Commonly known as the Reserve Bank or RBNZ, our central bank plays a pivotal role in overseeing the nation's monetary policies. It ensures financial stability and manages currency issuance, particularly the New Zealand Dollar (NZD). Its responsibilities include curbing inflation, supervising the financial system, and upholding the stability of New Zealand's currency.

Bank of the Banks

The RBNZ is a government body often regarded as the ‘bank of the banks’. Its primary role is to maintain price stability by controlling levels of inflation.

To avoid confusion, the RBNZ is not a commercial bank. Commercial banks, such as ANZ or BNZ, provide services to retail customers. Westpac is the commercial bank which performs the government’s own banking services, while KiwiBank is a commercial bank owned by the government.

The RBNZ determines the price that commercial banks must pay to borrow from it, and in doing so influences the rate that commercial bank customers receive (savers) or pay (borrowers). Although the RBNZ sets the official cash rate, the rates of mortgages and saving rates for Kiwi families are also affected by money borrowed from offshore at global interest rates, which can be impacted by a variety of international circumstances. This includes wars, disasters, and major economic events. Essentially, the RBNZ helps the banks we all use in setting the rate of interest you gain on your savings, and how much interest you must pay on a mortgage.

Monetary Policy

Monetary policy is like the volume knob for the country's economy, and RBNZ is the one turning the dial. If the economy is too “loud”, the bank can try and turn it down using several tools.

The Tools

Interest Rates

Imagine interest rates as the cost of borrowing money. When the central bank lowers interest rates (through the official cash rate), it's akin to increasing the volume on spending and investing. Individuals are more inclined to borrow money for items like houses, cars, or new projects because it's more affordable. Similarly, businesses find it more attractive to invest in new equipment, acquisitions, IT, and other ventures, ultimately giving a significant boost to the economy.

Money Supply

Envision the money supply as the overall amount of cash and credit available in the economy. The central bank can increase or decrease this supply through buying or selling government bonds. When they purchase bonds, they put more money into circulation.

The Important Factors for the Bank:

1. Inflation and Prices: Inflation is the steady increase in prices over time. The central bank's responsibility is to keep inflation in check. Should prices surge rapidly, they may opt to raise interest rates or reduce the money supply to temper the economic activity. If prices do not rise much, they might lower interest rates or introduce more money into the system to encourage spending.
2. Economic Growth and Jobs: This volume knob also influences the pace the economy grows and how many jobs are available. When the central bank makes money more affordable to borrow (lowers interest rates), individuals tend to increase spending and investing, which can create jobs and grow the economy.

In simple terms, monetary policy is about the central bank adjusting the volume of money and interest rates to keep the economy in tune. They aim to keep prices stable, promote economic growth, and create job opportunities. Just like a sound technician tries to get the volume right for a concert, the RBNZ tries to get the economy right for the country.

In Currency We Trust: Banknotes and Coins

Before the RBNZ's many modern tasks, it's crucial to understand the primary reason for the central bank’s establishment. The RBNZ was established in 1934 and its first job (also its most visible) was issuing banknotes and coins. Prior to the central bank’s intervention, currency was a free-for-all with each bank issuing its own notes, resulting in a multitude of currencies circulating throughout New Zealand. Since 1934, the Reserve Bank has been the official supplier of the New Zealand Dollar.

The central bank has another important role: ensuring financial stability through monetary policy. In addition to being the ‘bank of the banks’, it establishes and supervises regulations, like the minimum deposit needed for a mortgage. By holding this authority, it ensures the smaller banks follow the rules, aiming to maintain stability in the economy.

Everything changed in the 1960s when high and erratic inflation became a problem. This meant money was losing its value rapidly, causing difficulties for businesses and people. It was challenging to make plans because nobody could predict how prices might change. For example, the price of goods rose nearly 1,000% from 1967 to 1990 (23 years).

Then New Zealand started a worldwide financial revolution by becoming the first country in the world to adopt “inflation targeting”. This involved setting a specific target for inflation and utilising monetary policy tools to achieve it, like the official cash rate (OCR).

The plan worked. Over the next 23 years, the cost of goods only increased by a total of 60%, making life better for business and everyday people.

Inflation Targeting: A Unique Approach

Inflation targeting aims to maintain low and stable inflation. The two key central figures in steering the economy are the Governor of the Reserve Bank and the Minister of Finance. Together, they work to ensure inflation stays at a low and stable level.

