The global financial crisis dominated my second term as the Governor of Reserve Bank of New Zealand.
My first term saw five years of economic boom and my second term has seen five years of financial crisis and an economic contraction.
Some of the lessons are obvious and others are more subtle.
I personally do not know how much of what we see is an enduring new world and how much is simply a transition or rebalancing.
Globally, we have a completely different price set from five years ago.
High risks
We are seeing very low inflation in some countries with lower or sometimes negative interest rates. We have a higher price on risk.
We have a higher price on Australasian competitiveness in the form of higher exchange rates in this part of the world.
This makes it difficult to make policy decisions and for private agents to make sensible investment and consumption decisions.
In addition, we have seen markets where there have been discontinuities or freezes, and we have seen markets that simply do not look like they are equilibrating.
The worst problems are in countries such as in the Euro Zone.
We have seen the emerging markets taking on quite a different role as an engine of global growth and in the commodity markets.
Orthodox Zone
In terms of monetary policy, the world’s policymakers are learning what happens when you get towards the zero lower bound (for policy interest rates) and how unorthodox monetary policy such as quantitative easing might work.
I have to say there are still a lot of unknowns about unorthodox monetary policy; we have not really seen anyone complete a cycle successfully with that yet.
In New Zealand, we have felt more comfortable as we remain in the orthodox zone and interest rates could go up or down from here and we would still be in that zone.
On fiscal policy, I think the lesson really is that you have just got to be whiter than white when it comes to running good fiscal policies at the moment, especially in a small open economy like New Zealand.
‘Dangerous Institutions’
In the banking supervision space, I have learnt that banks can be very dangerous institutions and can be very complicated and it can be very hard to model the risks. Tail-end risks are something you can talk about, but are very hard to deal with. Contagion can be much more virulent than I thought, both between institutions and between countries.
The whole area of strengthening banks to reduce the probability of default and finding ways of resolving bank distresses in a way that can reduce losses and panic is a really complicated area, but we have learnt a lot.
Still, there will be more crises.
Policymakers have tried to strengthen banks by requiring them to hold more capital, but that does not guarantee that they would not encounter future problems. We are still in the middle of this crisis with European banks and sovereigns.
Uncertain times
When it comes to the local business sector, I do worry that some of them may be caught in a loop of uncertainty choosing to sit and do nothing but try and stay safe. That will have its costs for the country in the medium term and for the companies themselves, which might otherwise be out there innovating and growing.
Being a full service Central Bank helped us immensely during the financial crisis. It helped us with information flows. It helped us collect and coordinate views from the wide range of policy and functional areas of the Bank and it helped us with implementing policies.
We learned about aspects of the crisis through our economic forecasters, our financial stability analysts, bank supervisors, payment and settlement systems and the team managing distribution of cash to banks.
Those were all important in giving us a window on the economy.
We could triangulate these sources and understand from there.
We did not have the same problems of sharing information between different institutions that the Financial Services Authority (FSA) and the Bank of England faced, for example, because most of it existed internally. In addition, we were close to the Treasury, other relevant institutions and the banks.
When it came to putting crisis polices in place, we were able to do all of that in-house with emergency liquidity facilities through to broader macro-financial policies and traditional monetary policy.
We had different committees working on the details but were able to coordinate it all. Being a small economy and a small organisation helped as well.
The above is a slightly modified version of a part of questions and answers session that Bernard Hodgetts, Head of Macro-Financial Stability, Reserve Bank of New Zealand had with Dr Alan Bollard who left the post of the Bank’s Governor last month. For full version of the interview, visit www.rbnz.govt.nz
