Analysis by Keith Rankin.
New Zealand’s monetary policy decision today was presented as a “line call” (RNZ news) between a cut of 0.25 or 0.50 percentage points. In that context, the correct decision was made; 0.50%. In the context of the understood policy narrative, it was a binary choice.
In the mainstream expert and pundit commentaries, there was as usual a confused mix of comments about should-expectations (what the Reserve Bank should do, within the constraint of the options ‘on the table’) and would-expectations (what the Reserve Bank would actually do). Outside of that mainstream groupthink, there are of course potentially other could-expectations; about what else the Reserve Bank could do, if allowed and/or encouraged.
(See my comments on Modern Monetary Theory to get a sense of how monetary policies and governments’ fiscal policies represent two sides of the same metaphorical coin. And how the easing only of monetary policy during a structural recession is equivalent to another metaphor: pushing a string. Aotearoa should and could have more money spent into circulation as more government debt.)
The recent commentary we have been getting was that the Reserve Bank was facing contradictory ‘stagflationary’ pressures; a recession which would require a greater fall of interest rates, and rising inflation which – the groupthink alleges – requires a lesser fall (or even no decrease) of the OCR. Would the Reserve Bank prioritise an anti-recession or an anti-inflation policy position? We held our breath until 2pm!
The reality is, given that this was a binary contest – ‘matchplay’ to use the sporting metaphor – the bigger interest rate decrease represented a win (albeit a small win) on both the growth front and on the inflation front; a win-win decision. That’s at least something. History is littered with well-meaning (and, sometimes, not-so-well-meaning) lose-lose policy decisions.
The Interest Rate and the other two prices of money
For our purposes, the Official Cash Rate (OCR) is the interest rate.
In my historical review of monetary policy – I noted that there were three prices of money: the internal price (which is the inverse of pure inflation), the external price (the exchange rate between one kind of money – such as the New Zealand dollar – and a weighted-average of other kinds of money), and the interest rate (which is the price of inter-temporal trade, or what economists more commonly call the price that balances saving and investment).
Note that, in a simple economy, saving is the withdrawal of money from circulation and investment is the injection of money into circulation. (That’s not the way most pundits use the word ‘investment’, however.) Saving is a withdrawal from today’s economy with the underlying presumption that it will be invested into the future economy; or, as in the case of loan repayments today, they were invested in the past. Investment is either the injection of past saving into the present economy, or (through borrowing) the injection of future saving into the present economy.
Today, withdrawals from circulation are too great; and injections too little. (The Reserve Bank might want to switch on the Moniac machine in its museum, to see a simulation of this.)
Trickle-Up and Compound Interest
As noted in my earlier writing, the principal monetary objective of the socio-political elites is to have, on an indefinite basis, an interest rate that’s higher than the inflation rate, thereby creating a positive real rate of interest. This policy objective applies to both of the three elite ‘tribes’; the centre-right tribe (think National), the centre-left tribe (think Labour), and the tribe of economic liberals (think ACT).
Another name for this implicit but underlying policy objective is ‘trickle-up’; a policy to facilitate the accumulation of compound interest. Compound interest may be broadly defined as any financial situation whereby financial wealth appreciates over time, meaning that a dollar saved today buys more tomorrow than it will buy today. Under trickle-up, there is an unrequited flow – tribute, in reality – from debtors to creditors, from poorer to richer.
Real interest rates are positive when nominal interest rates (eg the OCR; or term deposit rates) are higher than the rate of inflation. We note that this definition applies also when inflation rates and/or interest rates are negative. Otherwise, real interest rates are zero or negative. Compound interest is a state of affairs whereby unspent money appreciates exponentially, as if by magic. Every dollar of compound interest gained by A is funded by B.
When real interest rates are positive, A is ‘creditors’ and B is ‘debtors’. Conversely, however, compound interest works the other way when real interest rates are negative. Further, the predominant story since say 1935, at least in New Zealand, is one of negative real interest rates. Our parents actually became rich (as if by magic) because they were debtors for much of their lives, and because compound interest flowed from creditors to debtors. That was trickle-down.
But the elites, most of whom benefitted from trickle-down in their younger lives, now want trickle-up. New Zealand Historian David Thomson documented this in 1989; it was called Selfish Generations? How Welfare States Grow Old (revised edition 1996).
Real Interest Rates are determined by the market, not by edict
The nominal rate of interest is now set by edict. But the other two prices of money are set by markets. The end result will be a positive real rate of interest if ‘investment demand’ exceeds ‘saving supply’. And the end result will be a negative real rate of interest if ‘investment demand’ falls short of ‘saving supply’. The later situation is very much the truth of the present structural recession in New Zealand, and to which much of the capitalist world is veering into. This means that inflation rates will be higher than ‘risk-free’ interest rates, such as the OCR.
It means that a reduction in the rate of interest will ease pressure on the rate of inflation. Under present conditions, the lower the interest rate the more room there is for price inflation to ease. The bigger the reduction in the OCR, the more present ‘investment’ will be enabled (leading to a greater positive or smaller negative rate of economic growth) and the less pressure there is for prices to rise in order to achieve balance between investment and saving.
The Open-Economy Complication: The External Price of Money
Under floating exchange rates, market adjustment in the price of money may take place through the exchange rate (external price) as well as through inflation (the internal price).
New Zealand’s OCR is now significantly lower than the equivalent rates in the United Kingdom, United States, and Australia; it’s the same as Canada and South Korea. It’s still a bit higher than in the European Union, Taiwan, Sweden, and Denmark. It’s still much higher than in Japan and Switzerland which, by not indulging in high post-covid interest rates, never had high post-covid inflation.
By all our conventional understandings, there should be a run on the New Zealand dollar, given that there are so many other-nation options where interest rates are higher and economic activity is less depressed. Two things are propping-up the New Zealand exchange rate; record high commodity export prices, and a history of giving good returns in the past to foreign creditors. Many foreign creditors remain loyal to their historic ‘golden goose’. How long can these circumstances last?
Finally
Historically, the migration of capital has often matched the migration of labour. Just think of flows of money and people within the British Empire over 100 years ago.
I recently took a look at the year-to-August international migration data for New Zealand. Out of 31 countries listed by Statistics New Zealand, only Samoa, Japan, Sri Lanka, Pakistan, had more citizens migrate to New Zealand on average in the last two years compared to the previous year. And the only ones with significant immigration into New Zealand after 2023 were Pacific countries, India, China, Philippines, Nepal, Sri Lanka and Japan. Japan has seen the recent return of those who left during covid. There has been a substantial increase in migrant departures by passport-holders of all of these 31 nations in Asia, Europe, South America, and Africa; and that’s despite the fact that some people who entered New Zealand on one of those passports have exited with a New Zealand passport.
New Zealand is crashing and burning economically, and still its best monetary policy options remain ‘off-the-table’. New Zealand’s recession-recovery policy is tantamount to ‘pushing on a string’. How long will it be before capital emigration matches the net emigration of people with New Zealand passports and the incipient net emigration of New Zealand residents with passports from high and highish income countries? How soon will it be before financial crisis follows economic crisis?
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Keith Rankin (keith at rankin dot nz), trained as an economic historian, is a retired lecturer in Economics and Statistics. He lives in Auckland, New Zealand.
