2000 Annual Report
The twelve months to June 2000 were a demanding time for the Reserve Bank. During that period, monetary policy entered a tightening phase, which always engenders stress. We also weathered the Year 2000 date change, completed the introduction of polymer bank notes, and undertook a significant internal restructuring. The Reserve Bank faced these challenges well.
In particular, for most of the year to June 2000, consumer price inflation remained around the middle of the 0 to 3 per cent target, although at the very end of the year annual inflation picked up moderately. This pleasing result overall was, for the most part, the result of monetary policy decisions made prior to the year under review. The consequences of the decisions made in the 1999/2000 period will not be known for some time yet.
When the 1999/2000 year began, the Official Cash Rate (OCR) was 4.5 per cent. By November, it was clear that demand in the economy had expanded strongly and that the highly stimulatory monetary conditions of the previous 18 months were no longer appropriate. In response, we increased the OCR to 5.0 per cent. When GDP statistics were finally available, it was apparent that in the second half of 1999 the economy grew even more strongly than we had thought at the time, indeed at an annualised rate of almost 10 per cent. Alas, as things stand, this is a much faster growth rate than the New Zealand economy can sustain in the longer term without inflation, suggesting that the November OCR increase had been fully warranted.
We continued to increase the OCR during the first half of 2000. However, with the exchange rate remaining well below historical averages, and indeed weakening over the year as a whole, monetary conditions continued to be quite strongly supportive of growth. This was notwithstanding an OCR of 6.5 per cent by the end of the year under review.
The weakness of the exchange rate over the past year or so has posed some challenging questions, both for the conduct of monetary policy and for the longer-term evolution of the New Zealand economy. In real terms, the currency has remained near the lows of previous cycles despite rising commodity prices.
Over recent years, the Bank has argued that, at some point, New Zealand’s persistent current account deficit and growing ratio of external debt to GDP would begin to weigh on investor sentiment. We have noted that such a change in investor sentiment might be reflected in diminished capital inflows, leading to a weaker currency and a higher risk premium in New Zealand interest rates. This could be part of a process by which our current account weakness would be remedied, since a shift in monetary conditions of this kind would encourage stronger export performance and higher savings, while leading to more subdued growth in domestic consumption. We hoped that, if such a transition could be achieved without significant economic disruption, New Zealand’s prospects for enduring prosperity would be enhanced. At the time of writing, the question before us was whether a positive scenario of that sort was under way.
Shortly after the present Government was elected in November, the Treasurer and I negotiated a change in the Policy Targets Agreement (PTA) which guides monetary policy within the legislative mandate to “achieve and maintain stability in the general level of prices”. Dr Cullen proposed that the PTA be amended so that, in delivering price stability, the Bank should “seek to avoid unnecessary instability in output, interest rates and the exchange rate”. I had no difficulty in agreeing to this proposal, and indeed the Bank has been operating in this way for some time. The amendment confirms that the Bank should be willing to accept some short-term variability in the inflation rate, if smoothing out such variability might produce unnecessary variability in output, interest rates and the exchange rate.
But neither Dr Cullen nor I imagine for one moment that the amendment implies that the Reserve Bank can, or should, seek to avoid all movements in output, interest rates and the exchange rate. Such an objective would be completely beyond the Bank’s powers to deliver. Indeed, there is some evidence that moving short-term interest rates in a firm and pre-emptive manner, before inflationary or deflationary expectations become entrenched, is more likely to keep output growing at close to its sustainable trend, compared to adjusting interest rates slowly
In May, the Treasurer also announced the terms of reference for an independent review of monetary policy, to be conducted late in 2000 by Professor Lars Svensson. The terms of reference make it clear that the price stability objective and the Bank’s operational independence are not on the table for discussion. That said, I welcome the review, as an opportunity to get some fresh thought from outside the Bank on how we do things.
The Reserve Bank has responsibility for promoting financial sector stability, as well as for keeping inflation under control. The year under review saw further work on policy development in this area, most particularly on the new policy of requiring local incorporation of systemically important banks and of some banks with substantial retail deposit business. Work also continued on contingency planning for a bank failure, remembering that in New Zealand neither the government nor the Reserve Bank guarantee banks or bank deposits. The financial system continued to be in good health, having coped easily with the mild recession during 1998, the steep depreciation in the exchange rate over 1999 and 2000, and the Year 2000 date change.
Like other central banks, we were concerned that Year 2000 fears might lead to a strong increase in the demand for cash over the end of the calendar year. In response, we stockpiled paper bank notes as they were withdrawn from circulation. We also sought to assure the public, via the media, that the banking sector was well prepared. In the event, the extra demand for cash was modest. The reserves of old paper bank notes were destroyed early in the New Year.
The Reserve Bank began the introduction of new polymer bank notes during the 1998/99 year, and introduced all the remaining denominations during the year under review. That process went smoothly.
Polymer bank notes last much longer than paper ones. In part for this reason, the Bank decided some time ago to scale down its note-processing operations. Our Christchurch branch closed in June, and our remaining branch, in Auckland, is scheduled to close in November this year. Our Wellington note-processing operations have also been reduced.
With this substantial scaling down of our note-processing operations, and the decision during the year to outsource the operations involved in our securities registry business, we decided late in 1999 to restructure our operational departments, to make them more appropriate to the Bank’s current needs. The total staff of the Bank will have declined from some 270 full-time equivalent positions at the end of 1999 to less than 200 positions by the end of 2000.
Notwithstanding this reduction in staff numbers, 1999/2000 was the second year since I became Governor in 1988 that the Bank’s operating expenditure somewhat exceeded the amount we had budgeted for the year. This was due to the unexpectedly high costs incurred in meeting the public’s demand for currency, particularly for additional coins, and higher than expected personnel expenses arising from the costs of restructuring the Bank’s registry operation. All other categories of expenditure remained close to budget. More importantly, the Bank continued to operate within the limit specified in the Funding Agreement signed with the Government in 1995. In May, a new five-yearly Funding Agreement was signed with the Government, as required by legislation, covering expenditure to 30 June 2005.
At the end of January, the Board appointments of Mr Lindsay Fergusson and Mrs Alison Paterson came to an end. Mr Fergusson did not seek re-appointment and I record my thanks to him for his contribution to the Bank since his original appointment to the Board in late 1988. His replacement was Mr John Goulter, and I welcome him to the Board. Mrs Paterson was re-appointed for a further term.
It is customary to end statements of this kind with perfunctory remarks about how well staff have worked during the year. I want to thank the staff of course. But in this case it is important to record that the Bank’s employees have worked with loyalty and commitment during a very difficult time, facing a major internal re-organisation and the Bank attracting considerable public criticism for tightening monetary policy. Such times are never easy for staff, and I am particularly grateful to them for their “dedication to duty under fire”.
Donald T. Brash