How tides keep turning. Reserve Bank of NZ was the first bank to start inflation targeting formally in 1989. Since then, inflation targeting has become a huge buzzword across central banking circles with more and more central banks taking up targeting inflation.
Now the pioneer of inflation targeting could be made to reconsider and change its single mandate. If the Labour government comes to power in NZ, there are high chances that the RBNZ Act will be changed and employment will be added to the single objective.
The superb blog on NZ economy – Croaking Cassandra blog reports:
I’ve already written a bit about Labour proposals on monetary policy (here and here) and, for now at least, I don’t want to write anything more about the proposed changes to the decision-making process or the plan to require the Monetary Policy Committee to publish its minutes. If there are all sorts of issues around the details of how, I haven’t seen anyone objecting to the notion of moving from a single decisionmaker model to a a legislated committee, or objecting to proposals to enhance the transparency of the Bank’s monetary policy. The Bank was once a leader in some aspects of monetary policy transparency, but is now much more of a laggard.
Where there has been more sceptical comment is around Labour’s proposal to add full employment to the statutory monetary policy objective. At present, section 8 of the Reserve Bank Act reads as follows:
The primary function of the Bank is to formulate and implement monetary policy directed to the economic objective of achieving and maintaining stability in the general level of prices.
Responding to this aspect of Labour’s announcement hasn’t been made easier by the lack of any specificity: we don’t know (and they may not either) how Labour plans to phrase this statutory amendment. There are some possible formulations that could really be quite damaging. But there are others that would probably make little real difference to monetary policy decisionmaking quarter-to-quarter. Probably each of us would prefer to know in advance what, specifically, Labour plans. But this is politics, and I’m guessing that there is a range of interests Labour feels the need to manage. In that climate, specificity might not serve their pre-election ends. One could get rather precious on this point, but it is worth remembering that there are plenty of other things that may matter at least as much that we currently know little about. Under current legislation, who becomes the Governor of the Reserve Bank matters quite a lot to shorter-term economic outcomes, and we have no idea who that will be. The details of the PTA can matter too, and under the governments of both stripes the process leading up to the signing of new PTAs has been highly secretive (often even after the event). For the moment, we probably just have to be content with the “direction of travel” Labour has outlined.
In some quarters, Labour’s plans for adding a full employment objective have been described as “cosmetic”, as if to describe them thus is to dismiss them. That is probably a mistake. When I went hunting, I found that cosmetics have been around for perhaps 5000 years (rather longer than central banks). People keep spending scarce resources on them for, apparently, good reasons. Why? They can, as it were, accentuate the positive or eliminate the negative – highlighting features the wearer wants to draw attention to, or covering up the unsightly or unwanted marks of ageing. They (apparently) accomplish things for the wearer.
Further, in all NZ elections central bank objective has been a focal point:
What is the relevance of all this to monetary policy? Well, there has been a long-running discontent with monetary policy in New Zealand, especially (but not exclusively) on the left. In the 28 years since the Act was passed there has not yet been an election in which some reasonably significant party was not campaigning to change either the Act or the PTA. We haven’t seen anything like it in other advanced countries. Personally, I think much of the discontent has been wrongheaded or misplaced – the real medium-term economic performance problems of New Zealand have little or nothing to do with the Reserve Bank – and many of the solutions haven’t been much better (in the 1990s, eg, Labour was campaigning to change the target to a range of -1 to 3 per cent and NZ First wanted to target the inflation rates of our trading partners, whatever they were). But that doesn’t change the fact that there has been discontent – and more than is really desirable.
But what about the trade-off?
I’m quite clear that there is no long-run trade-off adverse trade-off between achieving and maintaining a moderate inflation rate (the sorts of inflation rates we’ve targeted since 1990) and unemployment. And since something akin to general price stability generally helps the economy function better (clearer signals, fewer tax distortions etc) there is at least the possibility that maintaining stable price might help keep unemployment a little lower than otherwise. Milton Friedman argued for that possibility.
But I don’t think that is really the issue here.
Because it is not as if there are no other possible connections between monetary policy and unemployment. Pretty much every analyst and policymaker recognises that there can be short-term trade-offs between inflation and unemployment (or excesss capacity more generally – but here I’m focusing on unemployment). Those trade-offs aren’t always stable, even in the short-term, or predictable, but they are there. Thus, getting inflation down in the 1980s and early 1990s involved a sharp, but temporary, increase in the unemployment rate. That was all but inescapable. And when the unemployment rate was extremely low in the years just prior to 2008, that went hand in hand with core inflation rising quite a bit. Monetary policy decisions will typically have unemployment consequences. Unelected technocrats are messing, pretty seriously, with the lives of ordinary people. It is all in a good cause (and I mean that totally seriously with not a hint of irony intended) but the costs, and disruptions, are real – and typically don’t fall on the policymaker (or his/her advisers).
And it isn’t as if monetary policymakers are typically oblivious to the pain. There was plenty of gallows humour around the Reserve Bank in the disinflation years, a reflection of that unease. And yet often the official rhetoric is all about inflation – as if, in some sense, what look like relatively small fluctuations around a relatively low rate of inflation, matter more than lives disrupted by the scourge of unemployment.
So perhaps that is why cosmetics can matter, and serve useful ends even in areas like monetary policy.
Hmm..age old debates once again come to the surface when we were told they have been addressed. Inflation targeting was seen as the only thing that worked given NZ’s experiences. Now with pioneer considering changes, will it lead to change in thinking in other countries too?
There is little doubt that central banks though may just be targeting inflation but their actions have wide ramifications on the entire economy. This is particularly tricky in case of growth/employment issues which have to be answered by politicians. Thus, central banking is far more politicised than we imagine.
Interesting times. Who knows we could be going back to old central bank debates if we see so called cosmetic changes in RBNZ…