Keynote address - Resilience as a pathway to prosperity

Madison 

You sit on the monetary policy committee, you've been with the Reserve Bank for a while now. You've been at the forefront of some of the biggest momentous decisions and Christian has also told me that nothing is off limits today, so I'm very excited for this reminder that there is also that audience q and a. So please, we'll absolutely come to your questions towards the end.

Can I just get a show of hands first who he has a mortgage? I know it's a bit of a personal question, but you're all in financial services, so it's a crime if you don't have one. Wow. Looks like about 90% of the room on behalf of all of those hands. Christian, thank you for cutting the official cash rate the other day. I'm sure everyone who put their hand up is very grateful. We're going to going to discuss that decision in more detail, but also I want to talk about what everything that the Reserve Bank has been through over this sort of rollercoaster ride with rates and prudential tools and ultimately what the banks learned from it. But first, if I can sort of paint the picture of the system and where it's at right now. We had record mortgages in 2021. A number of those, a significant amount of those were also at six times people's income. We've had a tripling in retail interest rates since then. Now we have the tick up in unemployment, slight tick up in defaults and increased business insolvencies. How stable is the financial system given all of that? Christian? 

Christian 

Well, you've just given me a plug for our financial stability report, which is out in November, which covers all of that ground. We think the financial system's in a good position, it is resilient and we've done a lot of work through time to build up that resilience. If I was at this conference a few years ago, I would've been talking about the capital review and the way that we were building up capital requirements and liquidity requirements for the banking system, implementing macro prudential tools like the loan to value restriction and now the debt to income restriction as well. All of those things have been about building up resilience in the financial system so it can weather these ups and downs because we will go through economic cycles along the way. What we've been really pleased about is the way that financial institutions have used that resilience to stick with their customers through those ups and downs and communicated very early about if you're having problems come and talk to us, we can work with you. There are things that we can do. We think that that's one of the benefits that comes from building that resilience through time.

Madison

What you're very focused on at the central bank as well is this balance between resilience and competition. I think it's fair to say we're pretty lucky to have quite a resilient financial system througheverything that we've been through, but this government now is pretty hell bent on increasing competition in the banking sector, especially after the commerce commissions most recent report. How will that shift the balance between resilience and competition and everything else you have to keep in focus?

Christian

Yeah, I mean it's a great question and we've been very engaged in the commerce commissions market study both at a draught level and the final report that's come out as well. I think just in terms of the structure of the banking system and the financial system that we're in, there are a lot of returns to scale, so being big as a financial institution does give you a competitive advantage because you can spread those costs of operating over a much wider customer base. So just inherently, I think the system is one where there is an advantage to being big and it is an advantage from scale as opposed to anything else. What we are looking at is a chatted about where is it that we can on the margin promote competition as well? Where can we push ourselves to think? Do the rules need to be the same for different types of institutions? So just to bring this to life at the moment we're consulting on the deposit taker act. One of the things is the minimum amount of capital that you need to even be a deposit taker at the moment. 

Madison

What is it currently?

Christian

Well, under previous rules as to be a bank you needed at least $30 million capital. It's a bit money to get a licence. It's a serious business. Being a bank, you're taking risk requires a lot of trust and confidence. We are looking at that now across both banks and non-bank deposit takers and in consulting with the industry and saying, what do you think the right number is? We've put out five to $10 million as a starting point for that conversation and that might be a more achievable level for a startup company that maybe isn't going to provide all banking services but might provide some banking services. And I think that's the way of the future that there will be different types of financial institutions providing different pieces of what banks do at the moment. 

Madison

Interesting on resilience, the big guys, nothing's too big to fail though. Is it Christian in terms of the big institutions, no such thing as too big to fail?

Christian

Well, in New Zealand we have quite a unique regime which includes something that we call open bank resolution. So we need to be able in a position first and foremost, we want to build resilience such that we don't have failures, but we don't have a zero failure regime. We can't guarantee that's not going to happen. So in New Zealand we have a thing called open bank resolution and we have for the big banks, we have outsourcing requirements, which mean make sure that you don't have to rely on your big Aussie parent for everything that you do. Make sure that you can be able to stand alone if you need to, and open bank resolution gives us the tools to shut down a bank and reopen it as a going concern.

Madison

There must be at least some level of concern about resilience of the system given what it's been through because you are making some regulatory changes at the margin. LVRs have been loosened slightly in favour of bringing in new debt to income restrictions. Why are you adding new tools into the mix and what impact do you expect them to have?

Christian

Yeah, we are constantly thinking do we have the right tools for our mandate and the different aspects of our mandate, the different responsibilities we have in regards to the macro prudential tools that you mentioned 10 years ago, we were a pioneer in the world. We were the first country to impose a loan to value restriction and that followed the experience from the GFC. That was all about making sure that borrowers had enough equity in their home such that if house prices fell, they weren't in negative equity and the banks had something as collateral there in that situation and roll the clock forward. That's just one aspect of risk from lending through mortgages.

