The Reserve Bank of New Zealand – Te Pūtea Matua makes decisions about official interest rates in a way that is robust in the face of uncertainty about the economy, Reserve Bank Assistant Governor Christian Hawkesby says in a speech published today*.
A least regrets approach to uncertainty:
Hawks, Doves and the White Heron (he Kōtuku)
The speech outlines the types of uncertainties faced by the Reserve Bank navigating money policy decisions and how the “least regrets” approach was applied in the past 18 months during COVID. The speech reflects on what the bank has learnt about the economy during COVID and how this influenced our recent decision at the August Monetary Policy Statement.
In his speech, Mr Hawkesby says followers of monetary policy often call central bankers ‘hawkish’ for signalling higher interest rates or ‘dovish’ for signalling lower interest rates. In Aotearoa New Zealand, our equivalent birds are the kahu (the harrier hawk) and the kererū (the wood pigeon).
“But when it comes to making monetary policy decisions under uncertainty, it may be that the kōtuku (white heron) provides a much more fitting metaphor,” Mr Hawkesby says.
A key feature of our least regrets approach is responding to the environment, risks and uncertainties – the starting point of the economy, the balance of risks, and the threats to achieving our key aims of low and stable inflation and maximum sustainable employment.
“It requires an approach that is adaptable, sometimes moving with caution in slow, small steps, and other times moving with confidence, quickly and in large steps to remain successful,” he says.
In Māori culture, there are two whakataukī (proverbs) involving the kōtuku that capture this trait of responding to the environment around you.
The saying “he kōtuku rerenga tahi” loosely translates to “a white heron’s flight is seen but once”. It expresses an idea that “once ready, open your wings and commit to flight”.
In the world of setting monetary policy, this proverb translates to those times when the outlook for the economy has been subject to large and uncertain changes, the risks are heavily skewed in one direction, and there is a material threat of not achieving your mandate. In that situation, the path of least regret is to move quickly and take large steps to provide more confidence that policy settings will be appropriate if the risks to the outlook eventuate. This approach is consistent with our actions through the early stages of COVID-19 in early 2020.
In contrast, the saying “tapuwae kōtuku” translates roughly to “considered steps”, as you assess the environment around you.
In the world of setting monetary policy, this translates to having confidence in the outlook for the economy, and inching in the right direction based on how the economy is likely to evolve. This is consistent with the observation that when there is a typical amount of uncertainty, and the risks are evenly balanced, then central banks globally tend to follow a smoothed path and keep their policy rate unchanged or move in 25 basis point increments.
In response to the lessons of the impact of COVID-19 on both the demand and supply side of the economy, the August Monetary Policy Statement noted that we had more confidence that employment was at its maximum sustainable level and that pressures on capacity would feed through into more persistent inflation pressures over the medium-term.
In August, the Committee agreed that their “least regrets policy stance is to further reduce the level of monetary stimulus so as to anchor inflation expectations and continue to contribute to maximum sustainable employment.”
With a better understanding of the starting point of the economy, more balanced risks to the outlook, and the threat of consumer price deflation having abated, this formulation of our least regrets signalled a return to being guided by our central projections and how these evolve with new information.
Finally, the Committee also noted that whether or not a monetary policy response would be required in response to future health related lockdowns would depend on whether there was a more enduring impact on inflation and employment. This will involve continuing to deepen our understanding of the persistent impacts on both demand and supply.
*NB: The speech was prepared for presentation at a conference which has been indefinitely postponed due to the current COVID outbreak. The text was finalised on 15 September.