The planned amendment of the Reserve Bank’s mandate: The National Party’s most significant programme element and no one talks about it
Incompetence at its best (worst)?
Since Christopher Luxon became the leader of the National Party on 30 November 2021, he has consistently prioritised the reduction of inflation by replacing the mandate of the Reserve Bank of New Zealand. On the one hand, the recommended modification will have the most significant influence over the New Zealand economy, yet it is barely mentioned in public discourse. On the other hand, this National Party’s plan shows how incompetent and socially irresponsible the party’s current leadership is.
In September 2023, the Reserve Bank of New Zealand (RBNZ) has a dual mandate. Since 27 March 2018, when Adrian Orr, the Governor of RBNZ, started his first term, the Reserve Bank has to conduct monetary policy in a way that they maintain inflation between 1% and 3% and at the same time, they support the maximum level of sustainable employment within the economy. Before 2018, RBNZ’s primary focus was to maintain price stability. This is the aim the National Party intends to restore – quite ill-fatedly.
The plan is motivated by the desire to tame the inflation that has been elevated since the second quarter of 2021 when the consumer price index (CPI) first climbed higher than 3%, above the official band within which the Reserve Bank should keep it. Although it might be an attractive catchphrase for voters, it shows how economically incompetent the National Party is.
On the National Party’s website, it is easy to find the argument as to why they intend to modify the dual mandate of RBNZ. They claim that the amendment to the mandate was merely a social experiment. However, this argument is very far from the truth.
The intro to the 2018 amendment was not scientific. Indirectly, however, it is possible to see that the 2018 amendment is based on scientific arguments.
Grant Robertson, the fresh Labour Party finance minister, was aspirational to help social progress and equity, which was his primary goal with the modification. We have to remember that his mentor was Sir Michael Cullen, who served as finance minister in Helen Clark’s government between 1999 and 2008. Neither Robertson nor Cullen had an economic background. Robertson studied political science, while Cullen was an economic historian. Crucially, however, Cullen worked closely with Don Brash, the then Governor of the Reserve Bank, from 1999 until Brash’s resignation in 2002.
Brash wrote extensively about his experience as Governor of the Reserve Bank in his book Incredible Luck (2014, Auckland: Troika Books Ltd.). It was Brash from whom Sir Michael Cullen learnt much about economics, and Brash highly regarded Cullen as a quick learner. Importantly, Brash achieved a PhD in Economics and knew about the trade-off between price stability and employment described by a New Zealander, William Phillips, in 1958, which later became known as the Phillips curve. It is also apparent by the thoughts in his book that Brash was aware of the interrelation between “the two evils” within the economy: inflation and unemployment. He also did his best to balance them, even though the official mandate of the Reserve Bank did not yet emphasise the necessity to minimise unemployment.
It is possible to argue that practically, the existing dual mandate of the Reserve Bank is the political acknowledgement of the Phillips curve, and this dual mandate was implemented into practice way before the official amendment of the Reserve Bank’s mandate. Reversing this mandate would be scientifically unjustified, practically detrimental to the New Zealand economy, and even contradictory to human rights.
The scientific arguments to maintain the dual mandate
Globally, most of the central banks have this dual mandate, and they attempt to cut the right balance between inflation and unemployment. The underlying causes of the trade-off between the two evils are simple: expansionary fiscal (increased government spending) and monetary policies (increasing money supply, decreasing interest rates and making loans more accessible for entrepreneurs) create more feasible investment opportunities for businesses. Therefore, investments will grow. Larger investments require more people at work so unemployment will decrease. However, the increased government spending and money supply have inflationary effects by increasing economic demand.
When the economic policy intends to reduce inflation, fiscal and monetary policies should become restrictive: decreasing government spending and higher interest rates, lower money supply with narrowing access to loans. These will affect the aggregate demand by reducing inflation. The negative effect of the policies is the increased likelihood of growing unemployment owing to decreasing investments.
During the 2010s, there was a debate about whether the Phillips curve phenomenon still exists. Jerome Powell, the Chairman of the US Federal Reserve, argued that during the 2010s, expansive monetary and fiscal policies did not cause rising inflation. Importantly, however, it is crucial to say that the 2010s were particular circumstances: the increased money supply did not trigger significantly higher investments into new businesses; it only caused asset price bubbles as the mushrooming of crypto-currencies and the high real estate prices showed. Besides, there was a unique phenomenon: the detachment of underemployment (the proportion of people who were employed but wanted to work more hours) and the unemployment statistics. Before the Global Financial Crisis in 2008, underemployment and unemployment moved together. However, during the 2010s, when investments in working capital finally grew, underemployment decreased quicker than unemployment. This meant firms offered more hours to those already employed first, and they recruited new workers later.
The evidence is clear: the Phillips curve is still a valid scientific theory to maintain the dual mandate of the RBNZ. It might be worth debating whether it would be better to recommend that central banks also consider underemployment when elaborating on monetary policy. With the current flexible labour market conditions, it might be a better option than focusing on the balance between inflation and unemployment.
The practical argument
Although the public does not widely follow monetary policy decisions, they are probably the most influential among all policy decisions. Their effect is comprehensive and affects everyone. If the RBNZ’s sole focus were to tame inflation, that would result in constantly higher interest rates than operations under the existing mandate. It would cause slower growth, detrimental conditions to finance new investments, lower consumer demand and ailing businesses. (During the 1990s, the most elevated debate among economists was whether the criteria to reduce inflation for introducing the Euro caused sacrifices in terms of lower economic growth and high unemployment.) This is ultimately the opposite of what the National Party intends to build: a strong economy.