The other more significant one is just the ability to service the mortgage through different states of the world in the future, different levels of interest rates and that's what debt to income restrictions help us hone in. More specifically on what we noticed looking at overseas is that everyone had followed us in terms of everyone else's doing macro prudential tools as well, but they were using more than one tool and being able to be more focused, more targeted, more efficient and enabling them to have less restrictive settings if they get in that space. So we're really pleased that we've got that to hand and think that it's going to be somewhere down the track in the next economic cycle that we face. They're going to be a really important guardrail.

Madison

Well on the economic cycle and specifically the forecast that you recently released in your monetary policy statement for August, it showed that we are already in a recession and we're going to be in one for the rest of the year. Is that better, worse, about on par with what you expected and let's also be clear that that's what the reserve bank engineered, right.

Christian

We've spent a lot of time looking back at how the economy's evolved and whether that's been roughly what we expected or not. We actually go back and look at our projections back in November, 2022 and actually remember standing up in this conference around that time inflation was over 7% and it was a real really uncomfortable time to be a central banker globally and here in New Zealand and what we knew we needed to do at that point was cool demand. We were just in a position where through that covid experience, it had all been trying to soften the blow of Covid, keep cashflow and confidence going soften the blow. That response ended up being such that people just kept spending regardless of the fact that the productive capacity, the global economy had been cut back and so there was all that demand. We need new net demand needed to slow.

Our projections in November 22 show pretty much a profile like we've seen, which is going from an overheating economy to one where things are better balanced and potentially one where we've got a bit of spare capacity for a little while as things continue to cool down and inflation expectations really anchor back where they need to be. So we've been confident through that period that monetary policy is working, it's doing its job, it's panning out. The uncertainties have been around the speed and intensity of that. When's it going to come through? Have we seen enough yet? And so back in our last decision in August was really getting to that level of confidence that actually we've seen enough now we can move into a different zone in terms of where monetary policy is.

Madison

I wanted to ask you very specifically about that level of confidence because, but ahead of that August rate cut decision, the market was so heavily pricing that in they were well ahead of what the reserve bank's own projections were for the OCR track. Following that decision, the noise now criticising the Reserve bank for not moving sooner or at least even indicating that you were thinking about it has been pretty overwhelmingly loud. Why did you a not move sooner? Was there perhaps not enough evidence that gave you that confidence but also why did you not indicate that you were thinking even of moving at this stage?

Christian

Yeah, so I'd say through this whole period we've had a lot of confidence that monetary policies working and just because you see it working through the different bits of the transmission channel and it's kind of a sequence that you would expect, so confidence that it was working, confidence that we're on track, but the big uncertainties were really around whether it was going to be slower than we expected in terms of was price setting behaviour going to be sticky? Was it going to be slow? Was it going to make our job harder? Were we going to have to do more? That was the risk on the upside, the risk on the downside was we've done enough but we just haven't seen it come through yet and it's going to come and it's just ahead of us. So we're really for right through that whole period we're looking at those are those two risks balanced as we went into May earlier in the year, your things worse looking stubborn pricing intentions were still high even though the economy was cooling, that domestic price pressure was still high and was giving us cause for concern.

Through the course of June and July, pretty much everything moved at once, so all of those pricing intentions, inflation expectations, headline inflation, all these things came down at the same time that all of the economic activity indicators fell as well. So it gave us that confidence that we'd reach that level where not only had headline inflation come down to a zone that we're confident, but the capacity was really coming out of the economy, which meant that in the future inflation would stay down in the future as well. That happened pretty quickly through June and July. In our July monetary policy review, we did change our tone in terms of acknowledging what we were seeing and we started to talk about how well policy isn't going to be restrictive forever. At some point we're going to have to start moving into a different zone. By the time we got to August markets were pricing what we ended up doing, there'll always be economists on one side or other of the story and we hear all about that.

Madison

It's pretty crazy to think that only three years ago the official cash rate had zero in front of it was at a record low it feels like a long time ago because look at us now, the average one year mortgage interest rate has a seven in front of it. Ultimately throughout all of this, what has the reserve bank learned from the cycle? Because tools that were kind of just being tested on paper have now actually been tested in practise. So what have you learned about the impact monetary policy can have and also specifically its correlation to certain parts of the market and economy like housing?

Christian

Yeah, we've done a lot of reflection. As you can imagine. We put out from a legislative point of view every five years we have to do a review of what we've learned over that period, have that externally reviewed. That's been pretty timely given what we've come out of. So lots of lessons there. I think some of the lessons around the tools are that actually we've got the tools that we need in the sense of a lot of what we did there were new tools, they had new acronyms, all of that sort of stuff, but ultimately they were about different ways that we can keep interest rates down and that's what monetary policy is about. It's when stimulus is needed using different tools to keep interest rates as low as you can when you need to cool things. Lifting interest rates into a restrictive zone. So to some extent we know we've got the tools.

