High-interest policy’s days are over, says economist

Press, 9 December 1988, Page 12

High-interest policy’s days are over, says economist

Pattrick Smellie,

in Wellington,

talks to a leading analyst on the limits of Rogernomics

THE GOVERNMENT’S high interest-rate policy completed its task 18 months

ago. That’s the view of a senior economist, Mr Kel Sanderson, of the Wellington economic consulting group Berl — an establishment with 30 years experience of forecasting and advising corpo? rate clients on how to manage economic change. Mr Sanderson’s view is pitched against that of the Reserve Bank and the Treasury, and many of the economists in the financial sector, which has been one of the strongest areas of support for Rogernomics. To him, inflation has been a dead issue for some time, while the need for a Government commitment to policies directed at economic growth is becoming urgent. “I would like to see a Minister of Finance with a whole view, not just focusing on inflation,” he said in a recent interview. “It’s a broader view which should have been taken 18 months ago. “In my view, it’s becoming urgent that the Government look to a structure of Ministers which is able to do that. “The monetarism in Rogernomics concentrates on keeping short-term interest rates high, and thereby keeps the exchange rate high,” he said. At another level, the Government’s deregulation policy acts in a long-term way to improve competitiveness by removing bars to entering the New Zealand market, such as high tariffs, or restricted entry to particular industries. Mr Sanderson has no problem with these micro-econo-mic policy changes, which had been effective. His concerns are at the macroeconomic level.

The mechanism of keeping short-term interest rates higher than long-term rates is known as an inverted yield curve. It is not the normal way for interest rates to behave, but is one of the main ways the Government has chosen to squeeze inflation out of the economy. The policy of high short-term interest rates keeps the exchange rate high, placing pressure on local producers to compete with cheaper imports and hone their costs to price competitively on export markets. “It gives the short-term shock which forces people to start making the necessary changes. But we achieved that in 1985 and 1986. It hasn’t been viable since early 1987,” said Mr Sanderson.

“Real inflation was already tracing down then, and interest rates would have chased it down.”

In fact, the Government’s monetary policy was not so much a policy as a strategy. “I’m not

against it as a strategy for a period. But I don’t see it continuing to drive inflation down, unless it’s really screwing the economy down.” And in the present climate, Mr Sanderson fears that could lead to what some of the companies he advises are talking about as "industrial meltdown” — where the departure of major local industries has a chain reaction through the businesses which depend on them. He believes also, that the Government is not watching the right indicators to judge its monetary policy. "This strain of monetarism concentrates on confidence and inflationary expectations as indications of inflation,” he said. “But that is the wrong way to monitor it.

“They should be looking at the real economy — production, employment, profitability. But that is not closely monitored at all.

“There is too much concentration on nebulous indicators, rather than true inflation at various levels,” he says. Bert’s latest economic forecasts, released last week, say inflation at the retail level is running at around 1.1 per cent a year. In other words, within the 0 to 2 per cent range sought by the Minister of Finance, Mr Douglas. “The fact that we could be going on too long with this strategy is showing up in weaknesses in the financial sector,” Mr Sanderson said. “Our national balance sheet was already weak, thanks to Think Big and inflated farmland values, for example. “But that has been exacerbated largely by the boom in late 1986 associated with the America’s Cup, and March to June of 1987, when speculative activity re-emerged.” > He rejects the Government’s claim that monetary policy is tight, given the high level of growth in private credit during the boom last year. Berl estimates that around $5.2 billion more than was required for the normal running of the economy was borrowed in that period, much of which has now disappeared down the black hole created by the sharemarket crash.

While some of those losses have been absorbed by the major financial institutions, more is still to come, along with continuing costs of industry restructuring.

Mr Sanderson’s concern is that the productive sector of the economy should be able to continue functioning, otherwise those weaknesses may turn into unnecessary failures. “But when the economy is screwed down as it was in March to June of this year, and then in October, those weaknesses start to reemerge. “There are a number of financial institutions out there which are worried about weaknesses in their sector, and they are trying to stabilise interest rates to assist their productive clients,” Mr Sanderson said.

“Their medium-term profit depends on their clients, after all. Other institutions and authority showed much less commitment to interest-rate stability.” Moreover, since the brief but marked fall in interest rates and the exchange rate in mid-August, there have been clear signs that there has been a return to more vigorous pursuit of the inverted yield curve. The appointment of Mr Moore, particularly, as an Associate Minister of Finance at around this time appeared to signal a fresh policy direction. But this proved ill-founded when the anti-infla-tionary targets re-emerged in September with a rise in shortterm interest rates. It is that rise to which Mr Sanderson attributes the present rise in bank lending rates.

Mr Sanderson’s view is that the Government should attack the present level of interest rates, starting with statements that they believe inflation has been beaten. The aim would be then to allow short-term interest rates to settle to around 10 per cent, while longer-term rates would assume their normal position of being somewhat higher.

The exchange rate' could then fall to around a trade-weighted index level of around 57 or 58, compared with the present 61. “But the longer the exchange rate is held artificially high, the lower it will go when it finally does, because the markets will perceive that it’s more difficult to get the show back on the road,” Mr Sanderson said. Any inflation resulting from a lower exchange rate under Bert’s suggested course of action would be short-lived, he said.

“While import costs would rise, and industries margins are squeezed at present, there is so much slack capacity in the econ-

omy at the moment that profitability would improve through increased production.” And where would that leave the present Minister of Finance? “In that situation, the continued thrust of monetarism under Rogernomics would have a credibility problem,” Mr Sanderson said. “But the question is whether the Government as a whole would have a problem. “The Government could constitute itself in such a way that it could come out and say that in terms of the strategy for letting the economy grow, the present level of inflation was acceptable. “That would require a strong commitment to growth, not through intervention, but through measures which encourage and facilitate where the market indicates.” Mr Sanderson said this did not mean Government spending had a blow-out. It was important that the Government continue seeking efficiency' in public spending, although lay-offs in the core public sector could involve costly redundancies next financial year, he said. Nor would such a commitment necessarily mean a radical de-

regulation of the labour market. “Ken Douglas has already shown he’s committed to productivity and industry restructuring as the way to get more jobs. “The growth itself will mean that the industries which have restructured will be able to pay higher wages,” he said. “In the South Island, for example, the labour market has virtually deregulated itself out of necessity.” People and companies were ready to invest, to be flexible in their work arrangements, and had adopted a newly competitive outlook. But they were still waiting for the Government to give clear signals. “We have companies which won ; t start exporting till they are ’ convinced there won’t be more intervention in the exchange and interest-rate markets.” With unemployment growing to at least 200,000 over the year ahead of Berl’s estimates, the Government had to give a lead, he said. "The question is: Are you running the economy for a declining number of people, or are you running it for everyone who calls themselves a New Zealander?”