Reining in the RBNZ

Any new government after the October election must rein in an out-of-control Reserve Bank and narrow its focus to long-term price stability, says the New Zealand Initiative.

Blame for New Zealand’s inflationary spiral sits squarely with the Reserve Bank (RBNZ), it says.

Excessive money-printing, conflicting goals, grandiose aspirations and distractions, and a lack of core expertise have all contributed to the monetary policy failure, the Initiative says in its Prescription for Prosperity briefing paper aimed at the incoming government after the 14 October election. 

The paper says the RBNZ has fuelled inflation through its excessive monetary policy responses to Covid-19, resulting in massive losses to taxpayers, a house price whiplash, and a cost-of-living crisis – harming everybody.

As well, the Initiative says RBNZ Governor Adrian Orr’s forays into non-monetary areas such as climate change policy have heightened concerns about the bank’s focus and capabilities.

The Initiative’s policy recommendations to reset monetary policy are:

1.Amend the RBNZ Act

The Act should be amended to specify long-term price stability as the single monetary policy objective. By narrowing the focus of the RBNZ’s mandate, policymakers can make sure the central bank remains dedicated to its core purpose.

Long-term price stability is essential for fostering economic growth and therefore, prosperity, as it allows businesses and households to make well-informed decisions about investment and consumption.

2.Shift the RBNZ’s regulatory role to a new institution

Separating monetary policy and prudential regulatory functions is common elsewhere in the world including Australia where the Reserve Bank of Australia is charged with monetary policy and the Australian Prudential Regulatory Authority (APRA) is tasked with financial regulation.

Separating the functions into two organisations will improve governance and reduce the risk of political interference in the RBNZ’s core mission of price stability.

3.Limit RBNZ’s budget

The RBNZ’s budget should be limited to cover its monetary policy role, preventing the institution from engaging in matters beyond its scope, such as climate change and promoting the Māori economy.

While these issues are undeniably important, they fall outside the purview of a central bank. By constraining the RBNZ’s budget to its core function, policymakers could ensure the central bank remains focused on its primary objective of price stability.

4. Return the inflation target to 0–2%

The RBNZ’s inflation target should be returned to the 0–2% range instead of the existing target of 1–3%, which has proven to be insufficient in maintaining long-term price stability. A lower target range will encourage the RBNZ to pursue more prudent monetary policies, minimizing the risk of excessive inflation and promoting sustainable economic growth.

5.Stop the implementation of deposit insurance

The implementation of deposit insurance should be halted. While deposit insurance schemes can provide a sense of security for bank depositors, they risk inadvertently creating moral hazard by encouraging banks to engage in riskier lending practices.

By refraining from implementing such a scheme, regulators can maintain market discipline and encourage banks to act more responsibly, thus promoting financial stability.

6.Limit RBNZ’s discretionary ability to purchase securities to government paper

The Treasury has estimated losses on the RBNZ’s Large-Scale Asset Programme (LSAP) cost taxpayers around $10.5 billion – more than three times the bank’s equity position.

The crown’s exposure to losses under the LSAP happened without adequate parliamentary debate and scrutiny. The RBNZ’s actions were facilitated by finance minister Grant Robertson arranging for the crown to indemnify the RBNZ against those losses.

Better accountability is needed for such decisions. The RBNZ’s discretionary ability to purchase securities should be limited to purchases of government paper.

Such a restriction would prevent the central bank from intervening in the private sector and distorting the allocation of resources.

7. Ensure a credible timetable for reducing RBNZ’s balance sheet

Finally, the incoming government should establish a credible timetable for the RBNZ to reduce its balance sheet to pre-pandemic levels. The central bank’s asset purchases during the pandemic significantly radically expanded its assets and liabilities.

This poses risks to long-term financial stability and price stability. Such excess balances can become highly inflationary when individual banks decide the interest rate being paid on those balances is penal compared with what they can achieve by aggressively expanding their lending.

By committing to a clear and credible timetable for unwinding these positions, the RBNZ could signal its dedication to long-term price stability and bolster confidence in the economy.

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