Adrian Orr says bank may need to down inflation ‘over a reasonable horizon’

Reserve Bank governor Adrian Orr has stressed the “balancing act” in front of the central bank as it seeks to bring down inflation, in a speech to the NZ Economics Forum at Waikato University.

National Party finance spokesperson Nicola Willis reiterated at the conference on Thursday that a future National government would “return the bank to a single mandate of delivering price stability, with a 1% to 3% per cent inflation target band”.

Willis also reiterated it would commission an independent review of the Reserve Bank’s performance over the past few years when she said some “extraordinary monetary policy decisions were taken” that put New Zealand “amongst the top handful of Covid money-printers in the world”.

Responding to questions after his speech, Orr said that it would not be simpler to have a single mandate, as the trade-offs the bank faced would still be there.

READ MORE:
* Can the US Federal Reserve pull off a soft landing and avoid recession?
* 1% tax on high pay a possible precedent for a cyclone levy, says Reserve Bank deputy
* Official cash rate increase: What does it really mean for home loan rates?

Even before the bank was instructed by the current government to have regard to sustainable employment as well as inflation, it had always had to “have regard to avoiding unnecessary instability in output, interest rates and the exchange rate”, he said.

“And we have always had to have regard to where do we believe employment is relative to its maximum sustainable level.”

Whether that consideration remained explicit, or was implicit, was a “political decision”, he said.

“In reality it is always there.”

The Reserve Bank raised the official cash rate by 50 basis to 4.75% last week and Orr gave no substantive fresh perspectives on its current approach to monetary policy at the conference.

He instead emphasised the bank’s competing and broader objectives in his address, during which he referred to the term “trade-off” 17 times.

“Central bank functions are not ends in themselves, but contribute towards much broader policy and societal goals,” Orr said.

“If we wanted to write the algorithm to replace central bankers, we are trying to maximise several objective functions, subject to taking on no undue operational, legal, financial, and reputation risk.”

The central trade-off currently facing the bank appears to be how quickly to raise interest rates and try to bring down inflation, in the face of an expected local and global economic slow-down.

Orr last year acknowledged the bank was engineering a shallow recession as it sought to get back on top of inflation.

But evidence appears to be growing that global inflation may prove relatively prolonged, with “core” inflation in Europe – excluding the price of food and energy – now back on the rise.

“We need to bring inflation back to a target range. But of course, we need to do it over a reasonable horizon so as not to unnecessarily crash the economy and turn temporary, slower growth into permanent unemployment,” Orr said.

The bank also had to have regard to “other issues around financial stability and unnecessary volatility and that’s where the balancing act gets really hard”, he said.

“Lifting the official cash rate too far or too fast can, for example, lead to a severe downturn; spending and investment collapses, and you ended up with a much higher exchange rate because foreign exchange dealers chase the high yielding New Zealand dollar, and you crush the export sector.

“Lifting the official cash rate too fast or too far could … lead to a severe downturn in spending and investment, and a much higher exchange rate as international investors chase higher returns, crushing the export sector,” he also said.

“All economies have been through that before.”