Brian Fallow: Reserve Bank Governor Adrian Orr goes on the defensive

RBNZ governor Adrian Orr defended the Bank at the finance and expenditure committee last week. Photo / Mark Mitchell

OPINION:

Governor Adrian Orr has no regrets — at least none about how the Reserve Bank has run monetary policy in these challenging times.

He was on the defensive last week when appearing before Parliament's finance and expenditure select committee.

Understandably so, when consumer price inflation is at 6.9 per cent, a 30-year high, and it is the Bank's job to deliver price stability. There is a prima facie case to answer.

"Do you think with hindsight, looking back now, you were a bit slow to react to the risk [of inflation taking off]?" asked National MP Andrew Bayly. "Do you have regrets now about the approach you have taken with the OCR?"

"No, I have no regrets and I will continue to have no regrets," Orr replied. "Why? Because you have to play the cards in front of you at the time."

Rather than go into Edith Piaf mode, Orr might have been wiser to elaborate on what the Bank means when it talks of its "least regrets" approach.

Every six weeks, when reviewing the official cash rate, it has to make a decision, whose full effect on prices will not be felt for at least 18 months, in conditions of uncertainty.
Extreme uncertainty right now. As Orr pointed out, the combination of a global pandemic and a war is unprecedented in our lifetimes.

The war in Ukraine is another complicating factor for the global economy. Photo / AP

The monetary policy committee finds itself at a beggar's crossroads: peril lurks whichever path they choose.

So they ask themselves: "If we go this way and it turns out we were wrong, how sorry will we be? How hard will it be to correct, compared with going the other way and being wrong?" These are questions easier to pose than to answer.

And even hindsight is not 20:20.

The Bank's critics talk in counterfactual conditionals, assertions about what would have been the case if what is the case hadn't been the case.

But it is hard enough to know what is true in the actual world, the one we inhabit and can observe.

Assertions about what would have been the case in some subset of other possible worlds, which might have eventuated if other sets of decisions had been taken, should be treated with caution. People can have all sorts of intuitions and convictions about those other possible worlds, but knowledge is something else.

Typically, they reflect a mental model of the economy which is reductive to the point of primitive. You might say they erect an edifice of speculation on epistemologically boggy ground. Or in plain English: "Coulda, shoulda, woulda? How do you know?"

A striking feature of the current inflation is how fast it has taken off. Only a year ago the official inflation rate was 1.5 per cent, in the bottom half of the bank's target band. Within that, tradables prices — for things we import like oil or export like meat and dairy products — had risen by an historically normal 0.5 per cent.

A year later the CPI is up 6.9 per cent. Tradables inflation has jumped from 0.5 to 8.5 per cent, accounting for half the overall increase, while nearly half of the other, domestic half is down to residential construction costs.

As Orr admitted, that still leaves a troubling core of domestic inflation that is above the target range and evidence of excess demand in the economy.

It is something the bank can and should rein in, and it is intent on doing so, being at this point half-way through its signalled 3 percentage point rise in the OCR.

"Given the nature and scale of the economic shocks we have come through, I am positively surprised how well we have come through that," Orr said.

"We can't do anything about global oil prices. They will impact real incomes and demand and what we have to do different on interest rates." But as for being too slow to respond to accelerating inflation, Orr reminded the MPs that the Reserve Bank was one of the first central banks to call a halt to its Covid-related monetary easing cycle. It stopped quantitative easing last July and began raising the official cash rate in October.

Getting too far ahead of the international pack poses risks, not least to the exchange rate.
"As much as we like to think we are a big important country, going it alone on monetary policy in the face of a global shock takes enormous courage," Orr observed.

He has a point. Along with the benefits of living in New Zealand, and so out of global harm's way in most respects, comes an unfortunate tendency to insular complacency.
If you live in God's Own and it stretches to the horizon, it is easy to forget about, or at least underestimate, the capacity of the other 99.9 per cent of the world to sideswipe us with shocks.

Admittedly that myopia is less of a problem lately, with an ongoing pandemic, the fallout from a war of territorial aggression in Europe, and their misbegotten offspring, inflation.
But even a brief look at the biggest components of the global economy would suggest that the risk of a synchronised recession is rising, with unhappy consequences for jobs and incomes here.

In the United States, where CPI inflation is 8.3 per cent, the Federal Reserve is now tightening monetary policy aggressively.

The chances of the Fed pulling off a soft landing, as opposed to the undercarriage-buckling recessionary kind, may not be as good as we would like. March quarter GDP was already negative.

And fiscal policy's ability to help fend off recession would not be helped if the US returns to divided government and gridlock after the midterm elections this year.

It is hardly the only country battling an inflation problem, but it is the most important.
Meanwhile, in China, GDP growth picked up to 4.8 per cent year-over-year in the March quarter from what was, by its standards, a mere 4 per cent in December.

But now 200 million of its people are in some form of lockdown as a zero-Covid policy confronts the infectiousness of the current variants. The implications for global supply chains are not good.

And in Europe, they face a dilemma we are lucky not to, arising from abject reliance on Russian hydrocarbon fuels, especially natural gas. On the one hand, an inevitable recession if that flow were shut off, on the other, the dubious morality of pouring vast sums into Vladimir Putin's war chest. It does not look like a sustainable state of affairs.

With the US, China and Europe all looking vulnerable — and, importantly, for different reasons — if one were to fall over it would almost certainly knock over the other two as well.