Is it time to reform the Reserve Bank?

The Reserve Bank of New Zealand is in crisis – and so are we, as a result.

Having panicked over Covid-era inflation, our government-owned, but independently run, central bank hiked up interest rates to the point of provoking what is shaping up to be our longest post-war economic slump. Nothing it has done since, by lowering interest rates, has had a significant impact on employment and business confidence.

Is it time for a rethink?

For three and a half decades, the bank has blithely pursued an extreme and narrow economic doctrine known as monetarism. Under the 1989 Reserve Bank Act, the sole legislated objective for the governor of the bank was to keep consumer price inflation within a quite narrow band – currently, between 1% and 3 percent increases per annum.

In particular, full employment is not a goal. Almost to the contrary – while monetarists are not actively opposed to people having jobs, they are always willing to increase unemployment to try to decrease inflation by scaring workers from demanding wage increases.

Most recently (2022-24), the bank has deliberately increased unemployment by nearly two percentage points. That’s 50,000+ New Zealanders losing their jobs – and their families losing their livelihood. And this, just to hasten the decline in inflation that would have happened anyway, as our major trading partners’ post-Covid inflation rates unwound themselves.

Governments should care about jobs and unemployment, because voters care. So couldn’t they just re-write the legislation to instruct the central bank to at least seriously consider the effects of its actions on unemployment, alongside the low-inflation goal?

This has indeed been done in other countries, including the US and the UK. But it is not clear that a dual mandate works there – and I am sure it will not work in NZ. Why not?

Because it has been tried, and it utterly failed. The 2017 incoming Labour Coalition Government actually did expand the remit of the governor to include achieving “maximum sustainable employment” alongside the inflation mandate.

The bank’s workaround for this clearly unwelcome remit was clever – if cynical. From 2018 to 2024, in each of the 20 business-as-usual quarterly Monetary Policy Statements (ie, before and after the Covid period), in which it announced its interest rate policy, it simply asserted – with no evidence – that employment in New Zealand was at, near, or above its “sustainable” level.

That is, for those six years, unemployment was supposedly always too low (or threatening to be so), thereby justifying continued focus on the preferred anti-inflation front.

Then the incoming National Coalition Government quickly dropped the unemployment consideration, and the term “maximum sustainable employment” has not been sighted since.

Well, that didn’t work. What else could be done?

A lot.

We should be picking apart the monetarist dogmas at each level:

• That interest rates are the only anti-inflation tool
• That inflation policy be the sole preserve of the Reserve Bank
• That the bank should be free from “political” interference
• And that inflation itself is all-important to the economy

All these shibboleths are basically made to the order of the financial sector. Big Finance hates inflation because it erodes the real value of their loans book. They welcome high interest rates because these increase the value of their loan book.

They especially love it that the central banks who agree with them about inflation and interest rates are kept statutorily free from “interference” by elected governments, which might have broader economic and social objectives. As the CEO of Goldman Sachs said recently: “Central bank independence has served us incredibly well!”

So, what to do?

Switch the overriding economic goal to maximising employment. And recognise that doing this requires a broad suite of co-ordinated government actions – including fiscal, competition, industrial and regulatory policies – as well as a monetary regime focused simply on ensuring that there is enough liquidity in the system to accommodate a full-employment level of economic activity.

And just forget about interest rates – the money markets can sort them out.

As for inflation – there are ways, other than cranking up interest rates, that can keep this in check. And if the price of sustained very low unemployment is consumer price inflation a point or three higher than the current 3 percent upper target – well, that’s a trade-off I expect most New Zealanders would be comfortable to accept.

Our Minister of Finance is about to appoint a new governor and a new chair for the Reserve Bank of New Zealand. Wouldn’t it be great if she took the opportunity to make a few changes to their job descriptions?