Monetary Policy Error

The current very aggressive easing of policy by the RBNZ has all the hallmarks and an aura of déjà-vu from their very aggressive monetary policy tightening in 2005 to 2007. Both monetary policy actions are extreme and both could prove to be “inappropriate” and serious policy mistakes. Inappropriate, in that neither action has or will do anything to influence the inflation rate, but can (and has) caused substantial collateral damage to the economy.

We stated at the time of the 2005 to 2007 tightening that the “high interest rate/high exchange rate” policy would have no impact on inflation (the inflation was coming from oil/commodity and Government sources that interest rates did not affect) but would only send the NZ$ higher, cause problems for exporters and eventually cause a recession. That proved to be an accurate assessment of what subsequently occurred later in 2007 and 2008.

Today the RBNZ seem to be pressured once again by the short-term and changeable views of bank economists (as they were in 2006) into extreme monetary policy action at the other end of the scale. The bank economists did not predict that the 2005-2007 monetary tightening would cause economic recession in 2008 and goaded the RBNZ to push 90-day rates to over 9.00%. That was a grave policy error and the export and household sectors have been paying the price of that policy mistake ever since.

Moneymarket pricing and bank economist forecasts today are again pressuring the RBNZ to cut interest rates to record low levels of 2.50%. The RBNZ are obliging with 1.5% OCR cuts, but who will pay the price in 2-3 years time if this proves to be another policy error and inflationary pressures are re-ignited through interest rates being too low? ....

At some point, someone independent has to stand back and look at the last five years of monetary policy management and interest rate movements in New Zealand from 4% to 9% and back to 3.5%, and conclude that the extreme changes have done nothing to control inflation, all that they have done is destroy investment in the wealth/growth-creating export sector.

Wisdom from Roger Kerr