Thursday, 19 July 2007

Cullen changing "price stability" target may be all talk, but may not be all bad

I'm bemused to see suggestions from finance minister Michael Cullen that he is considering amending the Reserve Bank Act so that the focus is on something (anything) other than "price stability." On the face of it removing the focus on "price stability" would be a good thing for a number of reasons (most of which I've canvassed here before), but since no change proposed will result in removing the politicisation of the currency (which it should), whether it is a good move at all depends fundamentally on what the target changes to, and whether or not this is simply another attempt to talk down the currency.

Something certainly has to be done, and urgently -- as US economist Steve Hanke says, "by having a free, floating exchange rate combined with inflation targeting" "the New Zealand economy is on a death spiral" -- and removing the Reserve Bank's legislatively constrained myopic focus on "price stability" would be prime amongst things that should be done, but given the circling of monetary cranks around the rotting corpse of the Reserve Bank Stabilisation Act, I have little confidence in where such a change might end up.

The fact that Bill English is opposed (and solely it seems for the reason that, to paraphrase him in this morning's Herald, "this is how we've always done things") is perhaps good reason however to give it serious consideration, since Billy Boy is almost a beacon for the wrong side of every issue.

Let me just explain briefly why I've placed the words "price stability" in inverted commas above, and my answer to that will help explain why, on the face of it at least, removing this as a target for the Reserve Bank governor would be a good thing. As Frank Shostak explains, "the policy of "price stability" always leads to more instability." That may seem incongruous, but only if you fail to see how prices (plural) are formed. It's true that monetary inflation (that is, the Reserve Bank printing too much money) is the primary cause of inflation of prices, but it's not true that every change in prices is due to such monetary legerdemain; when prices need to fall or to rise for reasons other than monetary reasons -- when say a technological change makes a product line cheaper, or when supply and demand factors make a line of goods or services more expensive -- then mandating price stability puts an artificial constraint on markets, constraints that will and do lead to malinvestments and severe dislocations, just as we're seeing, and with our small currency it leads too to serious foreign exchange problems.

An article in the latest Free Radical explains this apparent paradox of how "price stability" leads instead to instability; says M.A. Abrams, it comes about through a complete misunderstanding of the nature of monetary inflation:
In an economically progressive community (that is, one where the real costs
of production per unit are falling and output per head is increasing), any
additions to the supply of money in order to prevent falling prices will be
hidden inflation; and in a retrogressive community, (that is, one where output
per head is diminishing and real costs of production are rising), any
contraction of the supply of money in order to prevent rising prices will be
hidden deflation. Inflation and deflation can occur just as well behind a stable
price level as when the price level is rising and falling

Thus, in the case where [economic progress] due to increased saving is
corrected by additional money for consumers, the result is to prevent any
[increase in the efficiency] of production; and where a fall in prices due to
improved knowledge is corrected by additional money, the result is to force a
transition to less [efficient] methods. In both cases the fruits of
progress are rejected because of a determination to keep prices stable
Moreover, in both cases the correction of the attempted advances has involved
the abandonment of some of the higher stages of production where certainly some
of the factors used are highly specialized and these will therefore become
unemployed as a result of the transition.
It's time to cut the Reserve Bank Stabilisation Act loose. That's one thing that could be done immediately. But cutting it loose should not be used to politicise the currency in another way. That would be a remedy worse than the malady from which we're presently suffering.


  1. Peter, after reading numerous posts of yours on this subject I'm still struggling to comprehend or understand your rationale. Do you want the Reserve Bank to print more money or less money? Correct me if I am wrong here, but your current opinion seems to be that a) the RBNZ should not exist; but b) since it does, it should be printing more money. Is this what you are saying?

  2. Best to get rid of the reserve bank altogether. Giving a branch of government the monopoly control over money has never worked out. The trouble is that this system relies on reserve bank and government employees being omniscient and omnipotent- Gods! Yet we have seen how fallible and weak and full of cant they really are. All this reserve bank system does is preserve cronyism and benefit insiders. It's too corrupt to survive.

    Dump it.

    100% asset backed currency is the best bet.


  3. "Do you want the Reserve Bank to print more money or less money?"

    Neither. See today's post.


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