Commercial Reserve Bank Governor on interest rates

Press, 10 April 1978, Page 24

Commercial Reserve Bank Go vernor on interest rates

PA Wellington 1 People who were seeking | a return to the controlled low interest rate structure ] of before 1976 were accused by the Governor of the Reserve Bank (Mr R. W. R. White) last week of basing! their ideas on criteria “relevant to the times of theMerchant of Venice”. “People who adhere to! these views might with ad-1 vantage update their reading and learn of the need to update to change by reading, Alvin Toffiers ‘Future; Shock'.” Mr White said. In an address to rhe Palm-1 erston \urth Lions Club; about problems with the: existing interest rate struc-; ture. Mr White spoke of the: wasteful use of money when interest rates were held artificially low. "Anything which is cheap) i is likely to be wasted, and this applie' to money as! well as other commodities.' The relationship between . inflation and interest rates! also has a strong influence! on the way borrowers use,

funos. “If in the interest rate! paid bv a borrower is less! than the likely rate of appreciation of fixed assets, people may borrow money; to invest in real assets i merely for the capital gain I !without the need to use the' assets productively.” Mr White said that ownership of fixed assets ini t'.iese circumstances is valu-1 |able, not for rhe productive! purposes, but because it pro-! vides a security which enables money to be bor- ( rowed fairly cheaply. Mr White said .he fully .agreed with the Bank Of New Zealand economist, Mr' 1.. Bayliss, who has ex-' pressed opposition to interest rate subsidies. “Whether the Government pays such a subsidy ilself or! forces savers to pay it by' fixing interest rates at an, I unreasonable low level is .r-| relevant. • “Subsidisation of some! activities may be justified, i > but to determine the amount! I of subsidy on the basis of ■ ■ the amount borrowed seems! to be the worst of all possible criteria and the one' most likely to lead to! inefficiencies.” Mr White said that until! i the changes initiated by the i Muldoon administration on! I March 2, 1976 direct con-j itrols prevented interest rates I from adjusting to the ! changed circumstances. ,changed circumstances. I “At least some of our I jprc lems with productivity, I inflation and L he balance of] payments arose from inter-1 est rates fixed by Govern-; jment edict at levels well! ! below those which efficiency l and stability demanded.” ; A rational interst rate pol- i | icy did not mean that interjest rates should never fall. ! ! A non-monetary incentive! towards saving was the cau-j j tion with shich people spend! | both on consumption and in-1 I vestment goods, at a time ! w h e n consumption! iconfidence is low. , If people are cautions' ;about spending on goods and; j services, they will automati- i I cally save more in the form! ;of financial assets and de-! jmand less credit. i Mr White said this was the present case, with inter- ■ [est rates falling. | “This is . entirely reason-’ | able. , “My argument is that interest rates fixed at arti- • ficially low levels by statu-: I terry authority will in buoy-! ,ant times encourage the inlefficient use of capital, be' an engine of inflation, and I give rise to a balance of, 'payments deficit. “The flexibility of interest.

rate movements introduced! in 1976 is essential to the! country’s economic wellbeing.” This led to conundrum. | ! “We know that interest; [payments at present cause! (hardship to many people and businesses. But at the same •time we also know that high interest rates may be neces- ■ sary to achieve a better baljance between the supply and ■ demand for loan money. I “The social and material hardships forced on borrow- ■ . ers by high nominal inter-! jest rates cannot be ignored.; ;But neither can we ignore; ’ with impunity the need to! ■‘provide through the in..rest .■rate mechanism adequate re-! ; wards to savers -and disiciplines to borrowers.” Mr White said he had ■jmade the conclusion that •this apparent conflict arises i not from the level of interJest rates but from the conItiniied adherence to the conJcept that interest is a reveJ nue item — whereas ’ realJity it is largely of a capital ■ nature in that it includes an ; i adjustment for the erosion J of debt principal by initiation. ,! Many people ignored the capital compensation elei ment of present da. interest jrates and instead judged J them against the criteria of previous years. ' “Today’s interest rates are usurious by those standards. But if the capital com-j [pensation element is taken into account they often rep-; i resent in reality gifts of, ■ significant proportions by] "[lenders to borrowers.” ; Looking toward solutions,! Mr White suggested four! steps toward a more rational! (and safer interest rate sys-i tern. These were: I . A clear recognition of the new role of interest. | This would include coml pensation to the saver for the depreciation in the purJ chasing power of his debt J principal. “Such recognition may allay the fears of those .(who regard high nominal !; interest rates as iniquitous jand may serv_ to moderate (the views of those who have •a fixation about the benefits J of low interest.” • ! .A recognition by lenders .{that inclusion of comi pensation for the deprecia- . I tion of debt principal in [interest rates has grossly (•accelerated the rate of re- .. payment of long-term debt Jin real terms. Adjustments .[should be made to the rate . of repayment to a sensible J and bearable basis in cases I! where hardship would otherfl wise result. • “This could be effected by i j schemes such as deferment

I of part or all of capita! re-' •payments in the eat-,y years! of debt, an arrangement now! being offered by some savings banks and the Housing (Corporation. J “Another solution, and one I prefer, would be to defer • all but a small part of the ; interest, with the amount • deferred being added to the . jnncipal outstanding and reI paid in equal instalments over the remaining ‘ears ofI the debt.” Mr White said his sug-. . gested scheme took account; I of inflation and accomJmodated any changes in r interest rates which might. ■ occur. . Third, the tax structure! J should ultimately take interest into account. I I . Finally, debt contracts; : should recognise the vari-i ; abilitv of interest rates and! . include either automatic! . variable interest rate clauses . or provision for early repayJment. “Variable interest rate I clauses ate already common, i though I believe the in- ! tention is usually to protect . lenders against rising interjest rates. The clauses should

be used for the protection of borrowers when interest rates decline,” he said.