Reserve Bank open to being made to prioritise inflation

The Reserve Bank believes its inflation and employment targets remain fit-for-purpose.

However, it is open to the Government requiring its Monetary Policy Committee (MPC) to prioritise targeting price stability over "maximum sustainable employment".

The Reserve Bank shared these views with Finance Minister Grant Robertson as part of a five-yearly review (which the Bank is required to do by law) of its MPC's remit.

Having received feedback from around 1500 submitters in its first public consultation, the Reserve Bank gave Robertson "preliminary" advice on the matter. It will finalise its advice by April, following a second round of public consultation. Robertson will decide if and how the remit is changed.

The MPC is currently tasked with keeping "future annual inflation between 1 and 3 per cent over the medium term", and supporting "maximum sustainable employment".

It uses tools like the Official Cash Rate (OCR) and quantitative easing/tightening to try to meet these targets.

The remit doesn't give the committee guidance on how it should balance its targets, particularly if they come into conflict with each other.

The issue is topical, as the Reserve Bank's efforts to curb inflation in the capacity-constrained economy risk causing large numbers of job losses.

The Reserve Bank explained, "[T]he onset of Covid-19 and the war in Ukraine has seen more frequent shocks to the cost of supplying goods for businesses (e.g. higher importing costs), which have increased prices without increasing economic activity.

"There is a risk that these conditions persist or occur more frequently. In such instances, the MPC may face greater trade-offs between maintaining price stability and supporting MSE [maximum sustainable employment], as well as other considerations such as seeking to avoid instability in interest rates and output.

"If monetary policy strategies become unclear to the public in the face of such shocks, this may pose challenges to the credibility of MPC commitments to bring inflation to target in the medium-term."

The Reserve Bank noted the Bank of England must prioritise its inflation objective over its employment one.

It told Robertson most written submitters to its consultation favoured a stronger emphasis on the inflation objective. A few preferred a more balanced weighting.

In its next round of consultation, the Reserve Bank said it would ask the public whether they wanted the MPC to target maximum sustainable employment, "subject to achieving and maintaining price stability".

Getting rid of the employment target altogether (as per what National and ACT are campaigning on) is out of the scope of the remit review, as this would require a significant legislative change.

Reserve Bank governor Adrian Orr in May said the central bank would be taking the same course of action as it was if it was only tasked with targeting inflation.

Meanwhile in June, the Herald asked Robertson whether he believed the MPC needed guidance on how to weigh the targets. He said, "I'm satisfied with where we are now.

"I think it's important the Bank is given flexibility in the way in which it balances those two objectives."

The Reserve Bank also expressed its opposition to Robertson requiring the MPC to "assess" the impacts of its decision on house price sustainability.

Robertson added this requirement to the remit in March 2021, as house prices went through the roof in part due to the Reserve Bank slashing interest rates.

"It may well be more appropriate to incorporate concerns around house price sustainability into an alternative document, such as the letter of expectations," the Reserve Bank said.

As for the level of inflation targeted, the Reserve Bank concluded there wasn't enough evidence to support changing the status quo.

The Reserve Bank noted some submitters wanted Statistics New Zealand to change the way it measures consumer inflation to put more weight on housing costs.

Some might argue that if housing costs were given more weight in the Consumers Price Index, inflation would've appeared higher in recent years, which would've prevented the Reserve Bank from cutting the OCR so aggressively; encouraging people to borrow a lot to buy houses, pushing prices up.

While the Consumers Price Index includes the cost of building a new house, mortgage interest payments, rent and council rates, the cost of buying an existing house isn't counted.

An argument against including this in the measure is that if you include the cost of property, do you include the cost of other assets that can fluctuate wildly in price? Where do you draw the line – at shares, bonds, cryptocurrencies, art?

The Reserve Bank concluded there are "drawbacks" associated with different measures of consumer inflation, but this is ultimately an issue for Statistics New Zealand.

Coming back to the MPC's "maximum sustainable employment" objective, the Reserve Bank didn't believe this should be defined in a more prescriptive way in the remit.

Currently, the remit notes that the MPC should "consider a broad range of labour indicators to form a view of where employment is relative to its maximum sustainable employment".

The Reserve Bank said, "A number of public submissions were critical of MSE as a concept, noting that it is difficult to measure and not widely understood.

"However, submissions also generally supported the focus on a range of indicators rather than relying on a single measure."