Monday, 2 May 2011

Maintaining Bank Independence

When the Prime Minister starts musing about which way interest rates should go, or might go, folks who care about central bank independence should worry. Bloggers and journalists can carp about bank policy all they like, but they're not in a position to renew the Governor's job. Jawboning about which way interest rates should go can be seen as a signal about what's necessary for a Governor's appointment to be renewed. And so Members of Parliament, and especially the Prime Minister, really ought to know better.

John Key has been awful on this front. Maybe it's his background as a currency trader, but he just can't seem to stop himself from musing about what effect things are likely to have on RBNZ interest rate decisions. When he does, Matt Nolan over at TVHE gets mad. I get annoyed. So do David Farrar at Kiwiblog and Rob Hosking at the National Business Review. That seems to be about it. It's rare that anybody reporting on the PM's interest rate musings notes that he really really shouldn't be doing that. It's happened so often, that I've damn near given up on it. Matt still jumps up and down occasionally. The latest one, which I'd missed as I was still busy being an earthquake refugee:
A drop to the official cash rate -- after Treasury figures showing the massive cost to the economy of Christchurch's quake -- would be useful, Prime Minister John Key says.

Mr Key was asked this morning if the figures would make a reduction in the official cash rate this week inevitable.

"That's a matter for the Reserve Bank governor and it's for him alone to decide what happens on Thursday," he told Breakfast on TV One.

"But certainly the markets have factored in a likely cut in the official cash rate. You've got to say lower interest rates probably help the country, but that ultimately is a matter for the governor."

Mr Key said he was not attempting to influence the process but was stating facts.

"The question was would it be helpful, well low interest rates help."
If your boss tells the media that it would be helpful for the company if you did X, but it's really up to you, you might think that you kinda hafta do X if you want to keep you job. The Policy Targets Agreement gives RBNZ a bit of wiggle room around its inflation target:
4.b In pursuing its price stability objective, the Bank shall implement monetary policy in a sustainable, consistent and transparent manner and shall seek to avoid unnecessary instability in output, interest rates and the exchange rate.
It wouldn't be crazy to see Key's media statements as instructing the Bank about whether they'd be given a pass for leaning on 4.b and perhaps punished if they didn't.

The New Zealand Prime Minister makes statements that could easily be read as pressuring the Reserve Bank ahead of an interest rate decision, and nobody much cares that this puts central bank independence in jeopardy. And those who do care have largely given up.

Now turn to Canada.

Jack Layton is the leader of the New Democratic Party of Canada. What the NDP thinks about anything, at least at the federal level, usually counts for about as much as what I think about anything - about nil. But in the most exciting election since '93, the NDP has surged up while the Tories and Grits focused on bashing each other. They're now a reasonably close second to the Tories. Amazing. Here's what Layton said about interest rates late last week.
Challenging the role of the fiercely independent Bank of Canada -- and stepping into territory where politicians rarely venture -- Layton said the Bank of Canada should hold off on raising interest rates because doing so may slow job creation and too many Canadians are already unemployed.
The Canadian economics Twittersphere jumped. @StephenGordon, @KevinMilligan, @MikePMoffatt and @andrew_leach weren't pleased. Neither were journalists Andrew Coyne and Terence Corcoran. Stephen Gordon's piece hit EconomyLab at the Globe and Mail.
The Bank’s mandate from the federal government is to keep inflation at around 2 per cent a year. Extremely low interest rates are appropriate during recessions, but when the economy returns to capacity -- as the Bank expects it will with the next 18 months -- then they become inflationary. By ordering the Bank to set aside its judgment and to let inflation increase beyond its target, the government would be in effect abandoning a policy that had provided the low and stable rates of inflation -- as well as the low and stable interest rates -- that we have seen over the past twenty years.

It took fifteen years and two recessions -- both of which were more severe than the one we just had -- to get inflation under control last time. That’s not an experience we want to repeat.

As I was writing this, another story appeared, suggesting that Mr Layton was merely expressing an opinion about the appropriate path of interest rates, and not considering the possibility of ordering the Bank of Canada to keep interest rates low. Later, an e-mail from NDP headquarters assured that "New Democrats are committed to the independence of the Bank." I greet these clarifications with no small amount of relief.

Perhaps the most important lesson to be learned here is that Prime Ministers -- and those who would be credible candidates for becoming Prime Minister -- should be extremely circumspect when discussing monetary policy. Twenty years of hard-won credibility is not something to be tossed aside so lightly.
Read those last two paragraphs again. Canada's a strange place. Academic economists note the dangers of a Party Leader who's still unlikely to form the next government mouthing off about interest rates and enough folks get worried that the candidate backs down before Gordon can even finish writing his piece for EconomyLab.

Here, maybe a half dozen of us tops care that the Prime Minister leans on the RBNZ - certainly not enough of us to get any traction on the issue.

It's encouraging that Canada's NDP, after some backtracking, seems to show more sense on monetary policy than New Zealand's Labour Party. Fortunately, Labour has less chance of getting anywhere near the Treasury benches this year than has Canada's NDP.

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