New Zealand. Economic and political structure in brief

Financial University

Under the Government of the Russian Federation

Chair of Macroeconomics

Laboratory work on Macroeconomics

Monetary Policy of Reserve Bank of New Zealand

Prepared by:

Stopnikov Nikita the student of

Finance University under the government of the Russian Federation

IFF the 2nd course student group 2-1

Tutor:

Vladimir Skalkin

Finance University under the government of the RF

Chair of Macroeconomics

Candidate of Economics

Plan:

1. Introduction…………………………………………………………...3
2. Literature review………………...……………………………………6
3. New Zealand. Economic and political structure in brief………….…..9
4. The Reserve Bank of New Zealand………………………………….11
5. Analysis and interpretation of data……………………….………….16
6. Conclusion and a look forward…….………………………………...45
7. List of References……………………………………………………48
1. Anti-plagiarism………………………………………………………49 
   Introduction

In today’s world, the Governments, the business and investment community, and the general public have no doubts about the importance of the role of policy makers in shaping the financial and economic events. If successful, the policies can make a significant contribution to the nation’s prosperity. If not, the effect of the wrong policies can be to ruin the economy, even with a lot of potential. The effect of the wrong policies can sometimes be compared to the effects of a destructive war. Monetary policy is the set of tools that are used mainly by the Governments or central banks if these are independent of Governments.

What is noticeable, each country has quite distinctive features of monetary policy compared with other countries. For instance, in Russia, monetary policy has been for a long time aimed at managing the Ruble exchange rate. In the United States of America, monetary policy tools are frequently used when GDP growth or unemployment is a matter of concern for the US administration. In Europe, Australia and New Zealand the central banks’ primary concern is the level of inflation1. However, in almost all counties (Russia being perhaps the only exception among the G8 nations), monetary policy was also aimed at controlling the economic cycle. In Russia the monetary policy until recently had little reference to what was happening in real economic life. The refinancing rate of the Central Bank of Russia was set and changed more or less regularly2. However, the effect of these changes on the economic events (which is the reason monetary policy steps are taken in the first place – to change the course of events) had been minimal. It is encouraging that recently the Central Bank of Russia has been taking a firm position on its role as the principal regulator of the economic environment. It is also encouraging that the Central Bank is moving towards realization of the fact that it should have the primary responsibility in maintaining the overall level of prices with the help of monetary policy instruments.

In my opinion, it would do much good for the Russian economy if the Russian Central Bank kept an open mind and was willing to use the policy instruments, which have proved to work well in other countries with open economies. In addition, it would also be beneficial if the administrative environment of such open economies was examined and some elements perhaps even copied directly into the Russian banking and financial system, and the economy in general.

New Zealand, despite being a very small country, serves as an excellent example in many areas, for other countries to follow:

• It is an economy open to the world, i.e. the country is not an autarky, it actively engages in foreign trade;
• The institutions and laws in New Zealand are among the best in the world, where businesses and households have confidence in the system’s ability to self-correct and self-regulate;
• Government intervention in the economy is minimal, but when it is required, the Government and the Reserve Bank of New Zealand are ready to step in with policy initiatives, which could help the markets;
• The country is so respected in the international community that it regularly shows in the Top 10 of the Doing Business ranking. In 2011 New Zealand was awarded the Most Peaceful Nation title, and the World Bank placed New Zealand at overall No 3 position in its 2014 assessment for the second consecutive year3.
• The Reserve Bank of New Zealand is openly accountable for its policy decisions4. On the other hand, the Bank never engages in anything, which would take its attention and effort away from the main policy goal – overall price stability as measured by the rate of inflation. The Bank of course keeps track of all the major economic indicators, including GDP growth and unemployment levels, but it openly states that it is outside the Bank’s competence to influence the unemployment levels, for example, or the long-term GDP growth5, because these indicators depend on factors largely outside its control.

Overall, the country’s position in the world is determined, among other things, by how truthful the actual policies were, compared to the declarations, and how successful the declared policies have been, when time comes to consider the actual policy results. Here, again, New Zealand offers an example to follow.

In this paper, I will begin with a brief review of the literature, which has been covered during preparation of this paper. I will continue with a brief outline of New Zealand economic and political structure. The next section will deal with some analysis and interpretation of data for different periods of time, and explain what the monetary policy decisions were, and why they were taken. The analysis will be supported by official statistics modified where appropriate and presented in graphical form so that it is easy for the reader to visualize. I will conclude with an opinion as to the success of the policies, and with some projections which have been developed in respect of New Zealand for the future.

