More on monetary policy

November 26th, 2009 at 2:00 pm by David Farrar

Matt Nolan blogs:

at heart isn’t about “unemployment” or “output” or “the exchange rate” (which is a relative price).  is about money, it is about the supply of money, it is about the price level and inflation.  The “interest rate” is merely an instrument central banks use to control the money supply and keep “inflation stable”.  By keeping inflation stable we increase certainty and we help make sure that money remains a good indicator of the relative value of REAL goods and services.

The idea that we should mess around with this to tinker with other things misses the point – if our exchange rate is funny, unemployment is high, or output is below potential we have to ask “what issues in REAL economy are causing this”.  Monetary policy in itself is irrelevant – monetary policy IS about money, it IS about inflation, it IS about expectations regarding these nominal variables, it IS NOT about real economic variables.

I am not saying that monetary policy hasn’t moved real variables – but in a world where monetary policy IS solely focused on inflation and consistent expectations is a world where monetary policies impact on the real economy is at its best.

It worries me greatly that Labour have abandoned support for a bipartisan monetary policy consensus.

18 Responses to “More on monetary policy”

  1. Countess (157 comments) says:

    Whats the problem ? Every body else is ‘relaxed’ about it. You surely cant be in favour of a system which serves the speculators well and disadvantages every one else . or could you.

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  2. wreck1080 (5,020 comments) says:

    Labour have lost the plot. The best thing they could do is replaced gormless goff with Don Brash. Thats what I’d like to see.

    The ideal solution is for ACT to set economic policy. They’ll sort out the economic mess, reject the ETS, and bring back smacking.

    I still don’t understand why Act do not get more support. Perhaps it is the perception they are too small to attract the best candidates.

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  3. Chthoniid (2,064 comments) says:

    It is somewhat disappointing that this area of consensus has been abandoned for reasons that seem somewhat opaque.

    The monetary signals being generated in the economy (high interest rates, high exr) were just that- signals. They were alarm-bells that we had some growing macroeconomic imbalances (household debt, housing asset-price bubble, current acount). It was these imbalances that needed to be fixed, not these ‘cries’ to turn off the warning signals.

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  4. Rex Widerstrom (5,113 comments) says:

    Well economist David Preston disagrees with Nolan. In a paper to the recent NZ Association of Economists: “Putting Credit Back into Monetary Policy: Reconstructing the New Zealand Monetary Policy Framework” he points out:

    ……the massive inflow of overseas capital into New Zealand during the period of exchange rate appreciation, a high proportion of it flowing directly into the banking system.

    One irony in the period is that to the extent that OCR increases had their intended effect of pushing up domestic interest rates, including bank deposit rates, the motivation for additional capital to flow into New Zealand to feed the consumption and asset price boom if anything increased.

    and he concludes that:

    the OCR, while a key economic tool, is on its own an insufficient tool of monetary control if a wider definition of monetary policy objectives is to be used… viewed from the perspective of a wider set of monetary policy objectives involving an adequate contribution to maintaining macro-economic stability and international competitiveness New Zealand monetary policy has been significantly inadequate. [my emphasis]

    He proposes an alternative monetary policy framework encompassing:

    • A wider range of variables as part of monetary policy consideration.

    • The selection of an appropriate quantitative target or targets for measuring the extent to which policy objectives are being achieved.

    • Additional policy instruments to supplement the role of the Official Cash Rate.

    So by no means every economist is “sold” on things as they are at present. I see a great deal of merit in Preston’s view, and think that the minimum we need to do is decouple mortgage interest rates from rates affecting the productive sector, which can be achieved in a number of ways – a mortgage levy, a savings rebate, a “Tobin tax”…

    There are also alternative mechanisms we choose not to use – because people like Nolan and DPF imply the sky will fall if we step outside the MPA – yet which seem to work for other nations. Singapore, for instance, opts to control the exchange rate rather than trying to use it to control inflation, and instead uses compulsory superannuation with an adjustable minimum contribution rate to control inflation.

    That’s one reason why I supported NZ First policy on compulsory superannuation (also law in Australia, of course, though they opt not to use it as an inflation control measure) but of course the referendum on the issue was sabotaged by the government of the day, partly out of spite and partly, I suspect, because of Chicken Little clucking from the RBNZ and possibly Treasury.

    Labour may not have the right alternative in mind — and judging on past performance and present calibre they probably won’t — but that doesn’t mean we should blindly accept current orthodoxy simply because “other countries do it”.

    If Labour’s position triggers a serious re-evaluation of the MPA and economic settings generally, then they’ll have done NZ a service.

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  5. stephen (4,011 comments) says:

    I still don’t understand why Act do not get more support

    If they embraced traditional values of well, socialism, like Labour and National they might have a shot, but they don’t, so they’re really just a bit weird.

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  6. Matt Long (101 comments) says:

    Rex, at last someone has something intellegent to say. Congrats.

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  7. Kimble (4,637 comments) says:

    Umm … Rex, all Preston is saying in that quote is that if you increase the number of things you want monetary policy to have “fixed”, then monetary policy hasnt work too well.

    Well … no shit.

    Lets say I reckon the Fair Trading Act should protect our domestic industries from overseas competition, I could then say that the FTA has been a dismal failure using Prestons logic.

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  8. right on roger (3 comments) says:


    I don’t know that you know your history – ACT was founded by one of NZ’s premier ‘Socialists’ Roger Douglas – who is a backbencher now as you probably know. As a backbencher and ACT MP he has released the document ‘Catching Australia by 2025: an Alternative Approach.’ If you understand the germination of socialist ideas in NZ, you would know the founders of NZ’s welfare state envisioned a country where all people could access basic social services – health, education, unemployment insurance etc, regardless of income levels.