The primary tool for controlling inflation is the OCR. Adjustments to the OCR are made eight times a year, but unscheduled adjustments can be made if necessary. This rate is central to the RBNZ’s mission.

As mentioned earlier, RBNZ is the ‘bank of banks’. Similar to how we can deposit and borrow money, banks do the same with the RBNZ. Banks can borrow cash at 0.50% above the OCR and deposit money to earn interest, typically at the exact OCR.

This ensures that banks provide loans at a similar price. If one bank loans at interest rates higher than the OCR, another bank offering a more affordable loan will likely outcompete them.

The Importance of Low Inflation

Low inflation is a cornerstone of a thriving economy in New Zealand, with real benefits for both businesses and consumers. It empowers businesses by providing a predictable environment to plan for the future, reducing uncertainty in cost projections and fostering sustainable growth.

For consumers, low inflation guarantees that their hard-earned money retains its value over time, enabling better planning and spending decisions. It encourages responsible investment, allowing people to make informed choices without the fear of their returns disappearing by rapidly rising prices.

Simply, low inflation creates an economic landscape where businesses and consumers can make better, more informed financial decisions, ultimately contributing to overall prosperity. The recent spike in inflation has challenged the prosperity of everyone, and it seems hardly anybody saw it coming.

“The RBA got it wrong, now it will crush everything”

The comment above was recently made by a respected Australian fund manager about the Reserve Bank of Australia (‘RBA’, the Australian equivalent to the RBNZ). This sentiment likely resonates even more strongly in New Zealand. Despite being well-staffed with hundreds of highly educated and talented individuals, the RBNZ, like any institution, lacks a crystal ball. Their miscalculation on the prospect of inflation is now exacting a literal cost on many Kiwis.  

Money Printing

In 2021, the RBNZ implemented quantitative easing (QE) by printing record amounts of money and purchasing assets such as government bonds. This was to provide liquidity to financial markets and support the economy through lockdowns and closed borders. The move was designed to encourage borrowing and spending, which would stimulate economic growth. At the time, the RBNZ believed that any inflation caused by QE would be temporary. Even in late 2021 the RBNZ maintained statements like:

“…high inflation is expected to be temporary… annual inflation is expected to ease towards our 2% target midpoint in 2022. Expectations for inflation in two or more years’ time remain anchored near 2%.”

Amid the pandemic, the RBNZ, like many central banks globally, faced open criticism for its approach including extraordinary public criticism by the former Governor.  

Present Day, Crushing It

Fast forward to the present day, and crushing inflation is widely regarded as being in all our best long-term interests.

There will be short-term casualties to achieve the common goal. The RBNZ has just conducted its steepest-ever series of interest rate hikes. Interest rates were hiked to counter inflation. While increased interest rates may be necessary, it can have significant negative consequences for individuals and businesses with heavy debts.

Higher interest rates function as a blunt instrument designed to crush the economy. They have the effect of pressuring financially vulnerable or over-leveraged businesses, households and individuals, suppressing consumer spending, and dampening the housing market.

There are two sides to this:

1. The RBNZ is taking action to address a significant issue. The situation could be much worse if they did nothing.
2. Nevertheless, the RBNZ's actions may have unintended consequences. For instance, higher interest rates could, in time, cause the exchange rate to rise, making exports more expensive and potentially harming the economy. This can have flow-on effects for ‘everyday Kiwis’, as nearly everyone has already felt the cost-of-living crisis.

Too Many Objectives?

Reputable and credible economic experts have differing views on the future of central banks, including the RBNZ. Consider these thoughts on inflation from Research Affiliates:

“Money cannot serve multiple masters. Nevertheless, central bankers seem eager to promote an array of goals they hope to achieve through monetary policy: price stability, full employment, low servicing costs of government debt, bear market disruption, and so forth. When money is asked to serve multiple masters, how long, on average, will a burst of inflation linger?”

The Bottomline: The Captain That Steadies the Ship

The RBNZ touches the lives of every New Zealander. Whether it's the New Zealand Dollar in our wallets, the interest rates on our loans or savings accounts, or the overall health of the financial system, the RBNZ's presence is felt everywhere.

With its pioneering approach to inflation targeting and commitment to financial stability, the RBNZ has established itself as a crucial pillar of New Zealand's economy. However, while such a high degree of economic uncertainty remains, the past successes of the RBNZ may count for little. As questions about economic management intensify, the ongoing cost of living crisis will only add fuel to the debate.