Abstract
Selected Issues
Interaction Between Monetary Policy And Financial Stability In New Zealand1
A. Introduction
1. The interaction between monetary policy and financial stability policy is an ongoing area of research and policy debate. This paper reviews the literature on the subject, takes stock of evolving consensus in the debate, and it examines the implications for New Zealand. It focuses on the role and interaction between monetary policy and other policies affecting financial stability, in particular, macroprudential policy. Another focus is structural vulnerabilities in the housing sector, the origin of much of current financial stability concerns.
2. New Zealand’s monetary policy has the dual objectives of achieving price stability and supporting maximum sustainable employment. The government is currently reviewing the Reserve Bank of New Zealand Act 1989 (RBNZ Act) to ensure that the RBNZ’s responsibilities, governance arrangements and policy frameworks are up to date. Phase One of the review, which considered the monetary policy arrangement, was completed in April 2019. The RBNZ Act has been amended to (i) include a dual mandate, with an employment objective supporting maximum sustainable employment added to the price stability goal, and (ii) establish a committee structure for decision making, to enhance transparency in monetary policy decisions.
3. Under the current monetary policy framework, financial stability must be considered in pursuing the price stability and maximum sustainable employment objectives.2 Under the RBNZ Act (amended), a Remit issued by the Minister of Finance operationalizes the monetary policy objectives for the Monetary Policy Committee (MPC). In pursuing these objectives, the Remit requires the MPC to have regard for several secondary considerations, including “regard to the soundness and efficiency of the financial system”.3 Risks to financial stability in New Zealand include: high-level concentration of banks’ exposure to the household sector (58 percent of bank lending) and agricultural sector (14 percent of bank lending, of which two-thirds is to dairy producers); and banks’ exposure to foreign funding. High household debt and house price overvaluation also pose macrofinancial risks.
4. The current monetary policy framework in New Zealand appropriately focuses on price stability and employment objectives, but enhanced policy communication could reduce uncertainty. Monetary policy can have significant effects on financial stability through its impact on credit growth and asset prices. For instance, at the current juncture, an accommodative monetary policy stance to meet price stability and employment objectives could have negative impact on financial stability through higher house prices and increasing household debt that warrants maintaining a more restrictive macrofinancial policy. Therefore, in the context of the RBNZ’s transition to an MPC-based decision-making process and the reformulation of the MPC’s remit, this paper considers how to operationalize and set out the objectives for monetary policy with respect to financial stability. In particular, whether we should formulate monetary policy objectives with respect to financial stability. Further, the interaction between monetary policy and financial stability policy imply that it can be useful and necessary in some circumstances, to coordinate these two policy decisions. In this context, this paper discusses the importance of enhancing communication to improve coordination and outcome.
B. A Review of the Debate on Monetary Policy and Financial Stability
5. Much of the debate on the interaction between monetary policy and financial stability has focused on whether monetary policy should be “leaning against the wind.” Two schools have emerged in this debate (Box 1). The “separation” school argues that price stability should be the primary mandate of monetary policy. As such, policy should react to changes in asset prices and credit only to the extent they affect inflation and output. Given its broad impact, monetary policy also is not a well-targeted instrument to address risks to financial stability, which should therefore be addressed through other instruments, such as macroprudential measures. In contrast, the “leaning against the wind” school argues that monetary policy should play an active role in maintaining financial stability. The argument is based on the view that monetary policy is a main driver of financial cycles. In particular, loose monetary policy has contributed to financial crises. By setting policy rates to lean against asset prices or credit, they will not be at the level required to stabilize prices only (IMF (2015).
6. The typical trade-off of leaning against the wind involves short-term costs of lower output and medium-term benefits in the form of a lower probability of a financial crisis. As illustrated in Figure 1, there are no policy trade-offs in periods which financial risks increase with inflation pressures building in an economic expansion. In contrast, policy trade-offs arise when high financial risks appear to require a larger interest rate hike than necessary to achieve inflation objectives. In such a scenario, the traditional approach for monetary policy would justify a hike in interest rates only to meet price stability objectives. Macroprudential policies could address financial risks. In contrast, the leaning against the wind approach would involve raising interest rates, paying a short-term cost arising from higher unemployment or lower output from higher interest rate for a medium-term benefit of lower expected costs from a financial crisis.
