Governor's statement
The 12 months to June 2001 proved challenging for the Reserve Bank at many levels. During the period, CPI inflation went above the Reserve Bank’s target range, reflecting the impact of so-called “unusual events” in terms of clause 3 of the Bank’s Policy Targets Agreement with the Government. The Government’s Independent Review of the Operation of Monetary Policy offered an opportunity to look carefully at the Bank’s governance arrangements and the operation of monetary policy. In the area of Financial System Oversight, fundamental policy work was underway assessing new options for dealing with a bank in distress. In the Bank’s operational areas, most activities went well, but we did experience some frustrations. The Bank’s financial performance was pleasing.
In terms of monetary policy, the period began with business confidence at very low levels, but the world economy very buoyant, the exchange rate at its lowest level ever on a tradeweighted basis, capacity utilisation at a high level, unemployment at the lowest level for a decade and headline inflation rising, partly because of a sharp increase in the excise tax on tobacco products and in international oil prices.
Taken together, these factors suggested that the challenge for monetary policy was going to be restraining inflationary pressures. In December 2000, we foreshadowed the likelihood that monetary policy would need to be tightened early in 2001.
But, as time went by, it became clear that the world economy was slowing much more quickly than seemed likely at the end of 2000, and the outlook for inflation began to seem more benign. Between March and May the Official Cash Rate was reduced in three steps from 6.50 per cent to 5.75 per cent.
Some concern was expressed that we were easing monetary policy too cautiously. However, world prices for many of New Zealand’s major exports remained very strong, the exchange rate continued to provide strong stimulus to many parts of the economy, and unemployment was at a 13 year low. Businesses that were increasingly cautious about the future of the economy as a whole were quite upbeat about their own prospects. Some easing in policy seemed appropriate; but a dramatic easing did not.
CPI inflation in fact peaked at 4.0 per cent in the year to December, and increased by 3.2 per cent over the year to June 2001. Nevertheless, the non-executive directors of the Bank reached the judgement that, given the special factors which had pushed up prices during the year - international oil prices, tobacco taxes, and the direct effects of the sharp depreciation in the exchange rate - this did not reflect “inadequate performance” of a kind which might warrant a recommendation to the Treasurer for my dismissal.
In May 2000, Professor Lars Svensson of Sweden was appointed by the Government to undertake an “Independent Review of the Operation of Monetary Policy”. The results were released at the end of February 2001. Pleasingly, Professor Svensson was very complimentary about the way in which policy had been formulated during the 1990s, with the notable exception of the way in which we used a Monetary Conditions Index between mid-1997 and early 1999. He also described our present approach to monetary policy as consistent with best international practice.
Professor Svensson did, however, suggest that it was anomalous to have the Bank’s Governor chair the Bank’s Board, given that the main statutory objective of the Board is to monitor the Governor’s performance. He also said that there was too much risk in having monetary policy decisions made by the Governor alone, and recommended that, from the end of my current term as Governor, monetary policy decision-making should be in the hands of an internal committee of five, chaired by the Governor.
In May 2001, the Treasurer announced his intention that the Bank’s Board should be chaired by a person elected by the non-executive directors from among their number, but also that monetary policy decision-making should continue to be vested in the Governor
In other areas of the Bank’s operations, we had some successes but also some frustrations.
The Reserve Bank has responsibility for promoting financial sector stability as well as for promoting monetary stability. It does this by registering and supervising banks, remembering that neither the Reserve Bank nor the government guarantees banks or the repayment of their deposits.
This year, after consultation with the banks, we introduced a requirement that all banks obtain and disclose a credit rating, as one important and relatively simple way to help depositors assess the strength of the banks with which they deal. We also introduced a policy requiring systemically-important banks, and some others where depositors are not ranked equally vis-à-vis the assets of the bank, to incorporate within New Zealand. As the financial year ended, discussions were continuing with the two banks most directly affected.
Work continued on two other important initiatives relevant to banking sector stability, these being how we might handle a bank failure and how we can eliminate the settlement risk currently inherent in foreign exchange transactions across different time zones. Progress on both of these projects was pleasing.
Similarly pleasing was progress in stream-lining our currency operations. As a result, the Reserve Bank’s Auckland branch closed in November 2000, the Christchurch branch having been closed in June 2000. The Bank’s Auckland building is being sold. The scale of our Wellington currency operations was also cut back as we reduced the Reserve Bank’s role in the distribution of bank notes and coins around the country.
The management of the country’s foreign exchange reserves proved to be slightly more expensive to the Crown this year than we had hoped. The results of our active management, while positive, were less so than expected. A decision to reduce the relatively high proportion of our reserves held in Japanese yen securities also involved unplanned costs. But despite this, the results were reasonably satisfactory in what was a turbulent year for world financial markets. We also completed a comprehensive review of our risk parameters in this area.
Less satisfactory was the outsourcing of the technology required to support our registry operations. Although successfully completed in early July 2001, the process took a great deal more time, energy, and resources than either party initially contemplated. There was, however, no net cost to the Bank as a result of these delays.
We had even more difficulty following our decision in May 2000 to relinquish our licence to operate the Austraclear system in New Zealand. After lengthy negotiations we reached tentative agreement, but at the last minute the party with which we had been negotiating decided not to proceed. While some costs were incurred by the Bank, at no time was customer service adversely affected.
Financial results for the year were very satisfactory. The Bank’s operating expenses were, at $37.8 million, 5.6 per cent below budget and 14.6 per cent below those in the previous financial year (when expressed on a consistent basis), in large part because of a sharp drop in the cost of issuing new bank notes and coins. In terms of net costs and income covered by the Funding Agreement, the Bank spent $28.6 million, which was 15.9 per cent below the $34.0 million permitted in the Funding Agreement. The Bank’s surplus for the year was $159.6 million, which was slightly up on the previous year, but for a central bank the extent of this surplus is not a good measure of policy or operational performance.
The membership of the Board remained unchanged during the year, but I want to acknowledge the considerable additional work undertaken by the Board on account of the Svensson Review, to which the Board made a substantial submission.
And, of course, I acknowledge the huge amount of good work by staff in all aspects of the Bank’s responsibilities. In addition to all our normal tasks, there was the extra work caused by the Svensson Review, down-sizing currency operations, outsourcing registry operations and the prolonged negotiations related to the intended relinquishment of the Austraclear licence. It was a challenging year, but staff rose to meet those challenges enthusiastically and effectively.
Donald T. Brash
Governor