Bollard's departure sparks monetary policy debate

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The impending departure of Reserve Bank governor Alan Bollard has got people thinking about changing the way monetary policy is set - and there are plenty of views on what to do. Jenny Ruth looks at the issue.

Tuesday, January 31st 2012, 9:06PM 2 Comments

by Jenny Ruth

The arguments for change surfaced after Reserve Bank governor Alan Bollard announced he won't be seeking a third term after his contract expires in September.

According to the National Business Review, even before Bollard's announcement Treasury had recommended to Finance Minister Bill English that rather than the central bank governor having sole authority to set the official cash rate (OCR), such decisions should be made by a committee.

Other central banks, including the Reserve Bank of Australia, US Federal Reserve and the Bank of England, all have committees to set their cash rate.

Business commentator Brian Gaynor says rather than simply aiming to keep inflation in check, the central bank should also be charged with promoting employment and economic growth as other central banks do.

ASB chief economist Nick Tuffley says even though other central banks may talk about growth and inflation, they still only have the same tool of adjusting their cash rates.

"The argument comes down to people expecting too much from monetary policy," Tuffley says. The one thing monetary policy is reasonably good at is keeping inflation low and other measures should be used to meet wider objectives, he says.

"I don't think the New Zealand model's broken" and therefore there's no reason to change it, Tuffley says.

Tony Alexander, chief economist at Bank of New Zealand, says if the current framework is changed the only option would be to "leave the country."

Over Bollard's time as governor, inflation has averaged 2.9% a year, just below the upper limit of the 1% to 3% target range the government has imposed. If you try to use monetary policy to also encourage employment and growth, "you're explicitly saying inflation will be averaging higher than that," Alexander says.

Such a policy would send a clear signal to buy property as a hedge against inflation and for employees to join strong unions to demand higher wages, he says.

Unlike Alexander and Tuffley, Darren Gibbs at Deutsche Bank says he can see some merits in having a committee deciding OCR moves but "it's not a burning issue."

When the current system involving central bank independence from government was introduced more than 20 years ago, when annual inflation was running around 18%, the Reserve Bank had no credibility.

The best way to change that was to make a single individual accountable, Gibbs says.

But now the Reserve Bank does have credibility, it might be a good idea to institutionalise decision making, he says.

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