Literature review

Paul Krugman and Robin Wells in “Macroeconomics” (second edition) outline the consensus thinking in monetary policy theory. That is, in the long run, changes in the money supply do not affect real GDP or the interest rate, and ultimately, monetary policy is ineffectual in the long term. But in the short run, monetary policy can successfully address output–demand imbalance through monetary policy instruments, such as inflation targeting and the use of central banks’ power to affect interest rates.

Mr Alan Bollard, who was the Governor of the Reserve Bank of New Zealand until September 2012, wrote in that month for The Banker magazine in his article “New Zealand learns from the sidelines of the crisis”. On the whole, he subscribes to the above traditional view. “The crisis experience has raised questions around whether we can still rely on orthodox monetary policy to work in the traditional way. In New Zealand’s case, we think so”6.

Thomas I. Palley with the German Macroeconomic Policy Institute, challenges this view. His “Monetary Policy and Central Banking after the Crisis: The Implications of Rethinking Macroeconomic Theory.” states that “The financial crisis and the Great Recession have prompted a rethink of monetary policy and central banking… The insider reform makes no changes to macroeconomic theory and is uncritical of the central banks’ pas actions… The outsider program fundamentally challenges existing macroeconomic theory and is also highly critical of the central banks. They should have a duty to shape the allocation of credit and the financial system in ways that ensure growth, full employment and a fair shake for all”7. “The paper’s critique of existing monetary policy and central bank practice and it recommended reforms are focused on the US Federal Reserve. However, the principles that are articulated and many of the proposed reforms carry over to monetary policy and central banking everywhere, including the Bank of England and the European Central Bank”8. For the Reserve Bank of New Zealand, which has been following the traditional line of thinking, this means that it is also subject to the same criticism.

The Bank’s Board of Directors in its ”Explaining New Zealand’s Monetary Policy” naturally disagrees with such a radical proposal and states that “Growth in an economy is driven by many factors, most of which have nothing to do with monetary policy… Over the long run, an economy’s performance is ultimately determined by productivity… Employment is maximised by having the economy operate as productively as possible. Price stability can assist, but it is far from the only factor affecting employment. For example, educational standards, skill levels, labour laws, and social policies can all increase employment levels, and these things have nothing to do with the Bank’s operation of monetary policy”9. The Bank’s position is that its primary concern is as stated in the Reserve Bank of New Zealand Act 1989 – to maintain the price stability with low inflation.

The Board of Directors of the Reserve Bank of New Zealand had also agreed on the place and role of the Bank in a wider context, that is, in macro-prudential regulation. The Board thinks that “When selecting an appropriate instrument, an important consideration will be the effectiveness of the instrument in meeting the policy objectives given the particular risks facing the financial system at that time… In some cases, the optimum response might involve using more than one instrument…”10

Rebecca Jackson-Young (lead analyst) and Fung Siu (analyst) of the Economist Intelligence Unit have provided an outlook for the New Zealand Economy in their November 2013 overview of political, social and economic risk assessment for the country for the foreseeable future.

Alan S. Blinder, Michael Ehrmann, Marcel Fratzscher, Jakob De Haan and David-Jan Jansen of the European Central Bank in “Central Bank Communication and Monetary Policy: A Survey of Theory and Evidence” maintain that on the whole, transparency and clarity in communication by the Central Banks could not only dispel public fear or misunderstanding of what central banks do and why they do it, but also make the monetary policy more effective11. New Zealand is commented on by the ECB as an enthusiastic pioneer and an example to follow.

The Reserve Bank of New Zealand Act 1989 governs the activities of the Reserve Bank through legal provisions. They concern different areas, such as the purpose – to establish that the Reserve Bank of New Zealand (RBNZ) has the overall responsibility for monetary policy, maintenance of a sound and efficient financial system, and carrying out other functions, appropriate to the nation’s Central Bank12. The Act also defines the principal terminology, the internal structure of the Bank, the role of officials and such functions such as the principal executor of the monetary policy, regulator in the macroeconomic area, foreign exchange, issuing of currency, and banking supervision.

