'll certainly keep the language of the monetary policy statement aggressive this week.
Powerful language might be the most subtle tool at his disposal.
If he can manage market expectations and the world gets a break on supply issues, then rates may not need to go so high as to stall economic growth.
But if Orr needs to keep swinging the hammer, he will.
