When interest should fall

Press, 9 March 1987, Page 20

When interest should fall

Dr Gareth Morgan, an economist with Infometrics, the private economic analysts, believes that interest rates cannot be allowed to fall until after evidence of significant and sustained progress on killing inflation, the Budget deficit, and the balance of payments deficit. He says this in replying to a letter to the Editor submitted by W. J. C. Royds. Mr Royds wrote: “Independent economists who speak up about New Zealand’s economic direction are responsible and provide the public with a valuable monitoring role, even if they sometimes confirm people’s worst fears. “Dr Gareth Morgan’s recent economic analysis was fascinating, but his suggestion that the

Government follows tighter monetary policies seems to contradict free-market principles and is it even possible in a deregulated economy?

“The Minister of Finance, understandably, says monetary policy is tight enough and the figures on bankruptcies, company liquidations and now rapidly increasing unemployment seem to confirm this. How tight is tight? “Would Dr Morgan please comment and provide money supply comparisons.” Dr Morgan replies: “My comments referred to the on-again, off-again nature of the Government’s monetary policy as conducted during 1986. “In particular, the Reserve Bank permitted short-term in-

terest rates to fall dramatically in April 1986, at a time when there was little evidence that the economy was adjusting to its fundamental imbalances in inflation (7 per cent above our trading partners), the Budget deficit (6 per cent of G.D.P.) and the balance of payments current account deficit (6 per cent of G.D.P.). This premature easing of monetary policy facilitated buoyant trading conditions over the second half of 1986. “At a time when people wished to buy to beat G.S.T. anyway we had the recipe for an inflationary burst. The data now supports the claim that sellers were putting up prices before and after’ October 1 more than G.S.T. alone can account for. “In addition, it is evident that household incomes were not rising sufficiently to pay for the increased spending so we have seen households run up considerable debts to pay for this orgy of expenditures. If the Reserve Bank had kept interest rates up at levels at least as high as they were prior to April 1986, this inflationary burst would have been dampened.

“After October 1, the Reserve Bank tightened monetary conditions by squeezing the cash position of the trading banks. The theory is that this will put a premium on liquidity on the wholesale markets and in the scramble for funds interest rates will be forced up. Certainly this has happened. ( “My point is not that monetary conditions are too loose this week (quite the contrary, probably they’re fairly tough) but that we could in 1987 once again see another premature fall in interest rates as we approach the election period, for similar reasons why it occurred in 1986 — the Reserve Bank thinks (inadvertently) that the economy is adjusting to those three fundamental imbalances and it’s the time to take the heat off.

“My own view is that interest rates cannot be allowed to fall until after we’ve evidenced significant and sustained progress on killing inflation, the Budget deficit and the balance of payments deficit. This is unlikely to be until into 1988.

“Given that recipe from the economic engineering perspective, it makes life pretty tough electorally for a Government sticking to such a strategy in an election year.”