Wednesday, 6 March 2013

Failure of Interest Rate Inflation Targeting and the part of former New Zealand Reserve Bank Governor Don Brash as flag bearer for the failed policy.

Failure of Interest Rate Inflation Targeting and the part of former New Zealand Reserve Bank Governor Don Brash as flag bearer for the failed policy.

An article in InFinance published October 1 2011 introduced Don Brash such;
Don Brash was governor of the Reserve Bank of New Zealand from 1988-2002. He is credited with helping to significantly reduce interest rates and spearheaded a new central banking model.

In the article Don Brash said of himself;
"For me, working in the financial services sector was almost an accident. My academic training was not in finance, but in economics. I did a PhD in economics at the Australian National University, and my thesis was on American corporate investment in Australian manufacturing. After that was published, I went to work at the World Bank in Washington, and although the World Bank might at a stretch be included as a financial services institution, it was (and is) really an economic development agency. It was only after five years at the World Bank that I was invited to be the CEO of a recently established investment bank in New Zealand.
My involvement in the financial services sector has been rather diverse. I spent 10 years as the CEO of an investment bank, two years as the CEO of an organisation established to merge the banking operations of nine savings banks, and 14 years as governor of the Reserve Bank of New Zealand.
I am most proud of the fact I helped implement a totally new model of the relationship between government and central bank. Prior to the Reserve Bank of New Zealand Act 1989, all central banks were either modelled after the 'old Bank of England' (with all decisions taken by politicians, and the central bank responsible only for implementing those political decisions) or modelled after the Bundesbank (with a high level of independence from the political process). New Zealand pioneered a 'third way', where the central bank is totally independent to operate monetary policy but the target at which policy must aim is an inflation rate pre-agreed between, and announced by, government and central bank. While I was governor, New Zealand also became the first country in the world to formally embark on inflation targeting. Inflation targeting is now almost universal among developed country central banks, while the 'third way' relationship between government and central bank has been copied by Australia, the UK, and Canada.

Ruth Richardson former New Zealand Minister of Finance in Jim Bolger lead 1990's National Party Government wrote of Don Brash in her book – Making A Difference- published 1995;
To Jim the Treasury staff were ideologues whom he instinctively mistrusted. I would regularly arrange meetings between Jim, myself, Graham and Don, seeking to provide Jim with that 'comfort zone' around macroeconomic policy that I knew would be vital. I thought it important that Jim be exposed regularly to Don Brash's thinking.

A Paper by John Sigleton of Victoria University of Wellington for workshop on Central banks and financial crises at the Reserve Bank of New Zealand, Wellington, June 2009 titled - The winds of change for central banks: the impact of economic crises on the central banking world – said this of Don Brash;
The example of New Zealand encouraged a wave of central bank legislation in the 1990s. In Britain the Thatcher and, to a lesser extent, the Major governments were not particularly sympathetic to CBI(Central Bank Independence). In opposition in the mid 1990s, however, the Labour Party held talks with international central bankers and academics about central bank reform. Labour was desperate to shake off its image as the party of high inflation and trade unionism. If Labour hoped to win more than one term in office it would have to appear competent, prudent, and disciplined. Ed Balls, a financial journalist and Labour adviser, introduced the prospective Chancellor, Gordon Brown, to leading central bankers including Don Brash of the RBNZ. Labour was pledged to restructure the Bank of England, and to enhance its accountability and autonomy, but a final decision on CBI was not made until shortly before the 1997 election. Brown did not reveal his plans for CBI to the Governor of the Bank of England, Eddie George, until after the election. According to Michael King (2005: 108), the central bank was astonished by this development.

The result of Don Brash's advice upon the banking architecture of England was that in 1997 the Government announced its intention to transfer full operational responsibility for monetary policy to the Bank of England. The Bank was given its independence as a central bank. It was also announced that the Bank would cease to be responsible for the Government’s debt management. The UK Debt Management Office was created in April 1998 as an executive agency of HM Treasury to take over responsibility for debt management. The Bank’s regulatory functions passed to the Financial Services Authority. Described as such on the -about- section of the UK Debt Management Office.

