2013 Annual Report
In many respects the outlook for the New Zealand economy is positive. The economy is currently growing faster than nearly all of the advanced economies and growth is expected to accelerate as construction activity in Canterbury and Auckland gather momentum, and provide further stimulus to the manufacturing sector. The unemployment rate should decline and approach 5 percent, and consumer price inflation is likely to increase towards the midpoint of the 1 to 3 percent target range. These summary indications, however, disguise the nature and complexity of the adjustments taking place in New Zealand.
Our economy is buffeted by a range of domestic and international factors. Some are driven by natural events, like the $40 billion (in current prices) rebuild in Canterbury, and the decline in agricultural production and spending associated with the recent drought. Some result from international conditions, like the 20 percent decline and subsequent recovery seen in our export commodity prices over the past two years, or the spill-over effects of the monetary and liquidity policies of major central banks that increase the upwards pressure on our exchange rate. Other pressures, such as the rapid house price inflation in Auckland and Christchurch, are driven by supply shortages, pent-up demand and the lowest mortgage rates in 50 years. And others, such as the Government's fiscal consolidation, represent major adjustments in domestic economic policy.
At the same time, our businesses face challenges in adjusting to powerful long-term structural changes that are global in nature. These include changing poles of global growth and international trade; the relative decline in the international price of information technologies and manufactured goods; and the rising international demand for highly skilled labour.
Just as firms and households develop strategies to adjust to the wide range of forces that hit our economy, the Reserve Bank also needs to respond to them in meeting its goals of price stability and financial stability.
A major challenge for the economy will be whether it can successfully redirect the resources necessary to rebuild New Zealand's second biggest city, including meeting its residential housing needs, and also meet the housing shortages in Auckland. The Bank will closely monitor this shift and strive to ensure that the relative price increases needed to redirect resources to these ends do not spill over into generalised inflation pressures, and threaten the Bank's price stability objectives. This is one reason why reducing the Government's demand for resources through fiscal consolidation is so important.
The two most significant challenges facing the Bank at present are the overvalued New Zealand dollar and overvalued housing market. The former is creating difficult headwinds for New Zealand's export and import substitution industries, although it has benefited purchasers of imported goods and services, and contributed significantly to the current low levels of inflation.
New Zealand's house prices, in comparison to household disposable income and rents, are high by international standards. Household indebtedness, relative to GDP, is currently rising from already high levels. The rapid increase in house prices in some regions, especially Auckland and Christchurch are of concern for several reasons, not least the increasing risks they present to financial stability and the wider economy.
The Global Financial Crisis demonstrated that economic and financial risks can build up for several reasons, even though an economy might be growing close to its potential, and be experiencing sound fiscal policy and price stability. Our main concern is that rapidly increasing house prices increase the likelihood and the potential impact of a significant and disruptive fall in house prices at some point in the future – particularly in a market that is already widely considered to be over-valued.
In May 2013, the Minister of Finance and the Bank signed a Memorandum of Understanding (see page 25) outlining the purpose of macro-prudential policy, the range of policy instruments, and governance arrangements relating to their possible deployment. The macro-prudential policy framework seeks to build additional resilience in the domestic financial system during periods of rapid credit growth, rising leverage, or abundant liquidity. The instruments can also help to dampen growth in asset prices that pose risks to financial stability.
Since balance date, we have announced the introduction of one such macro-prudential tool, speed limits on high loan-to-value ratio lending, with an implementation date of 1 October 2013. These are designed to help slow the rate of housing-related credit growth and house price inflation, thereby reducing the risk of a substantial downward correction in house prices that would damage the financial sector and the broader economy.
This Annual Report reports on the work we have undertaken to ensure that the Bank's strategies, policies, and tools are attuned to the challenges facing the New Zealand economy and financial system. The Board of Directors' assessment of the Bank's performance during the year is published inside this Annual Report.
During the year, we also adopted 10 Strategic Priorities over the next three years to enhance our capacity to respond to this challenging environment. Detailed in our Statement of Intent 2013-16, these priorities are designed to continue to strengthen the Bank's performance; develop a more integrated Bank approach to the Bank's policy; and improve infrastructure and reduce enterprise risk. In summary, they are:
Continuing to strengthen the Bank's performance
- We are strengthening the support for decision making in the Bank by establishing a committee comprising the four Governors to assist the Governor in all major monetary, regulatory and financial policy decisions that fall under the Bank's responsibilities.
- The Bank will continue to improve its performance culture by enhancing the quality of management through well-defined core competencies, greater emphasis on developing leadership and managerial skills, and rewarding strong managerial performance.
- We are proactively communicating on a broader front to enhance understanding of the Bank's policy choices, explaining the Bank's functions and roles, and what it can and cannot be expected to do.
Developing a more integrated approach to the Bank's policy
- A new Macro-Financial Department has been established, overseeing the stability of New Zealand's macro-financial system, and to design and implement macro-prudential instruments.
- We have developed a Macro-Prudential Policy framework, and proceeded to develop macro-prudential tools. This work is led by the Macro-Financial Committee and the new Macro-financial department, with contributions from the Economics, Financial markets and Prudential supervision departments.
- We are expanding our research to enhance our understanding of the interface between monetary and macro-prudential policy.
- We continue to implement a sound and comprehensive prudential regulatory regime, through initiatives including Open Bank Resolution, licensing insurance companies, licensing and reviewing non-bank deposit takers, reviewing the legislative framework for the payments and settlement system regulation, and progressing the operation of the anti-money laundering regime.
Improving infrastructure and reducing enterprise risk
- The Bank will further develop its operational systems to ensure a more robust operating environment, and develop new products and instruments.
- Business continuity resilience will continue to be tested and enhanced, including a comprehensive business continuity exercise relating to a significant regional event.
- Finally, the Bank is re-examining the Currency, Property and Security operations in light of a changing environment.
I am very grateful for the support and wise counsel I have received from the retiring Chair, Dr Arthur Grimes, and the Board of Directors. Arthur has been an outstanding Chair of the Board. My thanks also to Dr Chris Eichbaum, who made a substantial contribution to the Board, and whose term as a Director ended at the end of July 2013.
I wish to thank my colleagues in the Bank for their hard work, creativity, and dedication to improving New Zealand's economic prospects, and continuing to fit the organisation for the next decade. I endorse the Board's assessment of the high quality of their work. I am particularly grateful for the leadership and guidance demonstrated by my fellow Governors and other members of the Bank's senior management team.
21 August 2013