I've just got hold of the latest Listener, and the cover story - "High Anxiety" by David Young (offline) - reminded me of some stuff I've been throwing round in my head for a while about the future of monetary policy. Back in June, the Dominion-Post carried an opinion-piece by Bernard Hickey with the rather memorable title of "Bollard probably needs a new gun". Talking about the Reserve Bank governor's then-latest interest rate decision, Hickey said:
This week Dr Bollard kept interest rates on hold, but warned that inflation was right at the limit of his patience and the merest hint of higher prices would have him pulling the trigger to raise official interest rates.
In the language of central bank governors he is talking very tough.
He practically pulled out his gun and waved it in the face of the market and yelled: "I have an itchy finger and I know how to use it."
The markets and the banks gave him the figurative finger right back. ANZ, National and Kiwibank all cut their fixed mortgage rates by 15 to 20 basis points.
Needless to say, this is not how monetary policy is supposed to work. What was supposed to happen is that the banks would raise their rates, thus discouraging borrowing and (eventually) cooling off the housing market. The reason they didn't is down to one thing: globalisation. Our banks can also borrow overseas where interest rates are lower, and can thus ignore the Reserve Bank's signal. Young's article talks about the consequences for home-loan borrowers and whether the economy will have a hard or soft landing. But the problem goes deeper than that - in fact, it undermines the whole basis of our monetary policy. If banks can borrow cheaper overseas, and pass those lower interest rates onto borrowers (including home-loan borrowers, but particularly business), then the strong linkage between interest rates and economic activity which the Reserve Bank depends upon to control inflation is broken. And suddenly, they have no control at all...
Young points out that this is due to the fact that our economy is out of step with the rest of the world: while we've been doing well, they've been in recession, with the consequence that their interest rates are significantly lower than ours (low enough for all parties to profit while still undercutting the Reserve Bank). In the next few years, that gap should narrow - but I'm not sure whether it will do any good. As Young points out,
The best hope is to take advantage of the foreign cash and continue shifting to relatively cheap, longer-term mortgages, and try to stay slightly ahead of the wave.
And the Reserve Bank.
The upshot is that for the forseeable future, the Reserve Bank is essentially powerless. And this probably goes for the long-term as well. Globalisation has cut the foundations out from under our monetary policy, leaving us at the mercy of the market - and I don't think there's a damn thing we can do about it.