Reserve Bank admits monetary policy was ‘too stimulative’ during pandemic response


The Reserve Bank (RBNZ) has acknowledged that its monetary policy was “too stimulative” at one point in the pandemic response. But he seems to blame his inability at the time to take the official exchange rate (OCR) into the negatives.

The central bank’s rare admission of wrongdoing comes in an information document which explains why the RBNZ has taken the path of quantitative easing (QE), rolling out the Large Scale Asset Purchases (LSAPs) and Funding Loans Program (FLP) as part of its monetary policy response to Covid-19. The document also describes a framework for evaluating the impacts of these programs.

The LSAP program has seen the RBNZ buy around $53 billion in government bonds – which are now resold to the Treasury at a rate of $5 billion a year – while the FLP, which allows banks to borrow from the official exchange rate, has so far been used to the tune of $12.7 billion. The FLP officially ends in December.

The RBNZ is effectively indicating that it had to go the QE route due to the banking system’s unpreparedness for a negative OCR. This seems to imply that a negative OCR would be the preferred route going forward.

“OCR remains the most effective tool for managing the overall level of monetary stimulus across economic cycles. The banking system is now able to adapt to negative interest rates, and this will be part of the box monetary policy tools going forward,” the RBNZ said. said.

The backgrounder notes that consumer price inflation is above the RBNZ’s target range.

“Underlying inflation estimates, which measure the persistent component of inflation, hover between 4% and 6% per year, well outside the inflation target range of 1% to 3%.

“Looking back, this indicates that monetary policy was overly stimulative at some point during the tumultuous economic period of the pandemic. In response, the OCR is now above its neutral rate until demand domestic market better matches the supply capacity of the New Zealand economy.”

The RBNZ increased OCR by an additional 50 basis points on Wednesday this week to a seven-year high of 3%. The cash rate has been raised by 225 basis points this year and probably by at least another 75 points before the end of this year.

In the background paper, the central bank said the “pattern” in the monetary policy settings it followed was “a global phenomenon” and had happened in many other countries around the world since the beginning of the pandemic.

“There will be important lessons to be learned from this for the RBNZ – captured in our forthcoming review – and for national and international policymakers more generally.”

The RBNZ is currently undertaking a detailed assessment of its monetary policy actions over the past five years as required by the Reserve Bank Act (2021). The bank says that to ensure this assessment is fair and transparent, it will be externally peer reviewed by two international monetary policy experts.

“The RBNZ aims to learn as much as possible from this review, which will provide a balanced assessment of the net benefits of the RBNZ’s monetary policy actions over the past five years. The RBNZ will publish this work towards the end of 2022.”

The briefing note notes that “significantly”, during the period of “extreme economic uncertainty” in 2020, the RBNZ Monetary Policy Committee – which sets monetary policy for the RBNZ – “made it clear that ‘there could be “political regrets” in the future, given the circumstances”.

“Managing lower future high inflation, rather than coping with deflation and economic depression, was considered the ‘least bad’ regret, if one had to choose.

“We are now well advanced in tightening monetary policy to manage inflation within the RBNZ target range, having avoided economic depression, deflation and unnecessary high unemployment.”

The RBNZ said the net benefits of deploying its monetary policy tools must also consider the risks associated with political action versus inaction. “Although difficult to quantify, Table 5 provides a brief assessment of the risks associated with the deployment of LSAP and FLP.”

The RBNZ said exploratory work carried out in 2019 revealed that many New Zealand commercial banks were “not operationally ready” to handle negative interest rates, if necessary.

“This has raised serious concerns about any unintended impact of negative OCR on the efficient functioning of the New Zealand financial system. additional monetary policy tools The RBNZ has also asked commercial banks to prepare for a negative OCR, should it become necessary in the future.

“With further reductions in OCR, ‘quantitative’ tools – such as the ‘large-scale asset purchase program’ – have become increasingly necessary as options for implementing the Monetary Policy.

“In early 2020, with the global onset of the COVID-19 pandemic, the need to deploy additional monetary policy tools became increasingly evident. With OCR at its practical limit, additional means of providing monetary stimulus were necessary if the RBNZ was to achieve its monetary policy and financial stability objectives.

The RBNZ said its modeling shows that while the OCR cuts “were clearly critical”, the LSAP and (less) the FLP were “equally critical” to lowering interest rates and easing overall monetary conditions.

“By using the LSAP and FLP, the RBNZ was able to provide additional monetary support and financial market stability to New Zealanders, even when the OCR could not be lowered due to operational constraints in the financial sector.”

Although it is “extremely difficult” to isolate the individual economic impacts of the LSAP and the FLP, the decline in interest rates brought about by accommodative monetary policy has been fundamental to supporting economic activity during the pandemic, according to the RBNZ.

“RBNZ actions have led to higher spending, investment, jobs, profits and tax revenues than otherwise across the economy. Lower interest rates along the yield curve yields also exerted downward pressure on the exchange rate, contributing to improved net export earnings.Unemployment, business failures, social spending and long-term economic scars were all lower than expected. they would have been otherwise.

“Furthermore, the return of liquidity and stability to the government bond market has fostered broader financial stability, allowing business as usual for capital raising and government financial intermediation. and businesses. All of this has been achieved despite the continued extreme economic uncertainty associated with an unprecedented global pandemic.”


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