Debate on the Role of Monetary Policy in Achieving Financial Stability
The ongoing debate among academics and policymakers can on the role of monetary policy and its interaction with financial stability policy can be grouped broadly in two schools of opposing views:
One school (“the separation school”) views that monetary policy should consider asset prices only to the extent that it contains information about likely economic developments and risks, in particular, the outlook for inflation and other objectives such as full employment. Financial stability concerns should be addressed through other instruments, such as macroprudential measures. This is in part under the Tinbergen instrument rule, for each and every policy target, there must be at least one policy tool.
In the early debate, Bernanke and Gertler (1999) viewed that “Inflation-targeting provides an effective, unified framework for achieving both general macroeconomic stability and financial stability. Given a strong commitment to stabilizing expected inflation, it is neither necessary nor desirable for monetary policy to respond to changes in asset prices, except to the extent that they help to forecast inflationary or deflationary pressures.”
Vickers (1999) viewed that “asset prices matter for monetary policy simply because they help inform judgments about inflation prospects.” However, “if asset prices were a substantial element of the targeted inflation measure, then policy would respond partly automatically to asset price inflation or deflation, but he doubted that assets prices should be a targeted measure of inflation.”
IMF (2015) concluded that “based on current knowledge, the case for leaning against the wind is limited, as in most circumstances costs outweigh benefits,” while at the same time acknowledging that in future research “more circumstances may be uncovered in which deviations from a traditional policy response are warranted.” These discussions focus on the need to know more on initial conditions such as when rate increase has smaller macroeconomic costs, and structural conditions when costs of financial crisis are high.
In a similar vein, Svensson (2018), while acknowledging that “conducting monetary policy and macroprudential policy separately has the considerable advantage that each policy, with its separate goals and instruments, becomes more distinct, more transparent, and easier to evaluate”, he noted that on rare occasions (the Swedish example) some explicit coordination of policies may be warranted when monetary policy might pose a threat to financial stability that cannot be contained by macroprudential policy.
The other school which advocates “leaning against the wind” views that monetary policy cannot completely neglect financial stability risks, given risks to the economy, and that it should lean against the wind in some cases. Studies by BIS often advocate a stronger role for monetary policy in maintaining financial stability. This means “leaning more deliberately against financial booms even if near-term inflation stays low and stable or may be below numerical objectives, and easing less aggressively and, above all, persistently during financial busts” such that “these adjustments should help reduce the risk of a persistent easing bias that can lead to a progressive loss of policy room for maneuver over time” (Borio, 2015). The BIS view sees that one main driver of financial cycle is loose monetary policy and the costs brought about by financial crises (e.g., GFC) are large and very persistent. As such, “leaning against the wind” is an optimal policy reflecting the trade-off between short-run macroeconomic costs and the longer-run benefits of stabilizing the financial cycle. In addition, they view that the uncertainty about the effectiveness of macroprudential tools has left open room for the policy rate and macroprudential tools to be used as complements in the pursuit of financial stability.
Bayoumi and others (2014) also questioned if there should be new objectives for monetary policy as the GFC showed that long-term price stability is not a sufficient condition for macro stability. They noted that “additional intermediate objectives (such as financial and external stability) may play a greater role than in the past and these should be targeted with new or rethought instruments (macroprudential tools, capital flow management, foreign exchange intervention)” whereas “interest-rate policy might have to play a role, should these prove insufficient”.
