Monday, 9 January 2017

A cork in choppy seas

Every now and then I like to resurrect the Monetary Conditions Index (MCI), which was an attempt to combine both interest rates (the 90 day bank bill yield) and the exchange rate (as measured by the TWI) into a summary measure of the overall tightness of looseness of monetary conditions. It's not perfect - you could argue for including more measures or other measures (such as longer term interest rates) and for building the index differently - but it's better than a simple focus on interest rates alone.

Here's what it looked like at the end of 2016.

Yes, the Reserve Bank has set short-term interest rates on "very easy": the official cash rate (OCR), at 1.75%, is some 2.25% to 2.5% below the 4% or so that the RBNZ would regard as a neutral level. But overall monetary conditions aren't "very easy". The absolute level of the MCI doesn't translate in a straightforward way into "loose" or "tight", but given that it's currently well above its long-term average, you probably wouldn't be too wrong if you said overall monetary conditions were somewhere on the tighter side of neutral.

Focusing on the MCI is a good reminder that our overall monetary conditions are only partially under our own control: we're a small open economy in a world where the big guys' interest rate and currency policies are the ones that matter.. The RBNZ can set the OCR, but it doesn't have a lot of say about longer term interest rates (where our bond yields are set to a substantial degree by overseas yields plus a credit premium), and still less over the TWI, which is the resultant of a myriad of global variables.

Last year, for example, the NZ$ dropped a little against the yen (which strangely had become the 'safe haven du jour'), but rose a bit against the A$ (we offered higher yields and a faster growth rate), rose rather more against the euro (where the ECB is still in full negative interest rate / quantitative easing mode) and soared against the post-Brexit pound. Our ability to steer the TWI to where we'd prefer it is close to half of five-eighths of the proverbial.

It's also a reminder, as a corollary, that achieving our targetted 2% inflation rate can't be wholly under our own control, either. That doesn't mean that we shouldn't hold our RBNZ Governors accountable for making the best decisions they can under the circumstances they inherit. But sometimes - and the last year or two is one of those sometimes - I suspect that, given the macroeconomic hand they've been dealt by the overseas croupiers, there may not be any realistic setting for domestic policy that will meet the target,

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