Bollard under the microscope

Alan Bollard. Photo / Mark Mitchell

Alan Bollard's "go for growth" approach early in his tenure as Reserve Bank Governor set us up for both the unsustainable boom of the last decade and the recession that followed, says economist Rodney Dickens.

In the first of a three-part critique of the current monetary policy framework Dickens, a former Reserve Bank staffer and head of research at ASB who now runs consultancy Strategic Risk Analysis, says that Bollard, appointed in late 2002, was intent on trying a new approach to monetary policy.

He experimented with a low official cash rate which meant mortgage rates at levels history had taught would result in an inflation prob-lem.

"The experiment with low interest rates initially resulted in a period of strong GDP growth which drove the unemployment rate to well below average or sustainable levels between 2002 and 2004.

"The tightening in the labour market resulted in labour cost and general price inflation heading to the highest levels since inflation was temporarily defeated in the late-1980s," Dickens said.

The wage growth was not justified by higher productivity growth.

It was "just stealing economic growth from the future".

Bollard was forced to engineer a recession to solve the underlying inflation problem he had played the major part in generating, Dickens said.

"The global financial crisis brought forward the recession New Zealand was heading for anyway and meant the economy suffered more than would have happened otherwise, but a recession was unavoidable at some stage."

Dickens rejects the "spongy brakes" defence.

This is the argument that the Reserve Bank was frustrated in its attempt to rein in the housing market, and the associated debt-fuelled consumption boom, by the fact that the banks were able to borrow cheaply abroad and offer fixed-term mortgages at alternative rates, regardless of the official cash rate.

The central bank can drive longer-term rates higher by sufficiently stern signals about what it expects to do with the short-term rates it controls directly, he said.

However, Dickens gives Bollard credit for the way he has run monetary policy since the global financial crisis hit.

He puts that down to the governor's innate conservatism, a desire to see the whites of the upturn's eyes before raising rates.

But that same conservatism served him, and the wider economy, badly during the "go for growth" period, Dickens says.

Don Brash made, and has acknowledged, a similar policy mistake about 10 years earlier.

Then it was thought that the country's sustainable growth rate had been dramatically increased by the radical economic reforms of the late 1980s and early 1990, so that it could handle much more monetary stimulus without inflation.

It was soon apparent that it had not.

But by the time Bollard succeeded as governor the policy targets agreement had been amended to include seeking "to avoid unnecessary instability in output, interest rates and the exchange rate".

Bollard has delivered less volatile interest rates, Dickens said.

But he has also delivered a rollercoaster cycle in output and, partly as a consequence, in the exchange rate.

The casualties of the speculative bubble in the property market include investors in finance companies exposed to the property boom, small businesses that set up or expanded during that overheated period and those who lost their jobs in the subsequent recession.

Dickens said he would argue in future reports that there is a fundamental flaw in the way the bank makes OCR decisions and propose a better framework for making them.