Monetary Policy and Financial Stability To Lean or Not to Lean and their Trade-offs
Citation: IMF Staff Country Reports 2019, 304; 10.5089/9781513514765.002.A003
Source: Adapted from IMF(2015).Monetary Policy and Financial Stability To Lean or Not to Lean and their Trade-offs
Citation: IMF Staff Country Reports 2019, 304; 10.5089/9781513514765.002.A003
Source: Adapted from IMF(2015).Monetary Policy and Financial Stability To Lean or Not to Lean and their Trade-offs
Citation: IMF Staff Country Reports 2019, 304; 10.5089/9781513514765.002.A003
Source: Adapted from IMF(2015).7. On balance, recent empirical studies recommend against a leaning against the wind policy strategy. For example, Svensson (2016) argued against the strategy, based on the insight that with less effective macroprudential policy in the context of a credit boom, the cost of leaning against the wind would be higher. Instead, the optimal policy would be to lower the policy rate and reduce the probability of a crisis. Moreover, deviations from a traditional policy response might also undermine the credibility of the central bank and the effectiveness of monetary policy.
C. Macroprudential Policy, Financial Stability, and Monetary Policy
8. Macroprudential and other policies also influence financial stability. It is now well established that macroprudential policy is the primary policy tool for managing financial risks, but financial stability is also affected by other policies, both ex ante and ex post (Figure 2). There are complementarities and interactions between monetary policy and macroprudential measures, as discussed in the previous section. Macroprudential and microprudential policies are often complementary, but there can be tensions. The latter may arise in bad times, as macroprudential perspective may call for a relaxation of regulatory requirements while the microprudential perspective may require tightening of these requirements to protect banks’ balance sheet. Taxes can affect asset prices, and tax policies can create biases that contribute to systemic risk. Similarly, competition in the financial sector may create incentives for excessive risk-taking. Finally, effective and credible resolution regimes can reduce incentives to take excessive risks, thereby reducing the need for macroprudential intervention (IMF, 2013).
Achieving Financial Stability: Relationship between Macroprudential and Other Policies
Citation: IMF Staff Country Reports 2019, 304; 10.5089/9781513514765.002.A003
Source: Adapted from IMF (2013).Achieving Financial Stability: Relationship between Macroprudential and Other Policies
Citation: IMF Staff Country Reports 2019, 304; 10.5089/9781513514765.002.A003
Source: Adapted from IMF (2013).Achieving Financial Stability: Relationship between Macroprudential and Other Policies
Citation: IMF Staff Country Reports 2019, 304; 10.5089/9781513514765.002.A003
Source: Adapted from IMF (2013).9. There can be some role for monetary policy in achieving financial stability objectives even if macroprudential policy is the primary instrument. International experience has shown that a strong macroprudential framework, with a broad range of tools, can help to reduce the need for monetary policy to lean against adverse financial developments. The larger the reduction of financial vulnerabilities by macroprudential policy, the smaller the need for monetary policy to lean against emerging imbalances. Similarly, macroprudential policy may play an important role in reducing the likelihood of a severe economic stress resulting from financial instability, thereby, in turn, limiting the likelihood of monetary policy getting stuck at the zero-lower bound for interest rates. Nonetheless, since macroprudential policy may not be fully effective, there are times when monetary policy should take account of financial stability considerations, as long as in doing so it does not compromise the price stability objectives (see IMF, 2011 and RBNZ, 2019).4
D. Monetary Policy and Financial Stability in New Zealand
10. New Zealand has faced tensions between macroeconomic stabilization and financial stability objectives in the current economic expansion. While inflation has remained subdued and has been below the mid-point of the RBNZ’s target range for most of the period since 2011, house prices have risen sharply in real terms over the past 8 years or so (Figures 3, 4 and 5, Table 1). As in many advanced economies, these price increases were in part driven by persistently low inflation and very low interest rates, even though fundamental supply-demand imbalances have also contributed, particularly in Auckland where housing demand growth from population growth is the strongest (Wong, 2018). The rise in house prices has occurred on the back of a trend increase in real house prices since the 1970s, a concentrated exposure of the banking system to residential mortgages, and high, housing-related household debt (Figure 6). Much of the housing-related macro-financial vulnerabilities were built up before the current economic expansion, but they were not unwound during the global financial crisis and have increased further in recent years, albeit at a slower pace.
