1997 Annual Report
The year to June 1997 was challenging for the Reserve Bank.
In the first half of the year, we kept monetary conditions very firm, to bring underlying inflation back within the then 0 to 2 percent inflation target. Notwithstanding this, and the firm conditions which had prevailed for more than two years previously, underlying inflation was 2.3 percent in the year to September 1996, and 2.4 percent in the year to December 1996. Economic growth to December was stronger than almost all observers expected.
In the second half of 1996/97, inflationary pressures began to abate quite rapidly, as a result of a slowing in economic activity and a fall in the New Zealand dollar prices of imports due to the earlier substantial appreciation of the currency. These were both, in part, a response to the firm monetary conditions of the preceding two years. Underlying inflation in the year to March 1997 was 2.0 percent, and in the year to June 1.5 percent. Most observers expect inflation to fall further over the next 12 months.
As a result of this decline in inflationary pressures, the Bank was able to signal a modest easing in monetary policy in December, and a more substantial easing at the end of June. By the beginning of July, 90 day interest rates were some 3 percent lower than they were at their peak last September, while the trade-weighted measure of the exchange rate was similarly about 4 percent lower than it was at its peak, in March.
In December 1996, following the formation of a Coalition Government, I agreed to a new Policy Targets Agreement. This changed the target for monetary policy from 0 to 2 percent inflation to 0 to 3 percent inflation. While I did not push for a change of this kind, and indeed saw some risk that the change would encourage higher inflationary expectations, I accepted the somewhat wider range.
Certainly, the change has reduced the likelihood of the Bank having to move monetary conditions violently to stay within the narrower target, and, by reducing slightly the risk of having inflation fall outside the target, it has reduced risk to the Bank’s reputation.
The Policy Targets Agreement also made explicit for the first time what had previously only been implicit, namely that price stability is in many respects best thought of as a means to an end, “so that monetary policy can make its maximum contribution to sustainable economic growth, employment and development opportunities within the New Zealand economy.”
Unlike other models of central bank independence, the New Zealand model reserves to the elected Government the final right to determine the precise target of monetary policy; requires the Government to make that target public; leaves the central bank free of political interference to achieve the target; and holds the Bank’s Governor accountable for his performance under that target. In May 1997, the United Kingdom adopted most of the key features of this approach.
Because both interest rates and the exchange rate impact on inflation, especially in our small open economy, the Bank looks at both in assessing the effects of monetary policy. In December, we indicated publicly that, as an approximate guide, we regarded a 1 percentage point movement in 90 day interest rates as having a similar effect on inflation as a 2 percent change in the trade-weighted exchange rate. When we issued our June 1997 Monetary Policy Statement, for the first time we expressed our desired monetary conditions in index number form. Although we are by no means the first central bank to communicate in terms of ‘monetary conditions’, rather than interest rates alone, to my knowledge we are the first to formalise our communications in this way. The new approach helps explain the stance of policy to financial markets and to the wider public. Early indications are that it is working very well.
As in past years, the Bank devoted considerable effort to explaining monetary policy to key opinion-makers and to the wider public. We address our six-monthly Monetary Policy Statements, six-monthly Economic Projections, and quarterly Reserve Bank Bulletins principally to financial markets, business leaders, economists, and the media. As well, we continued a very active speech programme throughout the country and produced a series of brochures, aimed at the general public. Further resources were provided to assist the teaching of economics in schools. Use of our Internet site continued to expand rapidly.
1996/97 was the first full year of our new disclosure-based approach to banking supervision. We are well pleased with the way in which the new system has worked. There is evidence that the directors of some banks are now more conscious of their responsibilities than previously and that some banks have put better risk-control systems in place. There is still, however, a widespread public perception that registered banks are in some sense riskless, and that bank deposits are guaranteed by the Government or the Reserve Bank. At every opportunity, we make clear that, while the Bank promotes a sound and efficient banking system, we do not guarantee the survival of individual banks, and do not guarantee the repayment of deposits.
During the year, the Bank registered three new banks to operate in New Zealand as branches. In November 1996, Trust Bank New Zealand Limited relinquished its registration following acquisition by Westpac Banking Corporation. A few days after the end of the financial year another registration took place, bringing the total number of registered banks to 19.
It would be nice to be able to report that the real-time gross settlement system (RTGS), under development for several years, became operational during the year, as envisaged in our last Annual Report. Unfortunately, as many other countries have found, the technical problems of RTGS are many and varied, and New Zealand still has no RTGS system. At this stage, however, substantial parts of the structure are in place, and we are confident that a system linking all major banks will be functioning shortly. This will play an important part in further reducing risk in the New Zealand financial system.
New Zealand may be unique in not having intervened in its foreign exchange market over the last twelve years (since the New Zealand dollar was floated in early March 1985). The Reserve Bank nevertheless maintains a capacity to intervene in the event of “disorderly market conditions”, for which we manage foreign exchange assets and committed credit lines of some NZ$4.5 billion (exactly matched by foreign exchange liabilities to the Treasury, so that the Reserve Bank has no net foreign exchange position). During the year we undertook a full review of the costs and benefits of holding these reserves, recognising however that any conclusion reached would be in the form of a recommendation to the Treasurer, who determines the level of such reserves. We concluded that continuing to hold reserves is warranted, particularly given that the income earned on the assets now very nearly matches the cost of the related liabilities.
Issuing bank notes and coins occupies more Bank staff than any other single function, and the efficiency of that operation continued to be a source of considerable satisfaction. Despite an upsurge in the number of forged notes passed during the year, the total number of such notes was very low in relation to both the total notes on issue and the forgery problem in many other countries. Over the 12 months to 30 June 1997, our processing machines detected 1,100 counterfeit bank notes. We continue to explore ways of reducing this rash of forgeries.
The Bank’s registry operation, and the related Austraclear operation, also continued to grow and make a worthwhile contribution to the development of the New Zealand financial market. Austraclear will make a particularly important contribution to the operation of the RTGS system, by providing the core of the “auto-repo” system which is a key component of RTGS.
The 1996/97 year was the second under the five-year Funding Agreement signed with Government in mid-1995. That Agreement provided for $38.0 million in operating expenses for the non-commercial functions of the Bank for 1996/97 (our registry and Austraclear functions are not covered by the Agreement), and for the automatic adjustment of that figure in the event that the Bank’s inflation target was changed by Government. Because the inflation target was changed in mid-year from 0 to 2 percent to 0 to 3 percent, a change in the mid-point of the target by 0.5 percent implied an adjustment of the Funding Agreement limit of an extra $95,000. In the event, we were able to hold costs subject to the Funding Agreement to just $33.4 million, 2.6 percent below actual costs in 1995/96, 8.0 percent below budgeted expenses for 1996/97, and 12.3 percent below the Funding Agreement limit.
This was a very pleasing outcome, given that the Funding Agreement limit is itself well below the first five-yearly Funding Agreement signed in 1990 ($56.7 million annually). In part the result can be attributed to delays in the start-up of RTGS, the costs of which, even though recoverable from banks, will be a charge against the Funding Agreement. However, in large part, the outcome is a result of a continuing focus on efficiency and effectiveness throughout the Bank.
For that continuing dedication and commitment on the part of all of the Bank’s staff, I record my sincere appreciation.
Donald T. Brash