Statement by Gregory Taylor, Executive Director and Ian Woolford, Advisor for New Zealand

The resilience displayed by the New Zealand economy throughout the turbulence is a clear testimony of the benefits of the economic reforms. Executive Directors appreciated these developments, and cautioned against reforms that could reduce labor and product market flexibility, and suggested that the authorities should be flexible and pragmatic in their implementation. They commended the authorities for the high quality of economic and financial statistics, and agreed that the country is well placed to absorb shocks without undue economic or financial distress.

Abstract

The resilience displayed by the New Zealand economy throughout the turbulence is a clear testimony of the benefits of the economic reforms. Executive Directors appreciated these developments, and cautioned against reforms that could reduce labor and product market flexibility, and suggested that the authorities should be flexible and pragmatic in their implementation. They commended the authorities for the high quality of economic and financial statistics, and agreed that the country is well placed to absorb shocks without undue economic or financial distress.

Overall Assessment

The New Zealand authorities appreciate the balanced assessment in the Staff report. They are pleased that their position has, in the main, been clearly and accurately portrayed (although there are some points of clarification that we draw to the Directors’ and Staff s attention).

My authorities endorse the Staffs views on the:

  • importance of maintaining international investor confidence in light of New Zealand’s large current account deficit and relatively high level of external debt;

  • resilience of the economy in response to a difficult set of challenges over the past 2-3 years - this resilience being an important benefit of the economic reforms undertaken over the last 15 years;

  • appropriateness of the recent conduct of monetary policy and the challenges that lie ahead;

  • need to maintain confidence in the Government’s fiscal strategy to support domestic confidence and the confidence of overseas investors;

  • need to be pragmatic in the implementation of policy; and

  • the desirability of removing private disincentives to save and encourage more productive investment.

Similarly, the short and medium-term macroeconomic outlook presented by the Staff is broadly consistent with the authorities’ own assessment. Like staff, they see the key near-term macroeconomic policy challenge as being to successfully manage through the difficulties posed by a weak currency, rising oil prices and low domestic confidence to what are still good prospects for sustained economic growth in 2001 and 2002.

I. MACROECONOMIC POLICIES

The authorities agree with the Staff’s assessment that the broad range of micro and macroeconomic reforms, including labour markets, product markets and financial and other capital markets, have increased the ability of the New Zealand economy to respond robustly to the wide-ranging nature of shocks over the past 2-3 years. Significant reforms have also occurred in tax and transfer policy over the last decade. Relative to other OECD countries, economic reform in New Zealand has been rapid and extensive. Reflecting this, the economy came through the Asian crisis, adverse climatic conditions through 1997 and 1998 and a major slide in the currency relatively unscathed, and the financial system remains in good health.

The authorities recognise the difficulties for economic management posed by shifts in international investor sentiment and exchange rate changes. This is something that New Zealand has in common with many other economies at present, particularly smaller open economies. However, we believe that the Government’s current macroeconomic strategy is appropriate. Monetary policy continues to be focused on maintaining price stability. Despite short-term volatility in the economy, the Government is maintaining a fiscal track that is consistent with surpluses over the course of the business cycle, falling official debt and a gradually reducing level of government spending as a proportion of GDP.

In addition, within this appropriate fiscal stance, the Government is investing additional resources in the development of both general education and advanced technical skills, promoting increased private sector research and development, and encouraging the development of more competitive export industries. Together, these policies will contribute to an improvement in New Zealand’s growth performance, in the medium term.

II. MONETARY POLICY

The Government and the Reserve Bank remain committed to the goal of maintaining price stability. The period ahead poses many challenges for monetary policy, but the authorities have confidence that the Reserve Bank’s operating framework and the Policy Targets Agreement (PTA)-the document that specifies the inflation target-have evolved in a way that will allow the Bank to work though these challenges to best effect.

The authorities would like to make it clear that there has been no change to the Act, nor to the PTA, that would have the effect of weakening the operational independence of the Reserve Bank or to change the price stability objective of monetary policy. And no changes are proposed to either of these core features of the New Zealand monetary policy framework.

We say this because, in paragraph 35 of the report, the Staff indicate that the “government has implemented a change in the Policy Targets Agreement...”. This wording may cause the reader to infer that the Government has unilaterally changed the PTA, which is not correct. Under the Act governing monetary policy, the Government has no power to unilaterally change the PTA (except where the formal over-ride is used to require the Reserve Bank to conduct monetary policy for a purpose other than price stability). Except where the formal override power is used, the PTA can only be modified by mutual agreement between the Government and the Reserve Bank. The present Government has made it very clear that it has absolutely no intention of using the over-ride facility of the Act - ie monetary policy will continue to be directed solely at price stability.

