In April 2009 Reserve Bank Governor Alan Bollard cut New Zealand’s OCR to below that of Australia. He might just as well have handed in his retirement letter. Who does he think will invest in New Zealand at a lower return than they can get in Australia? And now, sure enough, he looks set to have to eat his words about not tightening monetary policy for another year.
It’s a few decades now since we introduced some of the modern monetary management tools, namely a floating exchange rate and the official cash rate.
Some observers have become worried about what they call the Reserve Bank’s single blunt instrument, the official cash rate, in controlling inflation. They fret that we may have over-simplified things by relying on just one tool for monetary control.
However, with so much debt now from overseas, even the official cash rate is becoming ineffective. In April 2009 the Governor cut the OCR by half a percentage point to 2.5%. But market interest rates actually went in the opposite direction – up. Investors can now comfortably find twice the OCR return in Government guaranteed bank deposits, and even higher returns with Government guaranteed finance companies. The single blunt instrument just got much blunter.
Some observers believe the Reserve Bank might be eventually forced to exercise its prudential powers to break this borrow and spend cycle. This would mean the Reserve Bank restricting commercial banks’ ability to lend for certain purposes, like housing. But the Reserve Bank itself doesn’t sound too keen on this option. “We believe that there would be potential dangers in extending the scope of existing prudential powers to pursue price stability, including a loss of clarity in the objectives.”
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