Acting Governor’s Statement
The Reserve Bank is charged with preserving stability in the value of money and promoting the soundness of the financial system. In this way, we reduce monetary and financial uncertainty, thereby making our contribution to sustainable economic growth and employment.
Monetary and financial predictability enhances planning and longer-term commitments by people developing skills, by employers taking on employees, and by savers, investors, borrowers and lenders. People making decisions can more readily rely on prices to reflect true costs and know that the mere passage of time will not make them worse off. They also can be more confident that their savings will be there, when required.
Price stability is also laudable because it is fair and equitable. When money loses its value in an unexpected way, those likely to be hurt most are people on fixed incomes, people who rely on bureaucratic processes to set their incomes, people with modest levels of savings, and people on low wages with the least negotiating power to win compensation year after year.
Financial system instability is a source of extraordinary injustice. When financial systems fail, promises are broken, and jobs, savings and trust are destroyed. These may take decades to repair.
So how have we done?
In the year under review consumer prices rose 2.8 per cent. Savers have been rewarded with positive real interest rates, preserving the purchasing power of the money that they set aside in low risk assets, such as bank deposits and government securities. Price stability in terms of expected outcomes, as agreed in the Policy Targets Agreement, has been achieved.
But there is more to this. In line with its broader responsibility for stability, the Policy Targets Agreement requires that, in maintaining price stability, the Reserve Bank must seek to avoid unnecessary instability in output, interest rates and the exchange rate.
In recent months there has been a growing debate about the extent to which the conduct of monetary policy has been consistent with this goal. Monetary policy inevitably faces uncertainty. Shocks, our incomplete understanding of how inflation expectations evolve, and long and variable lags in the impact of monetary policy on inflation outcomes - all call for judgement. Given this, the Reserve Bank must trade off the risks of pre-emption and gradualism against the risks of delay and the potential need for subsequent aggression in the conduct of monetary policy. Inaction now may mean greater instability later on.
Sometimes the Reserve Bank has to move very quickly. The terrorist events of 11 September 2001 required aggressive pre-emption in response, with the Reserve Bank cutting the Official Cash Rate by 100 basis points on top of 75 basis points of cuts earlier in the year. We did this even though headline inflation was outside the inflation target.
As spending power from an extraordinary two years of earnings in the agricultural sector pushed through provincial New Zealand, growth rose to an annual rate of over 3 per cent. Growth was helped along by a recovery in tourism, a rise in immigration and high levels of consumer and business confidence. More people than ever participated in the labour force. Retail sales grew at double-digit rates and activity in the housing market picked up. Stretched resources, headline inflation high in the target range and evidence of persistent inflation resulted in the Reserve Bank beginning to withdraw the stimulus provided previously by low interest rates. This reduction of stimulus was intended to ensure that economic growth continues at a sustainable rate, so as to reduce the likelihood of a more rapid slow down later.
As the year under review drew to a close, the weakening of the US dollar, rising relative interest rates and the rise in our growth prospects relative to some of our trading partners have seen the New Zealand dollar appreciate somewhat faster than we expected, to levels more in line with long-term trends. A weaker US dollar and a smaller US current account deficit are likely to place pressure on the tradable sectors of many countries, including New Zealand.
What of the financial system? The banks operating in New Zealand remain sound, with loan losses and impaired assets at low levels.
Offshore, a significant adjustment is underway in global financial markets, which will affect the real economy in the next few years. While losses to shareholders and bond holders in the US and Europe in particular are likely to be material, it presently appears that the major banks in those countries can absorb their share of these losses without any threat to the functioning of this key element of the global financial system.
The Reserve Bank stands at the hub of the New Zealand payment system, with banks settling over $30 billion a day via the systems that we are responsible for. During the year a significant new interface for these systems was successfully introduced, increasing efficiency while reducing risk and cost. More work remains to be done to further reduce settlement risks faced by banks dealing in New Zealand foreign exchange markets. The expected acceptance of the New Zealand dollar for settlement via CLS Bank, subject to several conditions, will, if achieved, be a material step. Progress by the New Zealand banking industry in agreeing and documenting failure-to-settle rules within the retail payment systems is advancing well.
On 26 April 2002, Dr Don Brash, Governor for fourteen years, resigned to stand for Parliament. It is a credit to both the framework and to Dr Brash that, on the day, the financial markets were confident that the Reserve Bank’s processes were robust and transparent. Neither interest rates nor the exchange rate showed instability and the Bank moved swiftly to reassure markets that for the Bank it was business as usual.
Dr Brash’s contribution to the flexible inflation-targeting regime, which now underpins monetary policy in New Zealand, has been substantial. Where New Zealand has gone others have followed. Under Dr Brash, New Zealand has led the world in central bank transparency and in harnessing market disciplines to improve the incentives faced by those responsible for the management of financial institutions. The Reserve Bank was an early adopter of polymer bank notes, real-time gross settlement of inter-bank transactions and more flexible human resource practices.
The Reserve Bank is highly regarded among central banks around the world. Reasons include the standard of its annual accounts, the way it communicates and how it organises itself. All current and former Bank staff contributed to this, but Dr Brash deserves a large measure of the credit for the renown of the Bank internationally.
It is also appropriate to acknowledge the contribution made by Murray Sherwin, former Deputy Governor and Deputy Chief Executive of the Bank. Mr Sherwin had been with the Bank since 1976 and served in many roles under various Governors and two distinctly different models of central banking. In recent years he represented the Bank extensively offshore, especially in the Asian region following the period of financial instability. His contribution in the evolution of the Bank into the institution it is today should not be underestimated.
In a year that has had its share of shocks and surprises, as well as the significant demands of routine business, I would like to pay tribute to the dedication and professionalism of all the staff of the Reserve Bank and to express my appreciation for a job well done.
Rod Carr
Acting Governor