House Prices
(Annual percent change; Index: 2010–100)
Citation: IMF Staff Country Reports 2019, 304; 10.5089/9781513514765.002.A003
Sources: BIS; and IMF staff calculationsHouse Prices
(Annual percent change; Index: 2010–100)
Citation: IMF Staff Country Reports 2019, 304; 10.5089/9781513514765.002.A003
Sources: BIS; and IMF staff calculationsHouse Prices
(Annual percent change; Index: 2010–100)
Citation: IMF Staff Country Reports 2019, 304; 10.5089/9781513514765.002.A003
Sources: BIS; and IMF staff calculations
Financial, Housing and Business Cycles
(In percent, y/y change)
Citation: IMF Staff Country Reports 2019, 304; 10.5089/9781513514765.002.A003
Sources; BIS; RBNZ; and IMF staff calculations.Financial, Housing and Business Cycles
(In percent, y/y change)
Citation: IMF Staff Country Reports 2019, 304; 10.5089/9781513514765.002.A003
Sources; BIS; RBNZ; and IMF staff calculations.Financial, Housing and Business Cycles
(In percent, y/y change)
Citation: IMF Staff Country Reports 2019, 304; 10.5089/9781513514765.002.A003
Sources; BIS; RBNZ; and IMF staff calculations.
Policy Rates, Inflation Gap, and Output Gap
(In percent)
Citation: IMF Staff Country Reports 2019, 304; 10.5089/9781513514765.002.A003
Sources: RBNZ; and IMF staff calculationsPolicy Rates, Inflation Gap, and Output Gap
(In percent)
Citation: IMF Staff Country Reports 2019, 304; 10.5089/9781513514765.002.A003
Sources: RBNZ; and IMF staff calculationsPolicy Rates, Inflation Gap, and Output Gap
(In percent)
Citation: IMF Staff Country Reports 2019, 304; 10.5089/9781513514765.002.A003
Sources: RBNZ; and IMF staff calculationsNew Zealand: Housing Price Cycles, 2000–2018
Percent change from trough to peak.
Number of quarters of rising natioanl house prices .
Change in percent points compared to 4 quarters ago.
Annual growth in real housing credit compared to annual growth one year ago.
Peak shows quarter of latest data.
New Zealand: Housing Price Cycles, 2000–2018
| Real House Prices | Real Cash Rate | Real | Household Debt to Income | |||||
|---|---|---|---|---|---|---|---|---|
| National | Housing Credit | |||||||
| Trough | Peak | % Change 1/ | Duration 2/ | Trough 3/ | Peak 3/ | Peak 4/ | % | % ppt Change 1/ |
| 2000Q4 | 2007Q2 | 90.7 | 26 | -2.0 | 2.6 | 2.0 | 158 | 50 |
| 2011Q2 | 2018Q4 5/ | 60.4 | 30 | -3.8 | -0.3 | 0.1 | 164 | 14 |
Percent change from trough to peak.
Number of quarters of rising natioanl house prices .
Change in percent points compared to 4 quarters ago.
Annual growth in real housing credit compared to annual growth one year ago.
Peak shows quarter of latest data.
New Zealand: Housing Price Cycles, 2000–2018
| Real House Prices | Real Cash Rate | Real | Household Debt to Income | |||||
|---|---|---|---|---|---|---|---|---|
| National | Housing Credit | |||||||
| Trough | Peak | % Change 1/ | Duration 2/ | Trough 3/ | Peak 3/ | Peak 4/ | % | % ppt Change 1/ |
| 2000Q4 | 2007Q2 | 90.7 | 26 | -2.0 | 2.6 | 2.0 | 158 | 50 |
| 2011Q2 | 2018Q4 5/ | 60.4 | 30 | -3.8 | -0.3 | 0.1 | 164 | 14 |
Percent change from trough to peak.
Number of quarters of rising natioanl house prices .
Change in percent points compared to 4 quarters ago.
Annual growth in real housing credit compared to annual growth one year ago.
Peak shows quarter of latest data.
