Did the Reserve Bank overstimulate the economy?

Expert says we need to "urgently right the ship"

Did the Reserve Bank overstimulate the economy?

With the Reserve Bank’s next OCR decision due next week, there seems to be a full consensus that we can expect to see another hike, with some commentators even speculating that we may see a “double hike” to bring the cash rate up to 1%.

The OCR is currently sitting at 0.50%, having been raised from 0.25% in October. Most major banks say that we can now expect to see a consistent raising of the OCR over the next several months, though it is more difficult to predict where and when it is likely to peak.

Regardless, with the labour market and other economic indicators going strong, the need to move away from stimulatory settings is now very clear. Sharon Zollner, chief economist at ANZ said that New Zealand is ahead of most major economies in this regard, with countries like the US and Australia still firmly on stimulatory settings - something she said needs to be handled carefully, in order to avoid a “hard landing.”

“The Reserve Bank of New Zealand is ahead of the game when it comes to tightening monetary policy,” Zollner said.

“It would have tightened in August if the lockdown hadn’t been so badly timed, they’ve already got one under the belt, and they’re going to hike again in 10 days. Indeed, some are wondering if they might do a double hike. We think that’s unlikely, but we agree with the principle that there is some urgency to normalise rates here.”

Read more: Major bank predicts higher OCR peak

“Whereas in Australia and the US, the CPI inflation is very similar - but you can see that their labour markets are nowhere close to being back to normal, so their central banks are pushing back and wanting to keep their monetary policy extremely stimulatory for longer in the hope that their labour markets will heal,” she explained.

“It’s not a risk-free strategy because inflation is very strong, and asset markets are very bubbly. It’s not going to be an easy matter to withdraw all this stimulus without causing an accident, and the later you start, the greater the risk that you’re going to have to go higher for longer than anticipated.

“Given global debt is now off the charts, that’s a risk of a hard landing.”

Zollner said that with the benefit of hindsight, the Reserve Bank did overstimulate the economy in a “hard and early” approach, which has characterised New Zealand’s response to the pandemic from every angle.

However, she noted that this was done in response to very consistent forecasts that pointed to a crash - something which didn’t eventuate, and, as a result, there is now “some urgency” to steer things back to relative normality.

The housing market has been at the centre of the economic boom throughout, and Zollner noted that there will be some households who may later realise that they have borrowed too much - something which puts them in a fragile situation, given that interest rates are only going to rise.

Read more: ANZ economist warns on impact of OCR increase on mortgage

“I’m not throwing rocks, because we had very similar forecasts, and we all thought this was going to be a big negative net demand shock, and it wasn’t - partly because monetary and fiscal policy were extremely effective in boosting confidence, spending and housing,” Zollner said.

“But it does mean that there is some urgency to right the ship.”

“Household debt is now at record highs relative to income, and household debt servicing has not been at record highs though because interest rates have been so low, and that’s more than offset the increase in debt levels,” she explained.

“But it is a more fragile situation than in, say, the 1990s, where we had quite low debt but super high, double digit mortgage rates. That was quite easy for the Reserve Bank to ease the pressure on heavily indebted households when trouble struck, just by slashing interest rates. But the OCR now is 1%, and if more trouble were to strike, there would be very little that we could do to ease the pressure on households who in hindsight might have borrowed too much.”

“As interest rates rise, households will become much more price sensitive, and it will become more difficult for retailers to pass costs on,” she added.

“That’s not fun for the retailers, but tightening monetary conditions isn’t fun. We caused a boom, and now we’ve got to rein it in and try to avoid a bust.”