The official data and announcements from the Reserve Bank of New Zealand, such as Monetary Policy Statements and supporting downloads on the website provide first-hand information on New Zealand economy and its main indicators over historically significant period of time, of which five such announcements are covered in the paper. Graphical support, prepared by the author of this paper, enable better visualization of economic trends in the country over the last ten years.

2. New Zealand. Economic and political structure in brief.

Background: New Zealand is a small country of only 4.5 million people (that is less than one half of the Moscow city). It relies in large part on agriculture, which is also its main export item. New Zealand is actively trading with the USA, Australia, UK, Japan and China, as well as with other East and South-East Asian countries. Some economic statistics are given in the table below13:

The country is focusing on reconstruction efforts after the devastating Christchurch (Canterbury region) in February 2011. There was a significant loss of life and a lot of damage to property caused by this earthquake. The Government sees its job in strengthening the state finances, improving the country’s economic performance and productivity and the environment of regulation. Many previously state-owned assets are now being privatized. The taxation level is relatively low, with personal income taxes starting at 10.5% and the top rate of 33%. This is similar to the United States, but lower than the top marginal tax rates in the Continental Europe (over 50%) or the United Kingdom (45%). The indirect taxation is represented by GST (Goods and Services Tax, the equivalent of VAT) at the standard rate of 15% on final purchases of goods and services. This level is above the sales taxes in most states of the USA, but lower than the Value-Added Tax in most European Countries and Russia.

Major exports are dairy products (25%), meat products (11%) and forestry items (9%). The leading export markets are Australia, China and the USA. Major imports are machinery (20%), mineral fuels (18%) and transport equipment (12%), and the country mainly imports from the same partners, although in imports China takes first place, Australia second, and the US – third. 

Political structure: New Zealand is part of the Commonwealth of Nations and is a democratic state. The latest government was formed following the November 2011 general election, by the Prime Minister, John Key. The political and social environment is stable with no major turmoil expected over the foreseeable future. The Prime Minister is widely expected to hold on to his job at the next general elections, although, as with many other countries, the Government regularly faces criticism from the Opposition.

3. The Reserve Bank of New Zealand

The Reserve Bank of New Zealand (RBNZ as it may be referred to hereafter in this work) will be 90 years old in 2014. It operates under the Reserve Bank of New Zealand Act of 1989. It is owned by the Government but is independent from the Government in making the monetary policy decisions.

The Bank’s current Governor is Mr. Graeme Wheeler. He replaced the previous Governor, Mr. Alan Bollard, in September 2012.

It is written in the law that “…the primary function of the Bank is to formulate and implement monetary policy directed to the economic objective of achieving and maintaining stability in the general level of prices”14. The main mechanism through which the bank conducts the monetary policy is the Official Cash Rate (OCR). This rate is set to influence the interest rates in the market in the short term. The Bank can lend overnight funds at 0.25 per cent above the OCR to banks, and on the other hand, the Reserve Bank can take deposits from banks at OCR less 0.25 per cent. The Bank has no limit on how much it can borrow or lend in the market at these rates. This creates a good mechanism to ensure that the level of the interest rates in the market is as close to the OCR as possible.

Adjustments to the official cash rate are made eight times a year. There is no obligation on the Bank to change the Official Cash Rate at any time. On the other hand, the Reserve Bank of New Zealand can make unscheduled adjustments, but does not usually do so unless in really exceptional circumstances.

The Reserve Bank of New Zealand is also responsible for, and engages in, macro-prudential regulation. This is a broader role and is aimed at taking measures to preserve wider economic stability (for example, to hold back economic risk-taking in good times, to prevent appearance of asset price bubbles, or to improve standards of performance by the country’s banks15.

The Bank has long subscribed to the view that its functions in the economic system should be limited to those, where it is naturally the most competent agent to provide direction and regulation – the financial and banking system. The policy tools which the Bank considers should be regularly used, are also standard – mainly the policy rate adjustments and general banking supervision. In other words, the Bank considers its role as specific.

This view and policy making attitude have been subject to a growing criticism from the group of economists who subscribe to alternative views. These views were recently restated by Thomas I. Palley in his Working Paper for the German Macroeconomic Policy Institute No 8/2011. The institution most criticized was the Federal Reserve of the United States, however, it is evident that most Central Banks (including the Reserve Bank of New Zealand, the European Central Bank and the Bank of England) and the monetarist theory in general are all targets of this criticism.

