Alan Bollard, the just-retired Governor of the Reserve Bank of New Zealand, is a genial man with a wry sense of humour. He is also a great public servant for whom we have much to thank. He will be best remembered for steering us through the trauma of the global financial crisis, which began in September 2008. Before his decade-long Reserve Bank role, Bollard was Treasury Secretary for four years, and he was chairman of the Commerce Commission for four years before that. At the commission, he thought a lot about how to regulate businesses when the market could not be relied on to give a good outcome by itself. Unlike his Reserve Bank predecessor, he was comfortable with developing comprehensive financial surveillance and regulation processes.
The contribution of his deputy, Grant Spencer, who was charged with the implementing the strategy, should also be acknowledged. Sure, there was skill, courage – and luck – in dealing with the financial crisis, but there had been considerable earlier efforts to develop the capacity of the monetary system to deal with shocks. Although Bollard departs from the job with affection and respect, an unresolved matter remains from his watch. Has the bank’s interest-setting regime hiked the exchange rate to the detriment of the export sector, jobs, economic growth and our overall well-being? Some argue that the Reserve Bank should be directed to operate its interest rate policy to lower the exchange rate. In his last official interview, Bollard rejected this view.
The issue centres on how influential a central bank is. Critics of the Reserve Bank think it wields more power than it does. They are like economist Milton Friedman, who focused almost exclusively on the importance of monetary policy. Whatever you might think of his ideology, Friedman’s position is more defensible in the US, whose currency is the international medium of exchange, and where Congress is slow, clumsy and ineffective at managing the Government’s tax, spending and borrowing. Neither characteristic is true of New Zealand. Our dollar is hardly important internationally; our Government has considerably more control over its fiscal stance.
The critics may be appalled to be bracketed with Friedman. That arises because of his inordinate influence on our 1989 Reserve Bank Act. It’s a national tragedy that we keep latching on to defunct economists. The myth evolved that we had an extremely powerful central bank, and that its governor was the most powerful person in the land. I doubt Bollard thought he was. Over the years the Reserve Bank learnt it has much less freedom to move than the public rhetoric assumes. There is much publicity when the bank announces the Official Cash Rate, which it fixes with care. But the exercise is usually routine, as shown by commentators’ ability to forecast each new setting. The world financial system probably has more effect on New Zealand interest rates than anything the Reserve Bank can do. When the country is borrowing heavily overseas, those lending to us will want a higher interest rate. The Reserve Bank has a little wriggle room, but only around a level set internationally.
As I explained in an earlier column (“Boom time rats”, October 24, 2009), the effect of offshore borrowing is to raise the real exchange rate, with the bad results the critics warn us of. It is our overseas borrowing that is giving us a high exchange rate, not the actions of the Reserve Bank. Overseas borrowing is a consequence of a national savings deficit. If we don’t address that, we cannot effectively control the exchange rate. Nostrums such as fixing the exchange rate or quantitative easing will cause long-run difficulties – especially inflation – unless we save more. This explains why the Reserve Bank is so cautious. It does not have the means to address the exchange rate level because the problem is a shortage of savings, not monetary policy. As Bollard would say, the bank is not that powerful.