An idiot's guide to today's changes at the Reserve Bank

The Government's just announced changes to the Reserve Bank that will affect how New Zealand's bank of banks operates. Before you nod off, how about you attempt to wrap your head around it in the form of a light, entertaining conversation. 

I've heard the Government announced something today on the Reserve Bank.

That's right. There are a couple of changes to the central bank. The main change is it will have to consider employment alongside price stability when setting monetary policy.

Hang on. What even is the Reserve Bank? 

Owned by the Government, its main job is to keep prices stable by controlling levels of inflation. In other words, how much prices go up over time.

So, it's the Government's bank?

Not quite… Westpac does the Government's actual banking, and Kiwibank is owned by the New Zealand Government. Treasury manages the Government's finances.

The Reserve Bank has total independence from the Government. 

It's more like a bank for banks.

OK so all the banks buy their money from the Reserve Bank?

Sometimes. Not always, but the Reserve Bank sets the official cash rate (OCR) so it decides how much money costs for commercial banks to borrow from them.

The thing is, rates of mortgages and saving rates are also affected by money borrowed from offshore and global interest rates, which can take a hit in times of international uncertainty (ahem, Brexit). 

Commercial banks' rates are also affected by how much money New Zealanders are saving. That money gets re-loaned to people who want mortgages.

But what difference does the Reserve Bank make in my life?

The official cash rate helps banks set the rate of interest you gain on your savings and how much you have to pay on a mortgage.

Ow, my head hurts. 

Try a large glass of water and a spot of fresh air.

OK, I'm back. What will the new employment objective do?

The Government hopes it will help give the Reserve Bank a clearer goal of improving "wellbeing and living standards" of New Zealanders.

Can the Reserve Bank even influence the rate of employment?

It could hypothetically decrease interest rates, stimulating businesses and borrowing rates, but remember it doesn't just have the responsibility of achieving "maximum employment" - it also needs to keep inflation within that 1 to 3 percent target and decreasing interest rates would have an effect on that too. 

This is a very delicate balancing act. 

Right, so if that's just a hypothetical. What are they actually likely to do?

In the meantime this new target means that every time the Reserve Bank looks at changing the Official Cash Rate (every 6 or so weeks) they need to take the employment rate into account and communicate what factors led them to make the decision. They'll have to include this in their official statement on the OCR decision  - so they'll be more accountable.

Will it work?

There's no actual employment target, so probably not. Our unemployment rate currently sits at about 4.5 percent. The Government wants to see that drop to 4 percent - but they haven't passed the responsibility of that target on to the Reserve Bank.

The Government says that's because there are lots of contributors to rates of unemployment, and the Reserve Bank doesn't pull all those levers.

What about this new committee?

That's a bit controversial. Up until now the Reserve Bank made decisions about Monetary Policy (like the Official Cash Rate) by itself. Now the Minister of Finance has told them they need some new friends from the outside to sit around the table and discuss it with them. One of those people needs to be from Treasury (they're the people that manage the Government's finances). 

But won't that undermine the independence of the Reserve Bank?

The Treasury representative won't get a vote. They'll be there as an 'observer' and to provide information about what the Government's spending and policy plans are. 

That kind of sounds like they'll influence the Reserve Bank, therefore undermining its independence.

Well, the Minister of Finance says it won't. We'll see. 

So how many people make the decision now?

Between five and seven members will sit on that committee and at least two of them need to be 'external experts'. Plus that Treasury official. 

I'm still confused.

You could watch this series of educational videos from the Reserve Bank. 

But I accept you will probably watch Nailed it! on Netflix instead.