Dr Allan Bollard speaks to Bernard Hodgetts, Head of Macro-Financial Stability at the Reserve Bank of New Zealand, just before he left the post of Governor of the Bank after completing two terms. The questions appear in bold, followed by Dr Bollard’s answers in normal font.
How does a new Governor go about learning to do monetary policy and make Official Cash Rate decisions?
Setting the Official Cash Rate is an unusual form of public policy. Of course, I had already seen plenty of areas of economic policy of government.
But this is an unusual one where there is a lot of information that you are looking at and then you are doing a lot of analysis and transformation of that information in structured ways to give you – you hope – a detailed picture of the future.
But you know that much of the picture will prove to be wrong, the future will be different. Knowing that, you have to make a trilateral decision. Rates can go up, down or not change. That is unusual. Monetary policy is really one area of discretionary or short-term economic policy.
Sole decision-maker
In addition, we have the Reserve Bank Act under which the Governor is the single decision maker. That is not one of the innovations that has been picked up and copied from the New Zealand model overseas, and it is quite unusual now. It puts a lot of stress on an individual’s decisions.
So I obviously had to learn from people around me.
In Treasury, I was involved with the ‘Svensson Report1’ and I had learnt quite a bit from that process. I had seen a lot of policy advice from the Treasury as well as the Reserve Bank on the whole area, but in the end, you learn by doing. There were certainly some confusions and uncertainties around those earlier decisions.
The Taylor Rule
We used to put a lot of weight not just on the Reserve Bank model projections, but also on other metrics like the Taylor rule.
The first Taylor rule calculation I was presented with advised me to increase interest rates by something like 200 basis points!
As a new Governor and newcomer to monetary policy, it is quite hard to know what a stable or reliable calibration is and how much you should rely on it. You take advice, but your early interest rate decisions are quite difficult.
During your first term (2002-2007), you had to contend with a very strong economic cycle as well as some nasty shocks along the way – SARs, droughts and electricity shortages come to mind. Tell me about some of the policy challenges and uncertainties the Bank faced.
There were uncertainties, although in hindsight, in the context of the global financial crisis, they do not look that bad. Indeed many of them were threats that really did not eventuate. We had the biohazards – SARS, Swine Flu, Avian Flu.
Precautionary action
The language used by the World Health Organisation and others about those risks was pretty strong. As it turned out, they did not really have major effects – the predictions were quite wrong.
But we had to take them seriously and we did react to them along with a fairly unusual double year drought, which led to the threat of electricity shortages at one stage. We took precautionary action (with monetary policy) which was probably unnecessary from hindsight and potentially damaging in a minor sort of way.
I remember approaching these events wondering whether our interest rate calibrations were right, why New Zealand policy rates had to be so high compared to other OECD countries and why that was.
What would happen if we reduced rates? However, we needed to be very careful because international asset prices were rising sharply and we had a strong New Zealand housing market.
Formalised structure
I think I had a more formalised decision-making structure than under the previous Governor. Previously, there had been more reliance on judgement by the
Governor. The Governor of course had also been the chair of the Board but this changed shortly after I came in.
We formalised and revised the Official Cash Rate Advisory Group (OCRAG).
We already had external people on it, but I required written advice from the members to be in the form of a “one pager” (with advice required under structured headings) that would then go to the Board.
When I cut rates in early 2003, I recall the views among the OCRAG group were quite divided. That’s the one decision from hindsight that probably wasn’t right. But at the time, it was insurance.
The above is a part of the Bernard Hodgetts interview. For full version, visit www.rbnz.govt.nz