Mr. Palley’s and his colleagues’ view is that the current rethink of monetary policy and central banking (called the “insider rethink”) does not go far enough as it only scratches the surface of the problems which culminated in the Financial Crisis of the late 2000s. In particular, the argumentation is as follows:

1. There is already a reform proposal (the “insider rethink” mentioned just above), but this proposal does not mean a change in macroeconomic theory;
2. The actions of many of the Central Banks, including the Federal Reserve, during the crisis are justified16;
3. The focus of the “insider rethink” is narrow – namely, (a) monetary policy and asset price bubbles; (b) regulation in monetary policy; and (c) zero limit to the nominal interest rate17.
4. Finally, the scholars claim that the proof of the need for deeper reform is that actions of many of the Central Banks have been unsuccessful. They may have succeeded in preventing the new economic collapse similar to 1930s, but, on the other side, the social cost of this was too great in the form of budget cuts, and significantly higher unemployment than before the crisis. These unemployment levels are still high today.

What they propose is the “outsider reform program”, which would focus on the following:

1. Governance of central banks and their independence
2. Changing the economic philosophy of central banks;
3. Big reform of the monetary policy, which would include adoption of an inflation target equal to the minimum unemployment rate of Inflation (MURI)
4. Other measures of the technical nature, such as asset-based reserve requirements;
5. Regulatory reform18.

I would like to briefly describe only points 2) and 3) because point 1) has been subject of numerous debates for many years in many countries, and there is probably no right or wrong answer that can be stamped on any given economy. Point 4) deals more with central banks’ regulatory and supervision role in the financial system, and point 5) has been going on in different countries at different speeds in different directions since the Financial Crisis started.

Changing the economic philosophy of the central banks.

Mr. Palley argues that the current thinking makes the central bankers favour only one range of outcomes of the monetary policy – they have a “preference for low inflation to protect financial wealth”19. Meanwhile, industrial capital will have a preference for a stronger real economy and lower unemployment. Workers of course will want full employment and higher real wages. Central bankers tend to side with the interests of financial capital, so the central banks will tend to favour macroeconomic outcomes, which have higher unemployment and lower inflation. This is a point lower on the Phillips curve. It is claimed that a central bank will more likely choose too low inflation, and if the economy has a negatively sloped Phillips curve, this causes permanent output losses and permanently higher unemployment20.

Mr. Palley says that this bias of the central banks in favour of the financial capital interests should be reversed, and that the central banks must fully represent competing interests so that a socially optimum inflation – unemployment outcome can be achieved.

Monetary Policy Reform

Mr. Palley’s proposition is rather radical – central banks should adopt such inflation targets that a point can be reached where the sustainable rate of unemployment is minimal. In his view, the Phillips curve, showing the trade-off between unemployment and inflation, is backward bending and central banks should redirect their policies 180º. That is, to make inflation rate a subsidiary indicator, and the unemployment rate – the primary target. He also proposes a term for this level of inflation – the minimum unemployment rate of inflation – or MURI. This is the opposite of NAIRU – non-accelerating inflation rate of unemployment. The backward bending Phillips curve and the MURI are illustrated in the graph below21.

Palley gives the reason why the curve is backward bending. It is because workers in high unemployment industries may agree to a small real wage reduction (for example, by having the same nominal wage for another year or two) at low rates of inflation. However, at higher rates of inflation reduction in real wage is unacceptable, therefore the curve bends backwards.

In Palley’s opinion, at low rates inflation is not a concern, and instead the unemployment is the real concern. Therefore, it is important that inflation targeting should be formalized in such a way, that the central bank has a responsibility for real economic performance22.

4. My own view is that this is a very bold and radical proposition, which the central banks will not like. However, this debate is far from over and ongoing. 
   Analysis and Interpretation of Data

This section of the paper will examine historic data of some of the key macroeconomic indicators, as they relate to the New Zealand economy, and are kept and utilized by Reserve Bank of New Zealand. RBNZ in each of its periodic Monetary Policy Statements holds the relevant data close to users’ hands, and has a download section with relevant material in the form of spreadsheets together with the Policy Statements themselves. As a rule, such spreadsheet material comprises the following data collected by the Government agency, Statistics New Zealand:

1. CPI, or Consumer Price Index – as the best indicator of the inflation rate. The data is given for the end of each calendar quarter. The example is illustrated below in Graph 1.

