1999 Annual Report
The 1998/99 year has been a pressured one for the Reserve Bank, but, despite some stresses and strains, actual outcomes have been pleasing.
Inflation remained comfortably within the Reserve Bank’s 0 to 3 per cent target and, at this stage, we are confident that inflationary pressures can be contained in the months ahead.
In the first half of calendar 1998 the New Zealand economy experienced a mild recession, which put considerable downward pressure on inflation. In response to that downward pressure, the Reserve Bank allowed monetary conditions to ease very substantially. Partly as a result, the economy began growing again in the third quarter of 1998. At the time of writing, growth seems well established again.
In March 1999, the Reserve Bank changed the way it implements monetary policy. Now we use our ability to control overnight interest rates in the inter-bank market, instead of relying on the threat of changing the target for settlement cash in the banking system. This change was well accepted by financial markets and by the public, and has delivered substantially greater stability in short-term interest rates and, so far, no offsetting increase in exchange rate volatility.
During the year, we undertook a comprehensive review of monetary policy over the last decade or so. New Zealand began formal inflation targeting in April 1988, and I have been particularly keen to find out what we can learn by reviewing events since then. It is not possible to record here all of the conclusions arising from our research, most of which have been summarised in a series of articles in the Bank’s Bulletin. However, one important feature stands out.
I have been very concerned that monetary policy may have unnecessarily caused the strong appreciation of the exchange rate between early 1993 and early 1997 - an appreciation of some 29 per cent in real terms - which meant a great deal of discomfort for many exporters. However, it appears that what occurred was not abnormal by international or historical standards. Comparable currency appreciations have been widespread throughout the world over the last 10 years. In this period, Britain and Japan, for example, experienced greater appreciations than New Zealand did, while those experienced by Germany and the United States were only marginally smaller. Likewise, similar appreciations have taken place in New Zealand’s past.
Given that the strong appreciation of the currency in the mid-1990s was not abnormal, inflation targeting has worked well for New Zealand. Inflation has gone from well above the developed country average to being at or slightly below the developed country average, and we have had a marked improvement in economic growth relative to other OECD countries and our previous record when inflation was high and variable.
Monetary policy aimed at keeping inflation low has the important side effect of tending to dampen down cycles in the real economy as well. When the economy is operating below potential, inflation tends to fall towards the bottom of the inflation target and the Bank eases monetary policy. The reverse happens when the economy is operating at above potential. In this important sense, monetary policy targeted exclusively on keeping inflation low is very much focussed on the real economy, as we saw vividly over the last year
There is now considerable international interest in inflation targeting as a way of operating monetary policy, and an increasing number of countries take this approach. During the year under review, Deputy Governor Murray Sherwin spoke on inflation targeting at a conference hosted by the Brazilian central bank, and I spoke on inflation targeting in Manila, Mumbai and Jakarta. I also signed a Memorandum of Understanding with Bank Indonesia under which our two central banks will co-operate in the area of inflation targeting
During the year, the Bank acted as Chair of SEANZA, a group of 20 central banks throughout the Asian region. We organised a three week training course for participants from all member central banks, with a meeting of the Governors of those banks at the conclusion of the course.
The period under review was also important for our financial system oversight function. Real-Time Gross Settlement for inter-bank settlements completed its first full year of operation, and exceeded all expectations. The Orders-in-Council under which banks are obliged to disclose extensive financial and prudential information on a quarterly basis were amended. Legislation which the Bank advocated improving the law in regard to netting of inter-bank payments was passed. We began a review of the present policy under which a foreign-owned bank operating in New Zealand can be either a locally-incorporated subsidiary or a branch. We have advised banks that we may in due course require local incorporation for systemically-important banks and in some cases those undertaking a significant amount of retail banking in New Zealand.
Also relevant to the banking system is the Year 2000 issue. Naturally, we have been working to ensure that our own systems are fully Year 2000 compliant. We have also built up our reserves of bank notes to meet any increased demand for cash late in 1999. The Bank has been proactive in encouraging responsible discussion of this issue in the media. We have encouraged the banks to communicate well with their customers.
During the period under review we began the introduction of new ‘polymer’ bank notes. By 30 June, polymer $20 bank notes were in circulation, with polymer $5, $10, and $100 bank notes scheduled for introduction during the remainder of calendar 1999, followed by $50 bank notes in the New Year. So far, the introduction of these notes has gone smoothly, and the new notes have been well accepted by the public and the banking industry.
The cost of the introduction of polymer bank notes has meant that, for the first time since I became Governor, the Reserve Bank has exceeded its budget for operating expenditure. Issuing a large volume of polymer notes just prior to the end of the financial year has pushed expenses well above the amount budgeted for currency issue expenses during the year. We have also provided for payments to staff who will become redundant over the next year or so, as the volume of bank note processing diminishes. The new bank notes are more expensive than traditional paper bank notes, but they last four times longer, and over a few years they will provide significant savings.
In the event, total operating expenses amounted to $44.2 million, 8.6 per cent above the budgeted amount of $40.7 million. At the same time, expenses covered by the Funding Agreement with the Government amounted to $39.4 million, still slightly below the limit of $40.2 million allowed by that Agreement. Total operating expenses of $44.2 million in 1998/99 compares very favourably with total operating expenses of $62.6 million in the 1988/89 year.
Last year, I mentioned the retirement of Mr Dick Lang in July 1998. His position as Deputy Governor was taken by Dr Rod Carr, who came to the Bank from a career in commercial banking. Rod has already made a considerable contribution to the Bank, in particular by promoting an improvement in the Bank’s risk management.
During the year, two directors, Sir Peter Elworthy and Mr Stuart Young, reached the end of their terms on the Board. I thank both men for their valuable contribution to the Bank, and especially record with gratitude the immense assistance which Sir Peter gave me over my entire time as Governor, particularly in his role as Chairman of the Board’s non-executive directors. Long-standing Board member Mr Bill Wilson has taken on the role of Non-Executive Chairman, and Sir Peter’s place on the Board has been taken by the Hon Ruth Richardson. Mr Young’s place has been filled by Mr Paul Baines. I am delighted to have both people on the Board.
Finally may I thank all of the Reserve Bank’s staff for their considerable contribution to a good year for the Bank. On every front we have encountered challenges and have met them with dedication and commitment. Many thanks.
Donald T. Brash