Bernard Hickey: Bollard leads world

Alan Bollard deserves to be congratulated for quietly leading the world's central banks towards a new tool for monetary policy that might help New Zealand avoid the tyranny of a high official cash rate (OCR) killing our export sector.

It's early days yet, but the Reserve Bank governor made it clear to Parliament's Finance and Expenditure Select Committee this week that the bank plans to use its new "core funding ratio" as a stabiliser to reduce swings in the OCR.

Anyone interested in interest rates should care about this core funding ratio. It is a formula the Reserve Bank has set for the banks forcing them to raise most of their funding from local Mum and Dad savers and for longer terms.

It means the banks can no longer dive into the international money markets to get cheap, hot money as they did in 2005, 2006 and 2007 when US Federal Reserve chairman Alan Greenspan and his investment banking mates pumped oodles of cheap cash around the world.

Back then, our banks borrowed the money on these hot markets at low interest rates and then shovelled it on to home buyers in New Zealand.

This added $100 billion to our foreign debts and helped almost double the value of our housing market to $600 billion.

The availability of this cheap foreign money frustrated the Reserve Bank's efforts to slow the housing market and the economy, which meant it had to raise the OCR to 8.25 per cent. This helped push the New Zealand dollar up over US80c and castrated our export sector, particularly manufacturing exporters such as Fisher and Paykel Appliances.

The Reserve Bank has worked out if it can turn down this tap of foreign money it can kill three birds with one stone.

First, it can stop the banks from becoming too dependent on foreign money, which is dangerous if these foreign money markets freeze up, as they did late last year. Secondly, it can help slow the housing market during these hot times, which means the Reserve Bank doesn't have to push so hard on the OCR lever.

The third benefit is forcing the banks to compete much harder for term deposits. This means local savers are getting much more than the OCR for the first time, which encourages saving. The banks are also passing on these higher local funding costs in the form of slightly higher fixed mortgage rates, which takes some of the pressure off prices in the housing market.

The Reserve Bank announced it was introducing this prudential liquidity policy in June and has been working quietly with the banks ever since on fine-tuning.

The Reserve Bank aims to introduce a benchmark core funding ratio of 65 per cent from April next year and then slowly ramp it up to 75 per cent over the next two years.

Once completed, this shiny new lever will act as an automatic stabiliser for the economy.

The rest of the world's central banks are following the Reserve Bank's lead to come up with similar policies. It's nice to see New Zealand at the forefront of monetary policy again.