Graph №1 – Consumer Price Index23 (Graphical presentation and compilation by Nikita Stopnikov)

The CPI data is presented on the quarterly basis. As one can see on the graph, the Consumer Price Index was extremely high during the World Crisis of 2008 and then again for much of 2011. Although it has to be said, that these peaks in inflation (both times just above 5%) were nowhere near those peaks experienced by the developed economies in the 1970s during the oil price shock. The first peak of inflation in 2008 was again caused by the worldwide rise in price of commodities, it is then that the oil price exceeded $140 per barrel. Because New Zealand depends on imports for many of its resources, this rise in commodity prices was quick to illustrate itself in the increased CPI figure24. A typical monetary policy response would have been to increase interest rates to fight inflation, all other things being equal. However, because the GDP trend was then clearly on the way down, the Bank took the opposite step and reduced the OCR for the second time from 8.0% p.a., this time by the full 50 basis points, to 7.50% p.a. in its September 2008 Monetary Policy Review.

The second increase inflation in 2011 is again characteristic, because it was the result of the contractionary fiscal policy, and had nothing to do with the monetary policy. Contractionary fiscal policy in most cases means an increase in some taxes in the economy. For New Zealand at the time it was the increase in indirect taxation, i.e. taxes on consumer spending. The Goods and Services Tax was increased in October 2010 from 12.5% to 15.0% on most goods and services25. This would imply an increase of 2.2% (115.0/112.5 - 1)*100% in the prices straight away, as a unit of goods or services previously costing NZ$112.50 would cost NZ$115.00 on the next day. When the standard rate of indirect taxes goes up, immediately this is reflected in the retail prices, which are an important component of the CPI calculation, so the CPI goes up as well. Of course, these increases may take some time to work through the system and consumers often cut back their purchases or look for bargains. However, in the case of New Zealand we see almost an immediate effect – prices started to go up much faster in 4th quarter of 2010. Increases in indirect taxes are often seen as drastic measures, designed to correct serious imbalances. A similar example at the time was the increase of the VAT rate in Great Britain from 17.5% to 20.0%. Opposite cases do happen, but less frequently, such as in Russia with the abolition of the sales tax in the mid-2000s. Then, the sales tax with the maximum rate of 5% was taken out of the system totally, helping contain the retail price inflation in the 2000s.

To get back to New Zealand, we do not see any action by the Reserve Bank of New Zealand on such high inflation figures, precisely because this increase in prices was the result of only one factor - the fiscal policy26. The OCR, which was then 3% p.a., did not move until the February 2011 earthquake in Christchurch, when it was reduced to 2.5% p.a.

Currently the CPI stands at 1.6% (see Graph 1) – the comfortable level for the Bank. It is between 1% and 3% and close to the 2% midpoint.

2. Real GDP growth – as the measure of the overall progress of the national economy. It is notable that the GDP data (at quarterly intervals) is given not just for the country itself, but also for its main trading partners, namely Australia, the USA, Japan and the United Kingdom. Graphs 2 and 3 below provide the illustration for New Zealand alone, and also in comparison with the two closer neighbours from Asia Pacific – Australia and Japan.

The dip in the GDP dynamics is explained by the Global Financial Crisis of 2008-2009. During this period, GDP was moving in the negative territory, with the trough at -2.2% for two consecutive quarters. Compared with the main trading partners, New Zealand did quite well because the period of recession was not as long and the fall not as deep as in Japan, or the UK. It was only outplayed by Australia, which did not experience fall in GDP at all.

The Reserve Bank response to the crisis had been standard and decisive – it had reduced the OCR by 50 basis points in September 2008, then by a full 1% point in October 2008, and then two times by 150 basis points each in December 2008 and January 2009. The Bank did not stop at that and continued with two further cuts of 50 basis points each in March and April 2009, bringing down the OCR to the historic low of 2.5% p.a., where it stands today. The Bank’s efforts appeared to have paid off, and GDP growth returned to positive in the second quarter of 2009, as can be seen on the graph.