Policy Rates, House Prices, and Household Debt
(In percent, change y/y)
Citation: IMF Staff Country Reports 2019, 304; 10.5089/9781513514765.002.A003
Sources: BIS; and IMF staff calculations.Policy Rates, House Prices, and Household Debt
(In percent, change y/y)
Citation: IMF Staff Country Reports 2019, 304; 10.5089/9781513514765.002.A003
Sources: BIS; and IMF staff calculations.Policy Rates, House Prices, and Household Debt
(In percent, change y/y)
Citation: IMF Staff Country Reports 2019, 304; 10.5089/9781513514765.002.A003
Sources: BIS; and IMF staff calculations.11. New Zealand’s monetary policy framework has largely followed the separation school, although financial stability was introduced as a secondary consideration in 2012. The RBNZ’s policy objectives are to maintain a stable general level of prices and, since 2018, maximum sustainable employment. Nevertheless, in the 2012 Policy Targets Agreement, financial stability (“efficiency and soundness of the financial system”) was introduced as a secondary consideration for the RBNZ to consider when pursuing the policy targets, a consideration that has been maintained in subsequent Agreements and the Remit for the MPC.5 Shortly after this secondary consideration was established, the RBNZ also introduced a macroprudential policy toolkit in 2013 (Box 2). Thereafter, Spencer (2014) termed New Zealand’s framework as a “conditional coordination approach,” in which the monetary policy targets agreement has financial stability as a secondary objective and macroprudential policy is required to have regards to its impact on monetary policy. More recently, Bascand (2019a, 2019b) illustrated that in the context of New Zealand, macroprudential policy (e.g., loan-to-value ratios, LVRs, and countercyclical capital buffer, CCyB), prudential policy (e.g., capital buffers, liquidity policy), and crisis management measures (e.g., collateral standards, open bank resolution, minimum capital) could contribute to financial stability by addressing different risks.6
12. LVR restrictions on residential mortgage lending have lowered the risks from high housing price inflation and high growth in household debt. Macroprudential tools are designed to enhance financial system resilience. The implementation of the LVR restrictions on residential mortgage lending to owner occupiers and investors since 2013 has largely eased the buildup of riskier loans with high LVRs, thereby mitigating potential stress on banks’ balance sheets from negative equity if house prices were to fall and moderating the accumulation of household debt with rising house prices.7 Notably, the share of mortgages outstanding with LVR of above 80 percent has declined to 7 percent in end-2018 from about 20 percent in 2013 (RBNZ, 2019). The share of new mortgage lending to investors has also reduced to 18 percent in end-2018 from the peak of 35 percent in mid-2016 (see also Figures 7 and 8). Overall, this easing in the build-up of household vulnerabilities has allowed the RBNZ to gradually ease restrictions on high LVR lending effective January 2018 and January 2019. Nonetheless, structural vulnerabilities remained as households are still vulnerable to adverse shocks given high household debt and high house prices. More active use of macroprudential policy should be considered.
New Residential Mortgage by Borrower Type and LVR
(Percent of new mortgage lending)
Citation: IMF Staff Country Reports 2019, 304; 10.5089/9781513514765.002.A003
Sources: RBIMZ; and IMF staff calcutionsNew Residential Mortgage by Borrower Type and LVR
(Percent of new mortgage lending)
Citation: IMF Staff Country Reports 2019, 304; 10.5089/9781513514765.002.A003
Sources: RBIMZ; and IMF staff calcutionsNew Residential Mortgage by Borrower Type and LVR
(Percent of new mortgage lending)
Citation: IMF Staff Country Reports 2019, 304; 10.5089/9781513514765.002.A003
Sources: RBIMZ; and IMF staff calcutions
Existing Residential Mortgage Lending
(Percent share of total)
Citation: IMF Staff Country Reports 2019, 304; 10.5089/9781513514765.002.A003
Sources: RBNZ; and IMF staff cakutions.Existing Residential Mortgage Lending
(Percent share of total)
Citation: IMF Staff Country Reports 2019, 304; 10.5089/9781513514765.002.A003
Sources: RBNZ; and IMF staff cakutions.Existing Residential Mortgage Lending
(Percent share of total)
Citation: IMF Staff Country Reports 2019, 304; 10.5089/9781513514765.002.A003
Sources: RBNZ; and IMF staff cakutions.Macroprudential Policy Framework
The RBNZ’s mandate for macroprudential policy stems from its legislative purpose of “promoting the maintenance of a sound and efficient financial system” (Reserve Bank of New Zealand Act 1989). Macroprudential policy framework in New Zealand is based on a clear mandate for financial stability, operationally clarified by objectives set out in a memorandum of understanding (MoU) between the RBNZ and the Minister of Finance. The MoU, signed in May 2013, establishes that the RBNZ initiates any macroprudential policy action, after consultation with the Treasury and Minister (even though the RBNZ has the existing legal powers to use prudential tools in a cyclical fashion). The use of macroprudential policy is currently one of the topics under the phase two Review of the RBNZ Act.