Iain Parker comment;
Interest Rate Inflation Targeting became the new mantra of the global financial architecture when New Zealand became the first of many countries that followed in trying it out from 1990 onwards.
The theory goes that given it is widely recognised that the greatest cause of a number of causes of inflation is excess quantity of money in circulation to available goods to be purchased will see prices inflate out of reach those on the average income as those holding greater expendable amounts of the excess quantity of money will pay above normal market rates for what ever they desire to purchase. Thus the senior financial management of the globe decided a basket of goods be monitored to detect if any rising of prices is occuring in process named Consumer Price Index (CPI). If rising prices are detected the demand for money would be slowed by raising the cost of it by raising interest rates on borrowing.
Despite the obvious hypocricy of targeting a quantity of money issue with a cost of money solution that would concern anyone with an indepth knowledge of Monetary, Banking And Credit Systems given where the extraordinary powers of credit origination as the primary money base and its distribution currently reside, it is not half as concerning as how obviously flawed the process would be if the cost of housing was left out of the Consumer Price Index allowing the quantity of money entering circulation to keep growing with artificially low interest rates. But the statements below from senior participants of the private global financial management make it quite clear that is exactly what happened;

20 February 2012 Deirdre Kent put this Official Information Act question to New Zealand Minister of Statistics;

- Despite the fact that section prices tripled in fifteen years to 2007, land is not now included in the Consumer Price Index. This means that the official measure of inflation is unreliable as it is far lower than the actual figure.

and received this reply;

Today I received a letter back from the Minister of Statistics, Hon Maurice Williamson. I had heard that land went out of the CPI but couldn’t remember when or why so I sent in an Official Information request. The Minister dates the letter 14 Mar 2012 and says 

Dear Ms Kent
Thank you for your letter of 20 February regarding the exclusion of the price of land from the Consumers Price Index (CPI) basket of goods.
I am advised by Statistics New Zealand that land (i.e. residential section) was included in the CPI until the June 1999 quarter. Following a review of the CPI in 1997 land was excluded, taking effect from the September 1999 quarter.
The 1997 review by an external advisory committee confirmed the CPI’s main purpose as being informing monetary policy setting, and that the CPI should be focussed on the concept of acquisition. The reason given for excluding land from the CPI from 1999 was that it was considered to represent the investment component of home ownership (with dwellings representing the shelter component).
The September 1999 quarter CPI information release explained it as follows: A dwelling provides shelter over a long period of time. Over time land is not consumed and so can be considered to represent the investment component of home ownership. As investment expenses are outside the scope of the CPI the rebased CPI excludes expenditure on residential sections.
Information on the sale of land is available from QV ( and the Real Estate Insititute of New Zealand (
I trust this information meets your needs and thank you again for taking the time to write.
Yours sincerely
Hon Maurice Williamson
Minister of Statistics.

BoE boss wants house prices in inflation

This is Money
22 July 2007, 12:00am
The Governor of the Bank of England has admitted he is ‘surprised’ that rising house prices are not included in the official inflation figures, according the BBC.
Mervyn King told Radio 4’s Money Box programme that he wished the Consumer Prices Index (CPI) – the measure that tracks the cost of goods and services – did include house prices, as the previous official measure, the Retail Price Index (RPI), used to.
He said: ‘Some of these issues are controversial. I wish it did include housing, but it doesn’t – at least at present. Maybe one day it will.’
Since 1997 Mr King and the Monetary Policy Committee at the Bank of England has had the task of keeping the CPI around a target of 2%. It has raised interest as a method to reduce inflation if prices climb too sharply.
However, critics have said that because the CPI does not include the cost of mortgage repayments, official inflation figures are artificially low. Some say this has created a bubble in the property market as house buyers are able to over-borrow with cheap loans.
Currently the CPI stands at 2.4%, but the RPI – which includes mortgage repayments – stands at 4.4%.
Economists expect the Bank of England to raise interest rates to 6% by September, something that could prove a problem for some homeowners struggling with large mortgages.
Mr King said: ‘CPI is meant to be constructed in the same manner in all European countries, and so far the European statisticians have not worked out a way of how they can calculate the cost of housing in a way that can be done uniformly across Europe.’
Notwithstanding the limitations of the CPI, Mr King defended the record of the Bank of England in setting rates. He said: ‘The track record is pretty good, so if we have made wrong decisions from time to time, there can’t have been very many of them and they can’t have been that wrong.’ ‘The Monetary Policy Committee I think was well designed. I think it’s been successful for 10 years and I see no reason to believe that it cannot be successful for another 10 years and decades after that.’

