Tuesday, 21 July 2015

Monetary policy has turned neutral

Just a quick update on where overall monetary conditions have got to - if you haven't come across the Monetary Conditions Index before, this or this will see you right -  given that the Kiwi dollar has plunged and interest rates have moved lower.

The graph is the historical record based on monthly data from the Reserve Bank: the star shows where we are today (based on 90 day bank bills at 3.07% and the TWI at 70.4).

In sum,we've already arrived at a 'neutral' setting for overall monetary policy. That's reasonable, given some slowdown in the economy and inflation still lying below the RBNZ's target range. We'll know on Thursday whether the RBNZ will fire the next 0.25% gun and take us towards the 'easy' end of policy, and then there'll be a pause till September 10.

It's just as well there's a pause for thought: I'm not sure - at least not yet - that there's a compelling case for a whole clatter of further rate cuts. Yes, the dairy price has plunged, and yes the latest ANZ and NZIER surveys were weakish, but on the other hand the latest BusinessNZ/BNZ PMIs for manufacturing and services were both solid. A time out is just the ticket: to see what the net trend really is, and to give some further time to try and get the Bank's head around the reasons for our unusually low rate of non-tradables inflation,


  1. Michael Reddell21 July 2015 at 20:04

    That conclusion - that monetary conditions are neutral - does seem to rest on an implicit assumption that the neutral interest rate hasn't changed over the historical period. That seems unlikely (given the long-term trend decline in short and long term, nominal and real, interest rates.

    Of course, you could counter that the neutral TWI may have risen.

  2. Thanks for the comment Mike. It's a fair point, though how you'd get a better estimate of where the neutral MCI might be (if it's changed over time) isn't clear to me! Esp, as you note, since you'd be trying to tie down the interest rate/TWI combo and not just the interest rate leg. If there'd been a series of episodes where inflation was stably at the mid-point of the target range, maybe you could use the MCIs in those periods as a better fix. But I'm not sure the data has enough of them. Or if you had a decent structural model you might be able to reverse engineer a neutral MCI. But structural models aren't 'in' these days, more's the pity

  3. Thanks for that Donal, provides a good perspective of the 'automatic stabilisers' the govt. now refers to (when the MCI was higher they were indicators of success...)

    Am I right that in a brief mad period in the 90s the RBNZ actually set an MCI target?

    1. You're completely right, it was the way things were done in Brash's day. Can't remember exactly when it got ditched, but if you fossick on the RBNZ website you can probably find out. I'm apparently in a minority, but it seemed to me to be an entirely logical approach

  4. Michael Reddell24 July 2015 at 20:32

    In fairness to Don, and the rest of us, the MCI as an operational target lasted for only around 18 months. And even then the target level was reviewed and reset (not enough for the shocks of the time) every 3 months. Here is the link to the history

  5. Thanks for that Mike - took me back! I'd forgotten that the MCI regime was only there for a short period: in my own mind I'd also misremembered it as happening earlier in the decade. I still have some sympathy with the logic that led to the MCI, though as the paper points out volatility in the $ will translate (for an MCI with tight bands) into undesirable volatility in interest rates, so I understand why it got junked