It must be noted here, that the Reserve Bank of New Zealand did not break world records in its policy rate decisions. During the World Financial Crisis, the developed nations’ Central Banks had to resort to drastic and unconventional measures. For instance, the Federal Reserve in the US had lowered the target rate to zero or close to zero. The European Central Bank recently set the policy interest rate for the Eurozone at 0.25% p.a. and only days ago said that negative nominal rates are possible. We can conclude from this, that the Reserve Bank of New Zealand chose to leave some room for itself in case the situation got worse, and that the depth of the crisis was not as severe as in some other countries.

Graph №2 – New Zealand GDP growth27 (Graphical presentation and compilation by Nikita Stopnikov)

Graph №328 (Graphical presentation and compilation by Nikita Stopnikov)

3. Mortgage interest rates (floating and fixed). These are the rates that households pay on their perhaps single biggest investment in their lifetime – their residence.

Graph 4 below shows us the mortgage interest rates in New Zealand. The dotted blue line is floating rate, the solid red line is 2-year fixed rate. Simple logic tells us that when interest rates start to fall, floating rates are better. However, if it becomes clear that interest rates will be going up in the medium term, the households are better off with the fixed rate mortgages, and have certainty at least for the 2 years. In New Zealand the majority of mortgages are fixed-rate mortgages.

Graph №4 – New Zealand mortgage interest rates29 (Graphical presentation and compilation by Nikita Stopnikov)

The differences, between the floating and the fixed rates are twofold:

• The floating rate is more volatile because it reflects all movements in the money market.
• The fixed rate tends to lag a little bit in its movements compared to the floating rate.

However, it is obvious that in all periods, both the floating and the fixed rate on mortgages closely follow the main OCR rate. Also, the mortgage rates are second closest to the main policy rates, after the interbank lending rates. The main reason is that these mortgage loans are secured on property, and the risk of default is greatly reduced. The OCR rates can be observed in Graph 11.

4. Housing data. Because the house price index is included in the overall CPI and is one of its major components, the Reserve Bank of New Zealand pays particular attention to the developments in the housing market.

Graph №530 – New Zealand housing data (Graphical presentation and compilation by Nikita Stopnikov)

In this section, two sets of data are given – the total value of housing, in NZD billions, and the annual rate of change of house prices at quarter ends.

The following must be pointed out in connection with observation of this data:

• The housing price index entered the negative territory in the 2nd quarter of 2008. This was when the World Financial Crisis was fully developed. As a reminder, the crisis was caused by mortgage lending practices in the USA, and quickly covered many other countries with house price bubbles, such as Spain, Ireland, and the UK.
• It should also be noted, that in the five preceding years before the first index reduction, the housing stock value more than doubled from 298 to 616 billion NZD (see Q1 2003 and Q3 2008 points on the graph, respectively). Naturally, this cannot be just the reflection of the new construction (too fast), and is obviously the result of price acceleration.
• To prove the point above, in the six years after the housing stock value peaked in Q1 of 2008, the total value has only increased by 15% from 616 to 708 billion NZD at present (see Q1 2014 data on the graph).

5. Household debt – as a measure of the financial strain, which is carried by the ordinary people.

Graph №631 - New Zealand Household debt

Household debt is given as a percentage of annual disposable household income (called nominal disposable income, or NDI, in RBNZ terminology), which is a useful measure in cross-country comparisons. In addition, average interest rate for the household debt is given. This average takes into account all known debts, including credit card debts, car loans and mortgage loans. The third indicator is the proportion of household nominal disposable income spent on debt service (principal and interest).

It can be seen that the ratio of debt to annual NDI has been steadily on the increase between the end of 2003 and the end of 2009 (from 124% to 153%, see graph). This situation is typical of the households of many economies. This was the result of the easy credit policies by the banks, which encouraged borrowing against rising asset prices (including property prices). The rising property prices made people feel richer, and able to afford bigger loans. After the rates went back up, many borrowers found themselves unable to pay their mortgage debts, and started the process of deleveraging – cutting back on spending and sharply increasing savings, which perhaps was good for each individual household, but, as we know from theory, bad for the overall economy. The process of deleveraging is clearly visible from start of 2010 and until the first quarter of 2012 (from the graph, the ratio fell from 153% to 142%), i.e. it lasted for more than two years, and after that households started accumulating more debt again.