    But the totalitarian aspect of socialism is what we have seen emerge historically thanks to the battle for power between left and right. Hence you end up with a state based on pork-barrel politics – that bankrupted the country after Muldoon’s efforts and necessitated those reforms of the 80s by then finance Minister Roger Douglas, viewed by the establishment as ‘right wing’.

    Yet if you look at this recent paper ( you see that in fact the same man responsible for the 1980s reforms is by all intents and purposes – keeping to the original socialist vision of universal access and control of social services, by and for the people.

    Unfortunately in today’s climate of misinformation, socialism is understood to be total ownership of the means of production by the government (I imagine this was not Marx’s intent) and union bullying of the public.

    A look back to the economic situation prior to Rogernomics should go some way to inform those who seek a return as to why the country cannot afford such chicanery – and a look at the economic impacts of the Helen Clark years should demonstrate why returning financial power to the people is the only way out of a totalitarian poverty-economy.

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  9. Economist (1 comment) says:

    @Rex Widerstrom

    No, no no no nooooo. Why is Singapore the only example people seem to be able to come up with? Firstly their finance minister recently said he doesn’t think targeting the exchange rate is actually a good idea – but let’s not even get into that.

    Singapore has a population roughly the same as New Zealand, but that’s about where the similarities end. Their productive sector is 200% of GDP, compared to about 30% for New Zealand. So let’s screw 2/3 of our economy and create massive distortions, just to try and deliver a stable exchange rate for exporters.

    On that last point, a stable exchange rate doesn’t mean stable prices. In fact it is likely to mean more volatile returns to exporters because the exchange rate can’t adjust. Last year commodity prices collapsed but exporters hailed the fact that the dollar fell too, softening the blow. But now that commodity prices are on the way up, they call for a lower exchange rate.

    Its as bad as farmers in the US calling for subsidies. If you can’t make a profit then you shouldn’t be in that business.

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  10. Countess (157 comments) says:

    I would have thought ACT would be all for abolishing monetary policy !
    They would say big government interfering in what borrowers and investors can negotiate is playing with the free market.
    And the fact the ‘old consensus’ hasnt worked would only confirm their beliefs

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  11. tvb (5,518 comments) says:

    Labour have abandoned a policy of honest money. They think you can create wealth by printing more money. That if you want something ask the Government. That if you want to do something get the Government to do it. Need money to run a campaign – get it from the taxpayer. You don’t like what people say about you – pass a law to BAN it. Think something is a good idea pass a law to MAKE people do it.

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  12. wreck1080 (5,020 comments) says:

    Act certainly do not want to see poor people suffer. In fact, they advocate the use of tax rebates to lessen these peoples tax burdens. In what way is that not socialism?

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  13. kiki (414 comments) says:

    ACT’s (Roger Douglas’s) policies on education, health and superanuation are very socialist in that a level is set that the government helps you achieve by taking from others if you can’t. Where he differs from socialists and national is that he would allow the people to control where they go for their education, health and super. If we followed at least these three ACT policies our country would be greatly improved.

    As for monetary policy nothing is set or should be set except the freedom of humanity. To think that there is no better option is to live with blinkers. There is always a better way because the world is always changing. Unless we freeze ourselves and our thinking and our country.

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  14. reid (21,447 comments) says:

    “I still don’t understand why Act do not get more support. Perhaps it is the perception they are too small to attract the best candidates.”

    stephen has a partial answer. The other part is, they have a flakey leader. I like Rodney, and I voted for him twice when I was in Epsom because he was always way better than Worth and that was before Worth self-immolated. But Rodney’s a flake and his support will be dropping off unless the SuperCity is a flaming success which it won’t be because it can’t be till the results are in and they won’t be till 2012 at the earliest and by then it’s too late.

    ACT like the MP remain essentially, single issue parties. They pretend they aren’t, but they are. ACT’s single issue is: small govt. But Hide keeps going off on tangents, he’s not got the breadth of Prebble nor the single-minded focus and simple-message delivery of Douglas.

    Unfortunately, I don’t think ACT’s going to survive beyond 2015 and that’s a real shame because the nation could really use a strong and vibrant party in that part of the political spectra.

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  15. Luc Hansen (4,573 comments) says:

    The US is richer than us.

    The Fed does not fixate on the inflation rate, although it is a primary concern, but they do not hesitate to let inflation blow out temporarily if they perceive that to be the greater good.

    But what would they know?

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  16. Rex Widerstrom (5,113 comments) says:


    [Sorry, I’ve been out earning a few elusive dollars so as to keep the effect of the RBA’s recent increase in the cash rate at bay 😉 ]

    You’re right, but Preston is also saying it could be used to achieve more objectives (“adequate contribution to maintaining macro-economic stability and international competitiveness”), but that its only “success” has been in controlling inflation.

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  17. Alistair Miller (557 comments) says:

    Luc, on what planet can you possibly live to think the US is richer than anybody? They are the most indebted nation in the history of economics. They will, quite literally, never get out of debt. The US is, in essence, bankrupt, and their current leadership is living by the axiom “when you find yourself in a hole, keep digging”.

    New Zealand has a slim chance of getting back into the black with some serious and efficient economic management (which we won’t get with a muppet like English as Min Finance). Australia did it with Howard and Costello (leaving a $21 billion positive bank balance which KRudd has subsequently put into the pokie machines), proving it can be done. But you can’t do it without pissing some people off (in Australia it was the unions. In New Zealand it will need to be the greens and browns, but that is not likely to happen, is it).

    The SNL fisking ( of Obama/Hu was the funniest thing I’ve seen in a long time.

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  18. stephen (4,011 comments) says:

    I must admit to using the lazy dichotomy of National, Labour and the rest = socialist, ACT = not socialist. ACT clearly are socialists if one gets strict with the word.

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