A lot of the lessons were actually about where we need to build capability, things that we need to understand better into the future if we're in a similar situation. Again, I think one of those areas is around we are very experienced on the economic cycle, the ups and downs of consumption and investment, all that's our bread and butter, but really having a better capability when it comes to understanding the productive capacity of the economy. What happens when you shut the border is what happens when there are disruptions to supply chains. All of these things which were very, very prominent and will be more prominent in a future of climate change and more disruption to the supply side of the economy. Also building capability and understanding on the impacts of fiscal policy.

The consensus approach over the last 20 or 30 years has been that monetary policies in the lead when it comes to cyclical management of the economy, fiscal policy just does its thing. The automatic stabilisers kick in taxes, fall benefits go up, but you leave the active management to monetary policy. What we learned through the Covid experience is that when you get close to the zero bound on interest rates, monetary policy needs friends and some of your stimulus needs to be really targeted, then you're into the active fiscal stimulus mode and there's a lot of learning to do in terms of how effective that is. The impact it has, and I think that was probably the big lesson through the Covid experience was how potent fiscal policy can be when you have something like the wage subsidy that creates that attachment between workers and their employers and gives people confidence to keep spending.

Madison

Do you think out of that then the Reserve Bank perhaps needs to, obviously you are independent but perhaps be more vocal on saying, don't do that, it's going to be stimulatory.

Christian

What we are looking at more is a research programme around fiscal monetary coordination, so working together to understand what those tools are, what their costs and benefits are, the different times that they would be used, building a type of playbook together of in these different situations, this is what would happen first. This is what would happen second, but through all of that, you need to respect the independence of the two organisations. We're independent for a reason and so that needs to be incorporated as well. Also, it's the treasury's job to advise the minister of the finance of the day what the fiscal strategy should be or fiscal response should be, but ultimately that needs to be left with the minister of the finance of the day to make that call

Madison

On inflation and specifically inflation targeting all central banks mostly said that it was going to be transitory. I think we can all kind of clearly agree now that it wasn't and when gangbusters stayed high for much longer than anybody expected. Some parts certainly now are proving quite sticky to remove out of our economy effectively. What's the lesson on the central bank's actual ability to A, understand inflation and B, control it?

Christian

Yeah, I think we're all in the same boat in a sense of we play the cards that were dealt with and what we know at the time, and so we go to the lengths of putting out a projection to say, this is what we know about the economy at the moment. These are the assumptions we're making going forward and here's our best foot forward in terms of what we think the outlook is and what we need to do because of that outlook. Then things change and we have shocks come along, events happen. The big lesson over that post covid experience is just the size and the impact of supply side shocks on the economy and what they can do, and we just hadn't experienced that before. A whole economy in New Zealand and globally going into hibernation, people all getting sent home, just the way that reduces the whole wealth of the globe in terms of producing less things.

The way that the supply side disruptions through that period where you go from a period where it's normal to have one ship docked outside Long Beach, Los Angeles, and you went to a situation where there were a hundred ships docked out one outside one harbour in the us. It's just an indication of how disrupted getting goods and services around the world was. So throw in the Ukraine war, all of these things. I think that's been one of the big lessons is just the impact that the supply side can have on that story, and it's out of our control in the sense we've looked back and thought, well, if we'd moved monetary policy quicker, if we'd moved a few quarters ahead and got on top of it already having been the first central bank to be tightening, we still would've had inflation with a five or six on the front of it.

Well, one percentage point is quite a big difference. The difference between six and then 7% is quite keenly felt in this economy

Christian

And these are just ballpark figures and that's assuming that we had perfect foresight, that we knew something that we didn't at the time, but it's to say that we focus on 2%, we've got a one to 3% range, we focus on 2% because that gives us the best chance to stay in that range. Simple as that, but that doesn't mean that inflation's going to be never going to be outside that range. There is. That's just the volatility that we are dealing with. Our job is to get it back and give people confidence that it's going to be anchored around there going forward, and that's what we're seeing now in terms of how inflation expectations have come down, pricing intentions have come down. Those surveys are saying that over a five to 10 year period, people still have confidence that we will be anchored around 2%.

Madison

So give us a figure where is the OCR going to land this cycle three something?

Christian

Well, so our projections are that the OCR comes down to somewhere around 3%, and that's because that's what we think a neutral OCR setting is over that longer term horizon, and that's predicated on everything working, everything coming back to where it should over the long run. There being no new shocks that come along, all of those assumptions that sit there when you think about it, if 3% is the neutral OCR and we've had the OCR up over 5% to be in restrictive territory, it means that you can quite easily be in a world over the next five or 10 years where the OCR is back between zero to 1% depending on what's in front of us and what we're dealing with at the time. So we need to prepare for those contingencies.

Madison

The only certainty at the moment is uncertainty. Right?

Christian

Exactly.

Madison

Best to be prepared for absolutely anything. Thank you so much for your time, Christian Hawkesby, lovely to have you here. Thank you so much.