When central banks ignore the Tinbergen rule – the case of RBNZ

The news from the global currency markets this morning:

New Zealand’s dollar was set for its biggest three-day drop since 2011 after the Reserve Bank said its sales of the currency in August were the most in seven years. The greenback headed for its best month since 2012

The kiwi dropped against all 31 major counterparts as Prime Minister John Key was reported as signaling that the currency needs to be weaker. Australia’s dollar declined below 87 U.S. cents for the first time since January. The Hong Kong dollar weakened along with equities in the Asian city amid the largest police crackdown on protesters since it returned to Chinese rule. The euro fell to its lowest in 22 months versus the greenback before the European Central Bank meets Oct. 2.

Everything is wrong about this. I normally think that the Reserve Bank of New Zealand (RBNZ) is doing a fairly good job, but over the past couple of years it has become increasingly erratic in its behaviour and seems to be having a problem focusing on its stated objective of keeping inflation close to its inflation target.

Hence, the RBNZ has in recent years had a pre-occopation with the development in the New Zealand property market and household debt etc. and now it is the level of the kiwi dollar, which is on the mind of the RBNZ. And maybe worse the Prime Minister is now also thinking that he should get involved in monetary policy decision making – at least indirectly.

You gotta ask yourself what monetary policy goal the RBNZ have? After all you cannot have the cake and it eat too. That is the Tinbergen rule – you can only have one policy objective for each policy instrument.

The intervention in the currency market seems particularly odd when we remember that the RBNZ is not unlike a lot of other central banks stuck at the Zero Lower Bound – RBNZ’s policy rate the Overnight Cash Rate is 3.5%. Said, in another way if the RBNZ thinks that the strengthening of the kiwi dollar in anyway was threatening its key policy objective (1-3% inflation) then it can just got the key policy rate.

Furthermore, the New Zealand economy does not exactly look like it needs monetary easing – real GDP growth is outpacing potential growth, inflation is within the inflation target range and inflation expectations seem to be quite close to the 2% mid-point of the inflation target range. And any Market Monetarist would of course also notice that nominal GDP growth has been extreme buoyant over the past year (admittedly it is slowing now).


The strong growth in nominal GDP during 2013 to a large extent reflected a sharp rise in New Zealand’s export prices particular higher dairy prices. That trend has changed significantly in 2014 and that has actually put considerable depreciation pressure on the kiwi dollar recently, but apparently there is enough pressure on the kiwi dollar if you listen to Prime Minister John Key and the RBNZ.

Just ask yourself the question what if the kiwi dollar remains “too strong” for the liking of the RBNZ and the Prime Minister and the RBNZ decides to intervene more what would then happen? What is currency intervention? It is money creation. The RBNZ would print kiwi dollar – expanding the money base.

That eventually will spur NGDP growth and with the economy operating at more or less full capacity utilisation this will spur inflation and increase inflation expectations above the RBNZ’s inflation target. So the question is how much higher inflation will the RBNZ be willing to accept to weaken the kiwi dollar? Will it be willing to jeopardize its inflation target?

This demonstrates that the RBNZ only permanently can weaken the kiwi dollar if it is compatible with the RBNZ’s inflation target. Unless of course the New Zealand government is willing to introduce capital and currency controls. That luckily that does not seem to be on the agenda.

If the RBNZ is targeting inflation then the RBNZ will have to accept the level for the kiwi dollar, which is determined by market forces. If it on the other hand wants to target the exchange rate then it fundamentally will have to give up its inflation target.

I don’t think that the RBNZ is going to mess up things dramatically, but the RBNZ’s pre-occopation with the level of the kiwi dollar is yet another example that central bankers around the world still fundamentally have a hard time accepting the logic of the Tinbergen rule. But there is no way around it – you can only have one monetary policy target – the inflation rate, the price level, the NGDP level or the exchange rate. You can’t do it all.

PS I have often argued that central banks in small open economies use the exchange rate as an way implement monetary policy if it is stuck at the Zero Lower Bound and if monetary easing is needed. However, that is not the case for the RBNZ.

PPS Maybe I am wrong and it might just be the case that the RBNZ knows better than the market – just see here (I don’t really think I am wrong…)

PPPS The RBNZ does not exactly have a good experience playing around with quasi-exchange rate targeting. See here.

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