In practice, households face restrictive fiscal and monetary conditions with one direct and one indirect effect. The immediate effect is the increased debt service in higher instalments. The indirect impact is the increased risk of losing employment. Businesses, however, face the restrictions on two direct fronts. First, they experience decreasing demand for their products and services, and second, they experience increasingly difficult financing conditions. If the National Party intends to improve conditions for entrepreneurs, why would they inadvertently cause business difficulties? Therefore, it would be rational to maintain the existing mandate of the Reserve Bank.
The human rights aspects
At the establishment of the United Nations, there were debates about whether the founding documents should include only political rights (universal suffrage, freedom of speech, etc.) or individuals' socio-economic rights as well. Among those politicians who argued for the inclusion of socio-economic rights into the founding documents was a New Zealand Prime Minister, Peter Fraser. Owing to the efforts of these statesmen like Fraser, the socio-economic rights were eventually included in the UN Charter (1945) and the Universal Declaration of Human Rights (1948).
Article 55 of the UN Charter defines full employment as a necessary condition for stability. Article 56 requires all member states’ commitment to using their policy powers to achieve full employment, among other socio-economic goals. The Universal Declaration of Human Rights goes further. Article 23 defines the right to work, favourable remuneration, equal pay for equal work and the right to form trade unions. Therefore, it is possible to see that improving employment conditions is a human right that needs to be respected by states. Nevertheless, it is not possible to derive from human rights that the dual mandate of central banks is required. But, when a state removes the requirement to maximise employment from the central bank’s mandate, it arises whether it is a de facto and a de jure violation of human rights.
Scholars of the modern monetary theory argue most strongly against economic policy focussing only on reducing inflation. They emphasise that full employment, as a human right, is achievable. They base their argument on the fact that during the Second World War, there was full employment in Western democracies. In peacetime, full employment is achievable by job guarantee programmes managed by the states.
These arguments are problematic, however. First, it is not desired to wage wars to achieve full employment. Second, it is unrealistic to believe that states can arrange the required number of jobs, which would also match the skills of the people who become unemployed. Businesses supported the flexible labour markets from the 1980s onwards because they could hardly arrange 40 hours of work per week for the people with the right skills. Why would states be more successful in this endeavour?
Concerning the human rights aspects of the Reserve Bank’s mandate, it is demonstrated that removing the aim to maximise employment and requiring them to focus only on taming inflation would be a political message that the National Party does not care about the basic human right to work. It is difficult to see why the National Party would invite such a political risk, namely, the accusation that they ignore universal human rights and are socially irresponsible for social stability.
For these three reasons, it is recommended the National Party leave the existing mandate of the Reserve Bank in effect.
If not for these three reasons, there is a fourth: Be a genuinely national National Party and honour the efforts of Peter Fraser and William Phillips, who were globally and historically influential New Zealanders.
Hi Laszlo. You’re right that this is one of the most important issues. But dropping the dual mandate will only make a bad Act slightly better. We don’t need the employment mandate but we do need substantial change and that’s not want National is proposing.
The employment mandate was predictably cited by RBNZ as it pro-cyclically inflated the economy more than needed, leading mostly to asset inflation. But when inflation kicked in, there was no sign of RBNZ using it to reduce unemployment. To the contrary, with its the aggressive engineering of a recession. So, its employment mandate made things worse on the way up, helping to overheat the credit-driven parts of the economy, and no difference to unemployment on the way down.
Your analysis also makes the mistake of thinking that the RBNZ’s interest rate mechanism works through its impact on real business investment. In fact, there is ample evidence that it primarily works through the (mostly unproductive) consumer credit channel. The difference of a point or two on already low interest rates really only affects “investment” that is highly sensitive to interest rates, i.e. property, shares and other financial instruments. Few jobs are created by that sort of investment.
The real change we need is to the Reserve Bank’s extreme form of independence. This extreme independence has been perfect for the banks it regulates who have seen a huge rise in size and profits under this regime. Politicians, as the public’s reps, are kept at arms length. Meanwhile, the expansion of private debt that underpins this profit rise -- almost all mortgage debt -- has risen alongside house prices to now far exceed the size of public debt. Yet it prompts hardly a word from politicians or the Reserve Bank. When the social and distributional damage is pointed out to the latter, we learn that it’s not its problem because it’s not in its mandate.
The return of RBNZ to a government department operating in a coordinated way with Treasury will ensure we have the tools and mandate to solve complex economic problems with a mix of monetary, regulatory and fiscal levers - more effective and with less social, economic, and environmental collateral damage (“externalities”) to deal with.
As for employment, fiscal tools are usually better for dealing with unemployment and - as we have seen in this inflation round - probably better at dealing with inflation when so much has been supplier profit-driven rather than wage-driven.
A closer relationship with Treasury - while not “in its pocket” - is how the Reserve Bank successfully operated for its first fifty years (and central banks had operated around the world). Then we got the monetarist experiment of independent inflation-targeting central banks. Plenty of evidence now shows this approach to be wonting.
The main thing to fear from National is more tinkering to solve the wrong problems while leaving the existing damaging system in place.