RBNZ is the single prudential regulator with responsibilities and powers for the supervision of financial institutions and macroprudential policies. Under a full integration model, given RBNZ’s role in central bank’s functions as in monetary policy, payment systems, and as lender of last resort, it has expertise in the analysis of systemic risk that help inform macroprudential policies.
The MOU sets out four macroprudential tools: the countercyclical capital buffer (CCyB), adjustments to the minimum core funding ratio (CFR), sectoral capital requirements (SCR) and temporary restrictions on high loan-to-value ratio (LVR) residential mortgage lending. LVR restrictions is the only instrument that is currently turned on.
In the implementation of macroprudential policy, the RBNZ has explicitly acknowledged the efficiency costs of macroprudential or prudential instruments such as LVR or debt-to-income (DTI) restrictions and the possibly unintended distributional consequences since they may restrict home purchases by owner-occupiers, including first home buyers.
13. Financial stability as a secondary consideration of monetary policy has however introduced new policy communication challenges. Since its introduction, the role of financial stability considerations in monetary policy decisions has appeared unclear, as much of the communication focused on traditional considerations. For example, when the RBNZ raised the policy rate in March 2014 for the first time since March 2011, the Monetary Policy Statement (MPS) referred to “inflationary pressures [that] are increasing and are expected to continue doing so over the next two years” and the importance of “inflation expectations [to] remain contained.” It also noted that “the speed and extent to which the official cash rate (OCR) will be raised will depend on economic data and our continuing assessment of emerging inflationary pressures.” Similarly, after the RBNZ started lowering rates in 2015, the June 2015 MPS explained that “a reduction in the OCR [was] appropriate given low inflationary pressures and the expected weakening in demand, and to ensure that medium term inflation converges towards the middle of the target range.” That said, in the same statement, the RBNZ noted that “proposed LVR measures and the Government’s tax initiatives planned for 1 October 2015 should ease the impact of investor activity [on house prices].” While an RBNZ Bulletin article had noted that one way to address tension posed by weak inflation pressure and high house price inflation was to allow inflation to return to the target midpoint at a slower rate than in the absence of risks to financial stability (Dunstan, 2014), this consideration was not mentioned explicitly in MPS statements during which the policy rate was kept constant in 2017 and 2018.
