Some readers, and two of my economist work colleagues, expressed the view that the Blog got carried away arguing the Reserve Bank is acting outside its legal mandate in continuing to slash interest rates. We aired a similar concern by one of our Wellington subscribers, Matthew Williamson, posting his views. Our reasoning was simple - inflation is already at 2% in NZ - on target. Yet the RBNZ says it wants to cut the Official Cash Rate by a lot more.
However, the new mandate given to it by Finance Minister Willis says it must focus solely on inflation - not engineering high employment and growth. The RBNZ has already "engineered" (to quote Governor Orr) not one, but three recessions. However its mandate is strictly not to engineer recessions, nor fuel property-market booms, like during Covid. It is, by law, required to achieve price stability alone. Yesterday, The Westpac Chief Economist, Kelly Eckhold, came to our rescue. He took up his role there in March, replacing Dominick Stephens, who's now Treasury Chief Economist.
Eckhold says an OCR of 2.5% is stimulatory and the "neutral rate" in NZ is closer to 4%. At the neutral rate, inflation neither rises, nor falls - it doesn't artificially expand, nor contract, the economy - only problem is you can't directly observe the neutral rate so its more like an academic concept. When the OCR is at 2.5% and inflation is on target at 2%, the real rate of interest is 0.5%, being the difference. When the OCR is at 4%, then the real rate is around 2%, which is the current situation. That sounds about right to me - a real interest rate of around 0.5% is a stimulatory low rate for NZ and 2% is neutral - especially since our country has long had a savings shortage which has meant NZ has had far higher real rates than most comparable nations in the world.
A few months ago, former US Treasury Secretary & Harvard President Larry Summers who has published on the topic, warned the US Federal Reserve was "wrong on the neutral rate", saying "its more likely above 4%". That'd mean our Reserve Bank is not just wrong, its making another outrageous mistake. There's a literature in NZ about how our "capital shallowness problem" has led to higher real rates here than the US (including by the NZ Treasury). It was first pointed out by former RBNZ economist Michael Reddell. What Eckhold reckons will probably happen as the RBNZ cuts further below an OCR of 4% is that it "over-eases in 2025, potentially setting up the next tightening cycle in 2026". Yes, NZ has a boom-bust central bank. Governor Orr disagrees. He says an OCR of 2.5 - 3.5% is neutral. But Westpac's Chief Economist & former US Treasury Secretary have more credibility than Orr.
With Westpac on the Blog's side, we're not backing down, not that we need it on our side. I'm going to keep arguing the Governor is acting illegally. His mandate is not to engineer booms & busts. He engineered a Covid boom that overcooked things; he engineered three post-Covid busts; now he's panicking again, trying to engineer another boom (as NZ ranks 180th out of 190 IMF countries in terms of how fast GDP is growing and the PM & Finance Minister are freaking out). The RBNZ is at it again. Super easy money policy; then way-too-tight; and now back to super easy again.
Sources:
https://www.westpac.co.nz/assets/Business/tools-rates-fees/documents/economic-updates/2024/Weekly/Weekly-Commentary_021224_report_02Dec24.pdf
https://www.bloomberg.com/news/articles/2024-03-08/summers-says-fed-is-wrong-on-neutral-warns-on-rate-cut-bets
Professor Robert MacCulloch holds the Matthew S. Abel Chair of Macroeconomics at Auckland University. He has previously worked at the Reserve Bank, Oxford University, and the London School of Economics. He runs the blog Down to Earth Kiwi from where this article was sourced.
Eckhold says an OCR of 2.5% is stimulatory and the "neutral rate" in NZ is closer to 4%. At the neutral rate, inflation neither rises, nor falls - it doesn't artificially expand, nor contract, the economy - only problem is you can't directly observe the neutral rate so its more like an academic concept. When the OCR is at 2.5% and inflation is on target at 2%, the real rate of interest is 0.5%, being the difference. When the OCR is at 4%, then the real rate is around 2%, which is the current situation. That sounds about right to me - a real interest rate of around 0.5% is a stimulatory low rate for NZ and 2% is neutral - especially since our country has long had a savings shortage which has meant NZ has had far higher real rates than most comparable nations in the world.
A few months ago, former US Treasury Secretary & Harvard President Larry Summers who has published on the topic, warned the US Federal Reserve was "wrong on the neutral rate", saying "its more likely above 4%". That'd mean our Reserve Bank is not just wrong, its making another outrageous mistake. There's a literature in NZ about how our "capital shallowness problem" has led to higher real rates here than the US (including by the NZ Treasury). It was first pointed out by former RBNZ economist Michael Reddell. What Eckhold reckons will probably happen as the RBNZ cuts further below an OCR of 4% is that it "over-eases in 2025, potentially setting up the next tightening cycle in 2026". Yes, NZ has a boom-bust central bank. Governor Orr disagrees. He says an OCR of 2.5 - 3.5% is neutral. But Westpac's Chief Economist & former US Treasury Secretary have more credibility than Orr.
With Westpac on the Blog's side, we're not backing down, not that we need it on our side. I'm going to keep arguing the Governor is acting illegally. His mandate is not to engineer booms & busts. He engineered a Covid boom that overcooked things; he engineered three post-Covid busts; now he's panicking again, trying to engineer another boom (as NZ ranks 180th out of 190 IMF countries in terms of how fast GDP is growing and the PM & Finance Minister are freaking out). The RBNZ is at it again. Super easy money policy; then way-too-tight; and now back to super easy again.
Sources:
https://www.westpac.co.nz/assets/Business/tools-rates-fees/documents/economic-updates/2024/Weekly/Weekly-Commentary_021224_report_02Dec24.pdf
https://www.bloomberg.com/news/articles/2024-03-08/summers-says-fed-is-wrong-on-neutral-warns-on-rate-cut-bets
Professor Robert MacCulloch holds the Matthew S. Abel Chair of Macroeconomics at Auckland University. He has previously worked at the Reserve Bank, Oxford University, and the London School of Economics. He runs the blog Down to Earth Kiwi from where this article was sourced.
1 comment:
Meanwhile those of us crushed by interest rates try to soldier on.
Margins at present are far too high. Don't worry it's just the everyday people who suffer.
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