Orr explains how the RBNZ is driving the economy

Fighting inflation during a pandemic led the Reserve Bank into a conservative position where it sought to avoid error, rather than boldly chart a new course, economists have been told.

This view was expressed by Reserve Bank governor Adrian Orr, in a speech to the Waikato University Economics Forum.

“From the outset of this health shock, the Reserve Bank’s Monetary Policy Committee was convinced that a search for economic certainty was near-futile,” Orr said.
 
“Instead, we needed to provide as much monetary policy certainty as possible within an uncertain economic environment.”

Orr went on to explain this approach further.

“This is why we adopted a ‘least regrets’ framework for deciding on our actions, and continue to do so today,” he said.

“By this, I mean ensuring our decisions avoid the worst policy mistakes while maximising our ability to meet our objectives over the medium term.”

Orr said in the early days of the Covid-19 pandemic, the economy appeared to be headed downwards, with low inflation, and falling employment, and a collapse in business investment.

The path of least regrets at that stage was to move quickly to ease monetary conditions. But this process went so far that it reached the outer limits of its effectiveness and other actions were needed, such as quantitative easing.

This was done via the Large Scale Asset Purchase Programme (LSAP) and the Funding for Lending programme (FLP)

The scale of this action was significant – together with Government payments, they amounted to 20% of GDP, and were the second highest level of public support among advanced economies after the United States.

Despite this large-scale action, Orr stressed it could have only a limited impact in the long term.

“We are aware that monetary policy can only provide a temporary buffer to an economic shock …. we generally cannot influence real variables in the long run.”

Much of Orr's speech was focussed on the unique challenge of fighting inflation while a pandemic was spreading.

To make matters worse, imported inflation, which had been either negative or zero before the pandemic, was now pushing up price rises at a time when domestic inflation was actually being contained.

Rising oil prices were a special problem, since the cost of fuel was pervasive within the economy.

In his speech, Orr stressed the importance of traditional methods of dealing with this crisis. This amounted to a defence of monetary controls via the OCR, which were 'tried and true', or 'business as usual'.

“Our ‘path of least regrets’ has now become one where we must ensure that consumer price inflation and inflation expectations do not rise persistently above our target level,” Orr said.

We are taking our foot off the accelerator now to minimise having to use the brakes harder in future.

“Anything less from the committee risks spiralling long-term economic costs and reduced wellbeing for New Zealanders.”

Orr went on to say that financial market pricing for future interest rate levels had been very responsive to RBNZ signalling.

And this meant New Zealand was expected to tighten monetary policy sooner than many other comparable economies.

“By getting on top of inflation pressures quickly, by raising interest rates sooner, we aim to prevent the need for even higher rates in the future. In other words, we are taking our foot off the accelerator now to minimise having to use the brakes harder in future.”

Orr went on to praise the Government for its fiscal support such as wage and business payments to affected people by the state.

“But, in normal times, monetary policy will remain the most effective tool to stabilise the economy.

“That was due to the ease and frequency with which it can adjust, its operational independence, and the potentially significant economic costs of dynamically adjusting government spending, taxes and transfers.”

Orr then went on to discuss the rise in asset prices during the crisis, mainly the cost of housing.

And he defended the role of monetary easing in this, with changes in New Zealand’s OCR having less impact on these prices than in other countries.

And it was not the RBNZ's main role anyway.

“Our monetary policy mandate recognises the limitations monetary policy has in influencing distributional issues.

“Instead it recognises that the best impact monetary policy can have on economic wellbeing for all is through maintaining low and stable consumer price inflation in a manner that contributes to maximum sustainable employment.”

And he stressed that the unique combination of inflation and a world-wide disease did not really upend RBNZ methods.

“Despite the unique global economic shock, the operation and response of monetary policy is relatively conventional,” he said.
“We are committed and confident we will return inflation back towards more acceptable levels, through the use of our conventional monetary policy tools.”