14. Looking forward, policy communication could focus more on implications of the interaction between monetary and macroprudential policies. In IMF staff’s view, New Zealand’s monetary policy framework appropriately follows the recommendations of the separation school and focuses on price stability and employment objectives. At the same time, as the coordination of objectives and implementation of monetary, macroprudential, and micro prudential policies all take place within the RBNZ, policy deliberations can, in principle, internalize any potential trade-offs (Nier and others, 2011). Against this backdrop, better communication on how the interaction of monetary policy and macroprudential policy has affected monetary policy decisions because of the secondary consideration for financial stability under the remit for the MPC, could enhance transparency and policy effectiveness. The Monetary Policy Statements and the Financial Stability Reviews could be used as vehicles for such communication. On a broader perspective, there could be potentially a role for the joint committee of the Council of Financial Regulators (CoFR)— comprising members from RBNZ, the Financial Market Authority, the Ministry of Business, Innovation and Employment (MBIE), and Treasury—or a separate committee to enhance the coordination of monetary, macroprudential and fiscal policies.8
15. A strengthening of the macroprudential framework would support the monetary policy focus on price stability and supporting maximum sustainable employment. The IMF’s 2017 Financial Sector Assessment Program recommended that the macroprudential framework could be adjusted along the transparency and governance dimensions, and the macroprudential toolkit could be broadened to include a debt-to-income (DTI) or a debt service-to-income (DSTI) instrument (IMF, 2017a). The LVR instrument has helped to slow house price growth and reduce the share of risky high LVR mortgages in bank’s balance sheets. As such, the banks’ recovery value in the event of a mortgage default should be higher. But LVRs are likely to be less effective in other dimensions, including for example, in limiting high household debt exposure or ensuring debt service capacity, dimensions relevant for the probability of default. A broader macroprudential toolkit (e.g., including DTI and DSTI thresholds) would allow for more targeted interventions. These enhancements would strengthen the effectiveness of the macroprudential policy, thereby reducing the possible burden on monetary policy from financial stability considerations.
E. Conclusions
16. Price stability and supporting maximum sustainable employment should remain the primary monetary policy objectives for the RBNZ. Recent studies have broadly established that monetary policy generally is not an effective instrument for maintaining financial stability, given its frameworks and instruments. Seeking to achieve other objectives, such as financial stability objectives, even if only in the form of leaning against asset or credit booms, typically involves costly trade-offs with regards to primary monetary policy objectives. Against this backdrop, the monetary policy objectives set in Phase One of the RBNZ Act meet the recommendations of the separation school.
17. The interaction of monetary policy and financial stability, and the role of the latter as a secondary consideration for monetary policy suggest the need for enhanced policy communication. Much of RBNZ’s current monetary policy communication is presented along standard inflation, output, and employment dimensions. This communication focus is appropriate, given the primary monetary policy objectives. Nevertheless, it also creates some uncertainty about the weight given to financial stability considerations in monetary policy decisions, notably in the context of housing market imbalances and house price inflation, and related macro-financial vulnerabilities. A more explicit discussion of financial stability considerations, in Monetary Policy Statements or the Financial Stability Review, could reduce uncertainty, and improve the understanding of the monetary policy strategy and its outcome.
18. A strong micro-prudential framework and macroprudential tools should continue to be the primary means to address systemic financial risks, and a stronger framework would support the updated monetary policy regime. Limits on DTI and DSTI could usefully be included in the toolkit to complement the LVR restrictions and more directly reduce households’ exposure to high debt.
References
Bascand, G., 2019a, “Reviewing the RBNZ’s Approach to Financial Stability,” speech delivered to 15th Financial Markets Law Conference in Auckland, June 26, 2019.
Bascand, G., 2019b, “Macroprudential Policy: Past, Present and Future,” speech delivered to 54th University of Otago Foreign Policy School in Dunedin, June 30, 2019.
Bayoumi, T., G. Dell’Ariccia, K. Habermeier, T. Mancini Griffoli, and F. Valencia, 2014, “Monetary Policy in the New Normal,” IMF Staff Discussion Notes, 4(3).
Bernanke, B. and M. Gertler, 1999, ‘Monetary Policy and Asset Price Volatility,’ Federal Reserve Bank of Kansas City, Economic Review, Fourth Quarter, 17–51.
Borio, C, 2014, “Monetary policy and financial stability: what role in prevention and recovery?”, BIS Working Papers, No. 440, January 2014.
Borio, C, 2015, “Revisiting Three Intellectual Pillars of Monetary Policy Received Wisdom,” speech, November 2015.
Dunstan, A., 2014, “The Interaction between Monetary and Macro-prudential Policy,” Reserve Bank of New Zealand Bulletin 77(2), June 2014.
Hunter, L., 2008, “The Relationship between Monetary and Financial Stability,” Reserve Bank of New Zealand Bulletin 71(2), June 2008
IMF, 2013, “Key Aspects of Macroprudential Policy,” IMF Policy Paper.
