RBNZ's McDermott talks about monetary policy decisions, but is quiet on current conditions; says RBNZ using committees more in OCR decisions; says regularly researching drivers of surprisingly low inflation

Dr John McDermott, Assistant Governor, RBNZ

By Bernard Hickey

Reserve Bank Assistant Governor John McDermott has given a speech on how the Reserve Bank makes its Official Cash Rate (OCR) decisions, but has steered clear of giving any guidance on the Reserve Bank’s next decision on August 11.

Since the last decision on June 9, further data has emerged showing house price inflation accelerating at the same time as the currency has risen much higher than the Reserve Bank’s forecasts, effectively pulling the Reserve Bank in two directions.

Some economists and market observers had hoped the Reserve Bank would give it some guidance in the speech, given the extent of the changes since June 9, when the Reserve Bank held the Official Cash Rate at 2.25% and signaled one more cut.

“I do not intend to send any particular messages about upcoming monetary policy announcements,” McDermott said in the first paragraph of the luncheon speech to the Manawatu Chamber of Commerce.

McDermott said the bank had strengthened the role of its committees in making monetary policy decisions since 2013 and now used a similar approach to that used by the Bank of Canada, whereby legislation mandated a single decision maker, but decisions were made within a committee framework.

“These changes mean the Bank now relies less on the single decision maker model,” he said.

A Governing Committee, which includes the Governor, Deputy Governors and Assistant Governore was formed and was responsible for reaching appropriate settings for monetary policy.

Although he noted the Governor retained statutory responsibility for policy decisions.

This committee was advised by a Monetary Policy Committee that included several senior staff, including the Governors, and two external advisors. They worked over a nine day period before decisions.

“In the first three days of this process, the Governing Committee has discussed with the staff and MPC: current economic and market developments; an initial set of economic projections; key risks and judgements that make up the projections; and a number of alternative scenarios and policy options,” McDermott said.

“This is supplemented by a range of additional information relevant to the policy outlook, including information on trends in household and business credit and unobservable variables like the output gap, inflation expectations and the neutral interest rate. Particular effort has been made over these three days to ensure a diverse range of views and opinions have been hear. The set of meetings conclude with a final set of conditional projections for the economy over the next 2-3 years and a conditional projection for the 90-day bank bill rate,” said.

The Governing Committee then met on day five to reach a monetary policy decision and finalised it on day eight, the day before the OCR announcement on a Thursday.

McDermott said the bank always made forecast errors, reflecting uncertainties in the current state of the economy and its outlook.

“For example, the vast majority of forecasters were unlikely to have been able to accurately predict the sharp decline in oil and export commodity prices that occurred over 2014 and 2015 – one factor that has led to current low inflation,” he said.

‘We were wrong, but less wrong than most’

He said the bank’s forecasts had been inaccurate since 2010 because CPI inflation had been weaker than forecast and the New Zealand dollar had been stronger.

Over a period of 8 quarters ahead the mean forecast error had been 1.13% for CPI inflation and 5.86 points on the Trade Weighted Index (TWI) measure of the currency, he said.

The Reserve Bank’s forecasts had performed better than benchmarks of other forecasters.

“This suggests that there were no obvious major sources of new information that the Bank could have used from these benchmarks in its decision making,” McDermott said.

“Overall, the Bank, other forecasters and the Bank’s statistical models did not foresee the persistent weakness in inflation or the persistent strength in the New Zealand dollar,” McDermott said.

“Despite this, the persistent period of weaker-than-expected inflation remains a focus for the Bank. Low inflation has been a common experience in most advanced and many emerging economies. The Bank has shifted its resources in recent years towards more fully understanding this low inflation environment, and this is a strategic priority in the Bank’s 2016 Statement of Intent.”

(Updated with more details)