Opinion & Commentary
Kiwi monetary muddle
New Zealand started a monetary-policy revolution when it introduced inflation targeting in 1989. That innovation swept the world in the 1990s, and was all the more remarkable for being introduced by the social-democratic Labour Party. Yet 20 years later, back in opposition, and facing a falling U.S. dollar, Labour is turning its back on the framework it pioneered. That could have serious consequences if and when Labour finds itself in government again.
In a speech to New Zealand’s Federated Farmers last week, Labour leader Phil Goff announced ‘the end of the consensus around the policy targets and tools of the Reserve Bank,’ the central bank. Mr. Goff said he will continue to respect the central bank independence, but that he no longer supports putting the primary focus on price stability. ‘The battle against inflation is no longer New Zealand’s sole or over-riding policy objective,’ he said. While not offering an alternative, Mr. Goff said the current policy framework is ‘not well designed to produce a stable and competitive exchange rate, nor to keep interest rates as low as possible.’
Mr. Goff further called for a stronger focus on economic growth and export performance. The clear implication is that Labour wants to use easier monetary policy as a lever to spur growth, in part by cheapening the New Zealand dollar and devaluing to stronger growth and exports. While Labour is not currently in the majority, it likely will be again one day so these remarks bear watching. Foreign-exchange markets certainly noticed, with the New Zealand dollar falling vis-à-vis the U.S. dollar by 2.4% in the aftermath of Mr. Goff’s speech.
It is no coincidence that Mr. Goff made his remarks to New Zealand’s largest farm lobby. As a small, open economy with large trade dominated by the export of commodities such as dairy, New Zealand is exposed to exchange-rate fluctuations. The highly cyclical New Zealand dollar has always been a sore point for the country’s exporters since, while it falls in value during slack times it always seems to strengthen sooner than they would like. One reason is that signs of economic recovery typically spur worries about inflation and, under the inflation-targeting regime, prompt the central bank to raise rates.
Mr. Goff’s criticism of this dynamic misses the important benefits inflation targeting and its effects on the exchange rate bring to New Zealand. The dollar’s fluctuations help insulate the economy from external shocks, not least during the recent global financial crisis. When demand weakens in the rest of the world, the New Zealand dollar depreciates, making New Zealand’s exports more competitive. When external demand is strong, the currency rises, moderating export prices in New Zealand-dollar terms and restraining import price inflation. New Zealand’s floating exchange rate thus smoothes external demand and economic activity, making the central bank’s job of controlling inflation much easier.
Many exporters resent the role of the exchange rate in moderating New Zealand’s economic cycle, viewing their competitiveness as being sacrificed on the altar of inflation control. But the idea that New Zealand can ignore inflation and grow faster through easy money and a lower exchange rate is a short-sighted view, no matter how tempting. It ignores the fact that higher domestic prices resulting from inflation would ultimately undermine rather than promote international competitiveness. Economic growth and export success must ultimately be built on real factors such as productivity growth, not easy money and exchange rate depreciation.
Lawmakers like Mr. Goff would therefore be better off focusing on structural reforms that will boost productivity and competitiveness, such as reduced government spending and taxing.
Meanwhile, the central bank’s primary focus on inflation recognizes that monetary policy needs to be based on a single instrument and policy objective. Pursuing multiple objectives with multiple instruments, as Labour now suggests, is a recipe for incoherent policy and poor economic performance such as New Zealand experienced before its path-breaking reforms of the 1980s. Already the inflation target has been relaxed, to 1%–3% from the original 0%–2% and given a medium-term focus by the central bank governor and successive finance ministers. It would be a mistake to weaken the bank’s inflation focus any further.
It might be tempting to dismiss Mr. Goff’s remarks as populist politics, but it would be complacent to assume that a future Labour government would not make good on such promises. That would be a backward step for a Labour Party that brought New Zealand such an important monetary-policy improvement in 1989, and for the economy overall.
Dr Stephen Kirchner is a Research Fellow at The Centre for Independent Studies in Sydney. This article is part of an occasional series on the dollar’s impact on Asia-Pacific economies.