IMF, 2015, “Monetary Policy and Financial Stability,” IMF Policy Paper.
IMF, 2017a, “New Zealand: Financial Sector Assessment Program: Financial System Stability Assessment,” May 8, 2017.
IMF, 2017b, “New Zealand: Financial Sector Assessment Program: Technical Note-Macroprudential Institutional Framework and Policies,” May 10, 2017.
Jeanneau, S., 2014, “Financial Stability Objectives and Arrangements-What’s New?” BIS Papers No. 76
Lu, B., 2019, “Review of the Reserve Bank’s Loan-to-Value Ratio Policy,” Reserve Bank of New Zealand Bulletin, 82(6), May 2019.
Nier, E., L. Ignacio Jácome, J. Osinski, and P. Madrid, 2011, “Institutional Model for Macroprudential Policy,” IMF Staff Discussion Note SDN/11/18.
Ovenden, P., 2019, “Macroprudential Policy Framework: Mitigating the Likelihood and Severity of Boom-Bust Cycles,” Reserve Bank of New Zealand.
Reserve Bank of New Zealand (RBNZ), 2019, Monetary Policy Handbook, Version 1, April 1, 2019.
Spencer, G, 2014, ‘Coordination of Monetary Policy and Macro-prudential Policy’, speech delivered to Credit Suisse Asian Investment Conference in Hong Kong SAR.
Svensson, L., 2016, “Cost-Benefit Analysis of Leaning Against the Wind: Are Costs Larger Also with Less Effective Macroprudential Policy,” IMF Working Paper, WP/16/3.
Svensson, L., 2018, “Monetary Policy and Macroprudential Policy: Different and Separate?” Canadian Journal of Economics 51(3).
Vickers, J., 1999, ‘Monetary Policy and Asset Prices,’ speech given at the Money, Macro and Finance Group 31st Annual Conference, Oxford University, September 22, 1999, printed in Bank of England Quarterly Bulletin, 39(4): 428–435, November 1999.
Williams, R. 2017, “Characterizing the current economic expansion: 2009 to present day,” Reserve Bank of New Zealand Bulletin 80(3), June 2017.
Wong, Y. C., 2018, “Housing Affordability in New Zealand and Policy Response,” New Zealand: 2018 Article IV Consultation—Selected Issues, International Monetary Fund, IMF Country Report No. 18/203
Prepared by Yu Ching Wong (APD). The chapter benefited from valuable comments by the Treasury of New Zealand and participants at a joint Treasury and Reserve Bank of New Zealand seminar.
Under the ongoing Phase Two Review of the RBNZ Act, the Minister of Finance has made an in-principle decision to replace the RBNZ’s existing ‘soundness and ‘efficiency’ objective that applies in relation to its prudential functions with an objective to “protect and enhance the stability of New Zealand’s financial system.” This objective is subject to public consultation and may subsequently change.
New Zealand’s monetary policy framework is set out in the RBNZ Act and includes three secondary instruments, the Remit, Charter, and Code of Conduct, that are established with the Act. Two other secondary considerations (set through the Remit) are to avoid unnecessary instability in output, interest rates, and the exchange rate; and to discount events that have only transitory effects on inflation, thereby setting policy with a medium-term orientation (RBNZ, 2019).
Similarly, the desirability for coordination also exist between monetary policy and fiscal policy. For example, if low interest rates are undesirable, expansionary fiscal policy could enable higher interest rates while also allowing monetary policy to be consistent with its price stability and employment mandate.
Other secondary considerations are to (i) seek to avoid unnecessary instability in output, interest rates, and the exchange rate; and (ii) discount events that have only temporary effects on inflation, setting policy with a medium-term orientation.
Bascand (2019b), Table 1 outlined how prudential banking tools in New Zealand work together to delivery financial stability.
See assessments of LVRs by IMF (2017a, 2017b) and by RBNZ in Lu (2019) and Ovenden (2019).
CoFR only considers financial regulation. For it to consider monetary, financial and fiscal policy, its remit and membership would need to change.