Excerpts from;

Crisis: One Central Bank Governor and the Global Financial Collapse
Contributors: Alan Bollard (author Governor Reserve Bank Of New Zealand ), Sarah Gaitanos (with) Format: Paperback, 210 x 138mm 176 pp Publication date: 01 Sep 2010 Publisher: Auckland University Press ISBN-10: 1869404696 EAN: 9781869404697
Pg 122
(he said this of year 2009); “To make matters harder we were now about to introduce our new forecasting model, called KITT( Kiwi inflationary targeting technology). This new model would give us a better way of simulating households, firm and bank behaviours, including housing market developments, but first we needed to understand how to use it, how to calibrate it, where its strenght and weaknesses lay. It was a terrible time to iron out the kinks of a new system.”
Pg 183 Allan Bollard wrote;
In self-interest, banks may encourage New Zealanders to take on more debt than is good for them individually or deliver more external liability than is good for the country.”

A speech by Governor Reserve Bank Of New Zealand Dr Alan Bollard and Enzo Cassino, delivered by Dr John McDermott to the Sim Kee Boon Institute Conference on Financial Economics Singapore, 5 May 2011
John McDermott admitted that the central bankers had lost the plot on the quantity of money supply side;
“Identifying bubbles will require new empirical tools … but as with assessing disequilibrium in the goods or labour markets, we will still probably need to rely on information from a wide range of qualitative and quantitative sources to help identify the presence of a bubble and understand the nature of it,” McDermott said.
“How successful we will be remains an open question,” he said.
“The crisis had also prompted a revival of interest by central banks in money and credit, whereas in previous decades central banks had paid less attention to monetary and credit aggregates” he said.
“Overall, there has also been a recognition that credit growth over the past decade was excessive and a potential risk to financial stability given the build-up in leverage and rising asset prices that accompanied it. We are continuing to build our understanding of money and credit at the RBNZ, and its inter-relationship with both sectoral financial decision making and potential risks for the banking sector.” he said.

Joseph Stiglitz, Ex Vice President of the World Bank and Noebel Price winner for economics wrote of the shortcomings of Interest Rate Inflation Tagetting in a 2008 article;

“The answer came in the form of “inflation targeting,” which says that whenever price growth exceeds a target level, interest rates should be raised. This crude recipe is based on little economic theory or empirical evidence; there is no reason to expect that regardless of the source of inflation , the best response is to increase interest rates. One hopes that most countries will have the good sense not to implement inflation targeting; my sympathies go to the unfortunate citizens of those that do. (Among the list of those who have officially adopted inflation targeting in one form or another are: Israel, the Czech Republic, Poland, Brazil, Chile, Colombia, South Africa, Thailand, Korea, Mexico, Hungary, Peru, the Philippines, Slovakia, Indonesia, Romania, New Zealand, Canada, the United Kingdom, Sweden, Australia, Iceland, and Norway.)”

Contrary to what Don Brash former New Zealand Reserve Bank Governor and Interest Rate Inflation Targeting poster boy says about no serious economist worth his salt questioning the concept the IMF held a conference 7-8 March 2011 that was almost in absolute consensus of its failure; 

No comments:

Post a Comment