Lessons from monetary policy mistakes during Covid

Dr Bryce Wilkinson
NZ Herald
3 February, 2023

How seriously does our Reserve Bank take monetary policy? There should be no doubt that it takes it very seriously indeed. But does it?

A combination of the Governor’s public comments, the Bank’s recent approach to hiring staff, and the scant time it has provided for public responses to its consultation paper reviewing monetary policy settings raises doubts.

Start with the Governor’s public comments. Astonishingly, in May 2022 the Governor told a select committee he had no regrets. Six months later the Bank acknowledged that monetary conditions were too easy for too long, but only in hindsight.

Yet the consequences of the most aggressive monetary policy easing in the Bank’s history are dire. Consumer price inflation has taken off, house prices have whiplashed and a $9 billion loss has been slung around taxpayers’ necks.

The implication that the Bank would do the same again is not good enough.

Dr Grant Spencer, former acting Governor, observed that house prices were clearly soaring by the end of 2020, but the Bank failed to act promptly. Former Board Chairman, Dr Arthur Grimes, has been similarly critical. Another, former Bank expert, Michael Reddell, has pointed out that it was clear during the second half of 2020 that economic activity had bounced back strongly from the nationwide lockdown.

The Bank should be very concerned that its published forecasts from 2019 consistently showed annual consumer price inflation staying in the 1-3% range -- until its August 2021 forecasts. It subsequently consistently forecast inflation would quickly drop back below 3%. Wrong again.

One of the external reviewers of the Bank’s useful November 2022 assessment of its own performance pointed out that the errors in the Bank’s over-optimistic forecasts had not reduced as inflation broke out.

The Governor has argued that most other forecasters got it wrong too. Again, that is not good enough. Taxpayers are paying tens of millions of dollars a year in staff salaries at the Bank. What value is the Bank adding if its forecasts are no better?

The Bank needs to improve its inflation modelling. Those on the job need to combine deep expertise in modelling, monetary economics and whole economy economics.

And those on the Bank’s Monetary Policy Committed (MPC) using these forecasts need to be experts in assessing likely forecast accuracy.

The unnerving thing is that technical expertise in core subjects is clearly not a Bank priority. Extraordinarily, and perhaps without parallel amongst major central, banks, expertise in monetary economics is ruled out when appointing the MPC’s external members.

The lack of deep expertise starts at the top. None of the nine governors have a PhD in economics, or in any other subject.

The technical credentials of those at the top of the Reserve Bank of Australia are incomparably stronger.

Most disturbingly, the RBNZ’s website gives no indication that the recently-appointed assistant governor responsible for macroeconomics and monetary policy has relevant expertise in those areas. How then can she hope to lead her team on internally-disputed technical matters?

The bank’s governors are very well-paid by New Zealand standards. The salary bill for governors in the year to June 2022 was $5.44 million. Divided by nine, that would be $604,000.

These well-paid people need a lot of support. The number of staff in the Governor’s category rose from 6 in June 2017 to 21 in June 2022. The number in “Comms” staff has doubled, rising from 9.6 to 20.

The recent history of Bank staff appointments also reveals the bank’s hiring priorities. Between June 2017 and June 2022, the Bank’s staff rose 80% -from 252 to 454. Annual salary expenses have almost doubled.

But not for its needed core expertise.  the number of staff in economics has risen only from 27.8 to 32. That is the department we would expect to be at the centre of the Bank’s inflation forecasts.

A significant focus has been on expanding into non-core activities. The Bank now even has a department devoted to “diversity, equity, inclusion and wellbeing”. All up it had 24 staff in its “transformation, innovation, people and culture” category. (All the above staff numbers are on an effective full-time equivalent basis.)

Surely what taxpayers really want is a central bank to excel at controlling inflation and financial regulation - regardless of gender, race, inequality, climate change or other distractions.

To round out the charge of not taking monetary policy seriously enough, the Bank set a deadline of 27 January for submissions on its latest consultation paper reviewing monetary policy settings. This gave submitters only the busy and broken months of December and January to get their heads around the 95-page document and associated material.

Many with an interest in the subject will have been heavily committed to other tasks, many not work-related during this period.

There is no obvious case for urgency. Economists have debated the options for decades, here and overseas. That is going to continue. It is as if the Bank is not particularly interested in getting as many high quality submissions as could be hoped for.

Yet the issues are important.  Here is a short list of what I suggest could be important lessons:

First, the 1-3% inflation target is too high. It has proven to be a mistake compared to the original 0-2% target. Low inflation is inherently benign. It was grotesque to see central banks striving to lift inflation expectations when there was no wellbeing need. They overshot.

Second, the centre-point for any target range for the CPI should be the level that is consistent with “stability in the general level prices” – the Bank’s prime long-standing statutory objective. (The Bank’s supporting paper provides overseas evidence that this might be around 0.5%.)

Third, the current dual objectives for monetary policy is a big mistake. No one knows what monetary policy settings are consistent with maximum sustainable employment. Monetary policy can control inflation, it cannot control output and employment.

Fourth, the Bank should stop making self-justifying assertions that are not supported by rigorous analysis. Its Covid-related asset purchases have cost taxpayers around $9 billion for no proven benefit.

The absence of proven benefits is troubling. Recently-published US research of the corresponding US programme put its cost to taxpayers after April 2020 at US$640 billion. It found no significant evidence of benefits in the form of lower borrowing costs or increased output or employment.

Our Reserve Bank could do a lot more to show that it is serious about learning from the monetary policy debacle of the last two years. Let’s see it.

Read more


NB: The version of this article that was published by the Herald on 12 February 2023 is slightly shorter.

Stay in the loop: Subscribe to updates