Moreover, in the Staff report, the changes to the PTA in December 1999, requiring the Bank to seek to avoid unnecessary instability in output, interest rates and the exchange rate, are characterised as being part of a move from a “relatively strict to a more flexible inflation targeting framework”. This is not the way that either the Government or the Bank sees it. The Reserve Bank has always been mindful of the potential for monetary policy to influence variability in output, interest rates and the exchange rate. Subject to conducting monetary policy in a manner consistent with achieving and maintaining price stability, the Bank has always sought to minimize the potential for monetary policy to contribute to instability in these areas. The introduction of the requirement to seek to avoid unnecessary instability in output, interest rates and the exchange rate therefore largely formalises what is already the Reserve Bank’s practice and implicit in the monetary policy framework.

The staff report also seems to suggest that the new PTA might be seen as a weakening of the Reserve Bank’s operational independence. In fact, in the view of the Bank, the new PTA does not affect the Bank’s “instrument independence”. Under the new PTA, the Reserve Bank continues to have full autonomy in the formulation and implementation of monetary policy.

III. REVIEW OF MONETARY POLICY OPERATIONS

Ten years have passed since the Reserve Bank of New Zealand Act 1989 (“the Act”) came into force on 1 February 1990. Having come through a period of transition to sustained price stability, the Government believes that it is now appropriate to review the way in which New Zealand’s monetary policy is conducted and to assess its effectiveness in contributing to broader social and economic objectives. As noted by Staff, the goal of the review is to ensure that the monetary policy framework and the Reserve Bank’s operations within that framework are appropriate to the characteristics of the New Zealand economy and best international practice. The fundamental principles underpinning the operation of monetary policy -- the sole objective of price stability and the operational independence of the Bank -- are not under review and will be preserved. The review is scheduled for completion at the end of February 2001. The review is being conducted by Professor Lars Svennson of Stockholm University.

IV. STRUCTURAL POLICIES

The Government has listened to market concerns about its policies and has made considerable effort to explain the Government’s economic and social strategy. The authorities have been taking steps to reassure markets on the direction and substance of their policies, and recently have stepped up efforts in this area (with business and Government forums). The key objectives of the strategy, as set out in the March Budget Policy Statement, emphasize the importance of innovative business, effective government and strong communities together contributing to the well-being of New Zealanders. These objectives highlight the Government’s focus on improving skills, enhancing the environment, strengthening national identity, and closing social and economic gaps between different sectors of the community.

The Government believes that some of the strengths of the reforms since the mid 1980s facilitated a vast improvement in the efficient allocation of resources, and an increase in transparency and accountability. They feel the economic direction they are now embarking on builds on the former reforms, by addressing some of the structural issues. However, they encourage staff to continue with their efforts to understand the role the reform process played in New Zealand’s past and prospective growth performance.

It is important to note that from the economic viewpoint the Government’s policies amount to no more than a modest rebalancing of policy. A number of measures are included -changes to the Commerce Act; reviews of whether competition in electricity and telecommunication markets can be enhanced; and the conclusion of a free trade agreement with Singapore - which the Government believes will strengthen competition and promote trade. The Government has also developed a program to lift performance in skills development and encourage the creation of an environment more sympathetic to the uptake of new technology.

Consistent with the Government’s announced intentions to build a more participative and inclusive society, changes in employment law have been implemented. In this regard, it is important to be clear that the intention of the Employment Relations Act (which came into force on 1 October this year) is to restore fairness to the bargaining process rather than to increase union power per se. The government believes the new approach provides additional scope for improving productivity by promoting more cooperative solutions to employment issues and improved workforce morale.

While there is some scope for further innovation in the New Zealand dairy industry-primarily in the marketing of technology and development of higher value added products-the industry is already productive. While the staff focus on the need for the Government to exercise leadership, the New Zealand authorities would suggest that increasing leadership from trading partners in reducing protectionism would potentially have a greater impact on this sector’s performance. More generally, we are disappointed that the appraisal has not pointed up more clearly to the deleterious effects on New Zealand’s growth prospects from trade protectionism.

External Vulnerability

The authorities support the Staff’s balanced and reasonable assessment of New Zealand’s external vulnerability. As already noted, New Zealand has come through various economic shocks (including a substantial fall in the exchange rate, adverse climatic conditions and the Asian crisis) relatively smoothly. This reflects a number of factors, including the advantages associated with a floating exchange rate, sound and credible macroeconomic policy, high quality transparency arrangements, relatively flexible factor and product markets, relatively few distortions to relative prices and a robust financial sector.

In particular, the authorities note that the New Zealand financial system is almost fully hedged against currency risk, is strongly capitalized, has a very low level of non-performing loans, has relatively conservative exposure concentration and high quality and diversified overseas bank parentage. Similarly, the corporate sector in New Zealand is well hedged against currency risk and has been operating on relatively conservative leverage. These factors significantly reduce New Zealand’s vulnerability to shifts in investor sentiment and other economic shocks.

V. FSAP

The proposal for an FSAP is under consideration by the authorities.