The interest rate and the proportion of NDI spent on debt servicing peaked at the same time as the overall household debt levels (at 9.5% and 14.4% respectively). However, after the 3rd quarter of 2008 both ratios began a steady decline, and were 5.6 and 3.4 percentage points, respectively, below their peaks (at 8.8% and 6.1% respectively at Q3 2013). This reflects a significant easing of the interest rates from the start of the financial crisis. The debt service ratio continued to decline even as the overall debt levels went back up (to 148% of NDI), because the interest rates became much lower.

6. Current account status – a deficit or a surplus as a percentage of GDP. These figures are given for complete financial years, and measure whether a country is a net borrower or a net lender to the rest of the world. New Zealand current account has been in persistent deficit for the last forty years, so the country has been the net borrower.

Graph №7 32 NEW ZEALAND CURRENT ACCOUNT POSITION (Graphical presentation and compilation by Nikita Stopnikov)

7. 90-day lending rates – these are a useful indicator of the lending risks perceived by the market.

Graph №8 90-day lending rates33 (Graphical presentation and compilation by Nikita Stopnikov)

The 90-day rates are closely tracking the OCR with minimum variations, which can be seen on the graph below. They never deviated from the OCR by more than 0.8 percentage points (from the graph – around April-May 2008), which is a very narrow spread.

8. Exchange rates – as an indicator of the foreign trade environment and the relative perception of the strength of the New Zealand economy. Two rates are given – the New Zealand dollar versus the US dollar, and a trade-weighted index (TWI) of the New Zealand currency against the basket of currencies of its main trade partners. I will only present the USD/NZD exchange rate history, for ease of visualization. Naturally, the exchange rate is influenced in part by the level of the interest rates in the economy – when interest rates in New Zealand rise, this increases demand for assets denominated in New Zealand dollars and the currency value goes up. The opposite is usually also true – when the interest rates are reduced, the currency becomes less attractive and often depreciates.

Graph №9 – New Zealand Dollar rate to the US Dollar34 (Graphical presentation by Nikita Stopnikov)

The horizontal axis of the graph displays the points in time (with four-monthly intervals). The dates begin with the time point ten years ago, December 2003, and cover the period until now. The vertical axis of the graph shows actual monthly average rates of the New Zealand dollar (NZD) against the United States dollar (USD). The scale is inverted, that is, the higher the purchasing power of the New Zealand currency, the higher the position of the data on the graph. This would mean there are fewer New Zealand dollars to spend to buy one unit of the American currency, and the weaker the NZD, the more has to be spent to buy 1 USD, the corresponding value will be higher (and the point – lower on the graph). As one can see on this graph, the New Zealand currency has displayed a relative stability, with some peaks and troughs against the USD. Overall, the trend appears to be upward, that is, the NZD has gradually strengthened against the American currency over the 10-year period under review. The most recent data (over the last twelve months, for instance) shows the New Zealand dollar trading against the USD at somewhere between 1.30 and 1.20 NZD for 1 USD. The most recent market quote was 1.2035.

In the past, because of the World Financial Crisis in 2008, its value decreased from 1.2485 (see period March-April 2008 on the graph) to 1.9383 (same period in 2009). This was the case for many currencies of the countries whose economies depended on the export of one commodity or a limited number of commodities. The Russian Ruble also lost at least 20% of its value against the US dollar as a result of the crisis. The difference from the New Zealand dollar is that the Russian currency has not regained its previous position for a number of reasons – principally because of structural problems in the Russian economy, and has on the contrary depreciated rather rapidly in the beginning of 2014.

The New Zealand currency however, is stronger today against the US dollar than it was before the financial crisis. This is explained by the belief in the country’s economic outlook from the markets. As was outlined previously, the strength of the currency is good news for importers and bad news for domestic demand and exports. The Reserve Bank of New Zealand, although does not directly monitor the exchange rate levels through interventions, does take into account currency considerations when making policy decisions.

9. Unemployment data – another key indicator of the macroeconomic performance, as well as indicator of conditions in the labour market. As will later be shown on the combined graph, lower unemployment is associated with higher levels of interest rates (although the Bank points out that no direct relationship exists), and higher unemployment rate is associated with lower levels of interest rates.

Graph №10 – New Zealand Labour Statistics35 (Graphical presentation and compilation by Nikita Stopnikov)

It can be noted from the above graph, that the total employment (in thousands of people having jobs or self-employed) was on the constant rise for 5 years from Q4 of 2003 through Q4 of 2008 (from 1975 thousand to 2210 thousand). Then it fell to its local minimum of 2155 thousand by Q3 of 2008 (height of the crisis) but then started rising again and it is still on the way up at almost 2300 thousand jobs at the end of 2013.

