Reserve Bank says its actions helped save the economy during pandemic

Thursday, 18 August 2022

The Reserve Bank says the official cash rate now has to be higher because its policies were too stimulatory at some point over the course of the pandemic.

The Reserve Bank has defended its programme of “money printing” but admits the current rate of inflation shows its monetary policies were “too stimulatory” in recent years.

The bank’s large-scale asset purchases (LSAP) and funding for lending programme (FLP) have been criticised for pushing up asset prices over the past two years, particularly house prices.

But in a paper released by the Reserve Bank on Thursday, it said the programmes were an effective response to the “unprecedented global economic shock” caused by the pandemic.

“Both programmes were implemented to reduce the risk of a deep recession in which inflation, economic activity and employment could become persistently depressed. LSAP and FLP were necessary because the official cash rate was close to its ‘effective lower bound’ and could not go negative because commercial banks were unable to operationally manage negative interest rates at the time.”

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It said by using the programmes, the Reserve Bank was able to provide additional monetary support to New Zealanders even though the official cash rate remained at 0.25%.

Through the LSAP programme, the Reserve Bank bought $54 billion of government bonds in a bid to drive down longer-term interest rates and support employment. Funding for lending allows banks to borrow at the official cash rate and $28b was made available to them.

The Reserve Bank noted that asset purchases were wound down and stopped by July 2021, although the funding for lending programme will run until December this year.

“The monetary stimulus currently being provided by the LSAP and FLP is small and will continue to wane through time. This modest impact can effectively be offset via the OCR. While LSAP and FLP did provide some support to bank funding and liquidity positions, there is little evidence that higher settlement cash balances resulting from these programmes have directly impacted on bank lending,” the bank said.

“The success of LSAP and FLP should be judged on the basis of their risk adjusted net benefits. The positive impacts of these monetary policy tools – such as supporting economic activity through the pandemic and normalising financial markets – also need to be taken into account alongside the costs of the programme.”

It said the current rate of inflation, which hit 7.3% in the June quarter, indicated that monetary policy was too stimulatory at some stage “during the tumultuous economic period of the pandemic”.

That meant the official cash rate now had to be higher to dampen demand.

But it said while there would be lessons in this from the Reserve Bank, this pattern had been seen around the world.

“The New Zealand economy has outperformed forecasts made at the beginning of the Covid-19 pandemic. The deployment of Reserve Bank’s monetary policy tools clearly contributed to this out performance and the avoidance of the negative outcomes that would have otherwise occurred.

“Accurately assessing the net expected risk adjusted return of different monetary policy tools is far from straightforward. Because monetary policy influences the macro economy, any serious evaluation of policy effectiveness needs to consider a range of macro outcomes, including any impacts on government funding costs.”

It said the Reserve Bank was carrying out a detailed assessment of its monetary policy actions over the past five years, which would be peer-reviewed and made public.

Governor Adrian Orr was to appear before the Finance and Expenditure Committee on Thursday.

The Reserve Bank’s response to the pandemic has been under scrutiny in recent months.

Last month, in an essay co-authored with New Zealand Initiative research fellow Bryce Wilkinson, former Governor Graeme Wheeler accused central banks of “errors of judgement” in overdoing interest rates cuts and their policies of quantitative easing, and said they should acknowledge their mistakes.

NZ Initiative chief economist Eric Crampton said there was a “strange circularity” to the Reserve Bank’s arguments.

“It concludes that, because the economy has outperformed forecasts made at the pandemic’s outset, the Reserve Bank’s tools can take credit. But its forecasts of economic performance, along with others’ forecasts, ought to have accounted for monetary policy. Forecasts of high unemployment for December 2020 were either forecasts of failures in monetary policy, or of severe pandemic effects that could not reasonably be addressed through monetary policy.

“So should the bank take credit now for stronger than expected economic performance, or for poor forecasting in May 2020? And to what extent should it recognise that fiscal policy assisted in avoiding a wave of business failures in April 2020, and that monetary policy should have more quickly adjusted to an updated reality?”

Act leader David Seymour said the Reserve Bank’s suggestion it had to buy bonds because interest rates couldn’t go negative was “red herring”.

“The real issue is why they needed to do so much stimulus at all.

“The Reserve Bank got it completely wrong. It distorted Government policy making by giving it cheap credit, now we are all paying the cost, literally in the rising price of everything. It now accepts it overshot.”