Treasury calls for cuts as Labour speaks out on monetary policy

Phil Goff says price stability will always be key. Phtoo / Daily Post

Even as the Labour Party was calling for a rethink of monetary policy arrangements, citing the collateral damage from a high exchange rate, the Treasury released a paper yesterday arguing that cuts to Government spending would take pressure off interest rates and the dollar.

Opposition Leader Phil Goff said the monetary policy regime adopted 20 years ago had worked reasonably well for a decade.

"But increasingly over the the past decade and most particularly in my role as Minister of Trade, I saw the huge difficulties being caused both by the level of the exchange rate and its volatility."

The Treasury, in a paper on closing income gaps with Australia, said a lower dollar would help but we could not have a permanently undervalued exchange rate.

"Ultimately structural reforms that make investment more attractive and consumption relatively less attractive must be at the heart of any successful economic programme."

Cutting government spending would help.

"In setting the official cash rate ... the Reserve Bank would give considerable weight to well-foreshadowed significant cuts in government spending. All else being equal, such cuts could be expected to result in the OCR being set lower than it otherwise would be for several years."

And as a result the exchange rate could be expected to fall, it said.

ANZ National Bank chief economist Cameron Bagrie said: "It's the old story. Monetary policy needs mates and right now its best friend should be fiscal policy, that is, [controlling] government spending."

Business New Zealand chief executive Phil O'Reilly said Labour's decision to ditch the consensus on the monetary policy framework was based on a fallacy: that monetary policy was the root of New Zealand's often high and volatile currency.

"In fact the root cause of the problem is our unproductive economy, which is failing to attract investment inflows and is instead attracting speculative inflows."

Labour's thinking has been influenced by Business and Economic Research Ltd (Berl) economists who have long argued that far from reining in inflation pressures, raising the OCR has the perverse effect of, increasingly, the money supply attracting inflows of foreign money.

Goff acknowledged the importance of keeping inflation and inflation expectations down.

"I'm part of the generation that remembers double-digit inflation under Muldoon," he said. "We won't throw the baby out with the bathwater. Price stability is important."

But he questioned whether it should be the sole objective of monetary policy and whether the tools at the bank's disposal were adequate.

Central banks around the world are looking at the issue of whether and how to ensure commercial banks increase their capital in good times not only to reduce the risk of running short of capital when the cycle turns but also as a means of "leaning against the wind" and leaving interest rate policy with less work to do.

O'Reilly said the destruction of the consensus would raise questions about New Zealand's financial stability and soundness as an investment destination.

But Goff said: "You can't say we can't put up alternative ideas [in opposition]. That is what our role is and the rating agencies know that when in government Labour has pursued responsible economic policies. But they would equally say what worries them about NZ is that it has run a current account deficit for as long as it has, and it would be stupid for us, or the Government, not to consider what alternatives might allow better performance."