From the unemployment rate data, this indicator in New Zealand is lower than in many developed countries including the United States. In the US during the Crisis the unemployment rate was at the level of more than 9%. Nowadays US has the 7% unemployment rate. One percent higher than in New Zealand. The position of the Reserve Bank of New Zealand is that unemployment cannot (and therefore should not) be addressed by the monetary policy instruments, and therefore should be outside the scope of Central Bank responsibilities. This view is being challenged by those who believe that the Central Banks have a much broader role in the modern economy than traditional tuning of the interest rate market or inflation targeting. This view will be covered in brief in the Conclusion section of this paper. 

Graph №11 – New Zealand Official Cash Rate (OCR)36

The graph above shows the development of the level of OCR since the date of start (March 1999) to this day (the latest Monetary Policy Statement for the complete year is dated 11 December 2013). In this section, I will briefly describe some of the more notable changes in the level of OCR. Before that, however, I would like to point out that overall level of OCR since the beginning has remained relatively low and not subject to wild swings which characterized, for instance, the interest rates in some other countries.

The graph has one X axis and two value (Y) axes.

• The X axis has points in time, when the Reserve Bank of New Zealand was considering the changes in the Official Cash Rate (OCR).
• The first Y axis (on the left) shows the actual OCR rates – these are set at least eight times per year. The Bank is not obliged to change them every time or indeed, at any time.
• The second Y axis (on the right) measures the direction of the change. Everything above the Zero line on the second Y axis represent an increase in the OCR. Everything below this line is a rate reduction. Points at the level of the line represent decisions not to change the OCR.
• The actual OCR values are represented by shaded columns, and the changes in OCR at the same point in time are represented by the green line.

The following sections comment on the more significant moves by the Reserve Bank of New Zealand in the conduct of its monetary policy:

1. December 2005. This is the first rate change I would like to examine in more detail. In December 2005 the Reserve Bank of New Zealand increased the OCR to its highest level on record, 7.25 per cent. As it was stated in the Monetary Policy Assessment of the time, there were considerable worries by the Bank that the dangers of inflation were persisting37. Although the exporters were already suffering from the relatively high exchange rate (around 1.44 New Zealand dollars for 1 USD), still the overall demand was very high and big pressures on productive capacity existed. The main source of pressure was household demand38. From the Keynesian cross proposition, this results in running down of inventories because of the inability of the producers to cope with the demand.

This situation can be proved by the official statistics taken from the site of the Reserve Bank of New Zealand which is shown on the graph below39. On this graph there are two value (Y) axes. The primary (left) Y-axis shows production-based and expenditure-based GDP. Expenditure-based GDP can be assumed to equal aggregate demand. The secondary (right) Y-axis shows the changes in inventories. Time period is on the horizontal (X) axis.

Graph №12 Production and Expenditure-Based GDP (Graphical presentation and compilation by Nikita Stopnikov)

It can be observed from the data, that for most of the time except September 2004 and September 2005 quarter ends, expenditure-based GDP was consistently higher than the production-based GDP. I have specially taken a longer period to demonstrate that demand pressures were not one-time but long-term. High inflation was also evident in the labour costs. The Bank saw this as a danger because inflation expectations could become locked in (embedded) in the economy and disinflation would be especially difficult if this happened. The Bank further stated that further increase in the OCR might be needed depending on how the housing market and demand in general respond to the increase40. If the demand did not slow down, the rates could go up again. The Bank also said that it did not see any prospect of the rates going down in the foreseeable future. It specifically mentioned the situation to the left of the Keynesian Cross, where household and business demand have been very strong in recent years, outstripping growth in the economy’s productive capacity. The labour market was also very strong, with the unemployment rates dropping to their “20-year low of 3.4 per cent”41. Note that currently the unemployment rate in the Russian Federation is around 5 per cent, in the USA – around 7 per cent, in the UK – around 7.2 per cent, and in the Eurozone as a whole – over 10 per cent. The Russian Federation rate of unemployment is considered very moderate against some other G-8 countries. Accordingly, in this context, New Zealand figures can be considered zero unemployment.