No QE “free lunch” for NZ

By Matt Nolan 07/10/2012

As a general rule of thumb, whenever someone offers you something for nothing they aren’t telling you the full story – and that is exactly what we have with the Greens stating the Reserve Bank should start rebuilding Christchurch themselves by printing money.

Now, in order to come to this conclusion a bunch of points are being mashed together.  So in order to understand what this entails, and why does it in this way isn’t the best way forward, we need to have a think about what such a policy really means by splitting it into “monetary” and “fiscal” policy.

Monetary policy, fiscal policy

Having the RBNZ buy up a bunch of government debt which has been taken on to rebuild Christchurch works through two channels we need to think about distinctly:

  1. Monetary policy – by “increasing the money stock” in this example, they are loosening monetary conditions.
  2. Fiscal policy – by getting the RBNZ to go and fund the rebuild by printing money, we are in essence transferring resources for the rebuild.  They don’t appear from nowhere.

Now here Ganesh Nana states that he thinks RBNZ monetary policy is distinctly wrong – and that we will face deflation.  If that is the case, they should cut interest rates first.  However, he may believe that there is even more risk than that, and that cutting rates towards zero AND putting in place QE is required.  Viewing QE as a form of monetary policy this could make sense.

But, this is far from the consensus view, it is a long way away from households and firms expectations of what we will experience (which determine much of what usually happens with inflation) – and it is far from the way the Greens described it.  In truth, the RBNZ has policy about where it should be – and if it should be looser then it probably shouldn’t be by much.  As a result, we cannot use the monetary policy argument … and QE will increase inflationary pressures.  So from here, I’ll assume that the RBNZ is currently meeting its inflation mandate – a view that is held up by the evidence.

Russel Norman is completely misrepresenting QE by saying that the recent crisis is “evidence it isn’t inflationary”.  QE was put in place to fight the fact that policy was too tight overseas, and they were trying to fight deflation – in essence the fact that inflation stayed near the “target band” in these countries is evidence that QE is indeed inflationary as you would expect … just in the way they were intending.

Fiscal policy

Furthermore, choosing to do QE that is premised on an extension of government borrowing funded by the RBNZ is different to what is being done overseas!  Overseas, much of QE has been the Fed buying existing long-dated Treasury bonds from the private sector.  They haven’t been “financing deficits” persee they have been trying to increase the amount of high powered money in the general economy.

The form of policy being suggested by the Greens is effectively full scale fiscal policy being fully accommodated by the RBNZ, or monetizing debt – it is saying that the government will borrow and the RBNZ will then print money to pay for it, thereby increasing inflation as a tax to pay for it.  Resources do not appear from the ether – no matter how many people inside and outside New Zealand want to pretend this is the case – this is a straight transfer of resources towards rebuilding in Christchurch and away from other places.  [Note:  This view comes from the presumption that the Greens are saying the RBNZ should buy the bonds and then write them off – if the RBNZ is just holding the bonds and expecting repayment, then you are still running a “deficit” it is just being hidden on the RBNZ’s balance sheet instead … in this case we are again easing monetary policy, we have a larger deficit which will need to be paid for with future taxes, and given monetary policy is currently sufficient this will lead to excess inflation].

Now you may believe we should fund the rebuild with a one-off tax – that’s fine, in that case get the government to put a tax in place directly (or to directly cut spending from other place).  However, taxation by stealth of this sort is likely to be worse in multiple ways:

  1. We have betrayed RBNZ independence for virtually no reason … understandably a sneak tax by the RBNZ would make people less likely to believe them in the future about holding to their inflation mandate.  As a result, we run into the time-consistency issue in monetary policy again, and it will become more painful for economy when the RBNZ tries to commit to its inflation mandate again.
  2. We have a relatively rough redistribution of resources due to this.  By putting in our sneak tax through QE, we transfer resources to those with assets, those doing the rebuild, and those who can easily adjust prices/wages – while hurting those on fixed income, and those who have saved.  It is an inflation tax – pure and simple – and as a result, it will initially transfer resources from those who can’t protect themselves (generally the poor) to those who can (generally the rich).  If we introduce the tax through fiscal policy instead we can sort out these distributional issues a little better.
  3. A country that is willing to introduce QE as a clear fiscal transfer – when there is no monetary policy reason – will destroy its credibility with international lenders.  People will scoff at this, but such a policy will increase the level of “inflation insurance” lenders ask for – increasing the cost of credit in New Zealand.

These are obvious and true costs, that have been seen from similar policies around the world for hundreds of years.  QE really isn’t anything new, and if we want a fiscal transfer of this sort just say it (as the Greens previously have to be fair), and do it through fiscal policy – it has nothing to do with the RBNZ.

But the exchange rate, it will get that down!

The constant banging on about the exchange rate and the RBNZ shows a fundamental misunderstanding of the “issues” NZ faces.

The Greens, and Ganesh Nana, are wrong in stating that the RBNZ has failed.  Distinctly and totally wrong.  Things like this:

”No system of monetary policy is perfect and New Zealand cannot remain the last devotee to a failed monetary theory while the rest of the world moves on,” Norman said.

Paint a complete and utter misrepresentation about the lessons from the Global Financial Crisis.  Our flexible inflation targeting framework saved us from a massive crisis at home – while the rest of the world fell apart.  We have learnt that there are issues of financial stability we should have looked at – issues we have discussed for a while – but this is definitely not a reason to start “fine tuning” the economy through the RBNZ.  That is exactly what Labour, the Greens, and NZ First are trying to do … and its something that has been shown time and again as folly!

We can easily make the case for the exchange rate having been persistently too high – the key word there is persistently – and the key point that comes out is that, as a result, our real exchange rate is too high.

The high real exchange rate is not due to monetary policy – which is cyclical in nature – it is due to persistent structural factors.  Things related to government policy and competition policy.

The confusion stems from the fact that the combination of the current nominal exchange rate, inflation rate, and nominal interest rate are the indicators that move around with monetary policy.  They do, and they tell us things about the stance of monetary policy – but the RBNZ only makes up one part of the determinant of these factors.  The RBNZ works to achieve its inflation mandate while other institutions in the economy run around and do what they do.

So what happens to the real exchange rate when we print money to do some building in Christchurch?  Well if this activity persists it will likely go up as we are funding more government activity through an “inflation tax”.  If it is indeed a one-off tax, then the outcome is more uncertain.

Lets stop dwelling on the exchange rate like it is some shackle holding us back, and that we have a silver bullet to shoot it down.  The macroeconomy is not, and never will be that simple.  Instead lets us “why” NZ keeps running current account deficits and why our discount rates are so high – is it because we treat investments differently, is it because we have higher growth expectations, is it because government spending is too distortionary, is it because we have issues with competitiveness in the non-tradable sector, is it because we are naturally impatient people?  The one thing we know, is that it is not because of monetary policy – that does not follow.


To summarise I’m saying:

  1. We don’t need QE in NZ, as we have enough monetary stimulus (and if not we can cut interest rates further).
  2. What is being suggested isn’t even QE – its the monetization of government debt, effectively a inflation tax to pay for the rebuild in Canterbury.
  3. It is unlikely that such a tax is the “best” way of raising the revenue to rebuild Christchurch – which should be the primary question.

This is the main gist of what is going on here.