Living without the MCI
The Reserve Bank's move away from the MCI to an official cash rate will reduce cash fund volatility, Macquarie division director Wayne Fitzgibbon says.
Wednesday, February 17th 1999, 12:00AM
The Reserve Bank of New Zealand has finally abandoned its controversial monetary conditions index (MCI) approach to monetary policy. The bank will, from March 17, simply be announcing an official cash rate (OCR), which it will review every six weeks. This approach is broadly similar to how every other central bank in world operates monetary policy. For nearly a decade the RB has been the odd man out in central banking circles, with very different ideas about what monetary policy actually is and how it should be conducted. It has now returned to the fold.
What was wrong with the MCI?
There were many shortcomings with the MCI, but the basic problem was that it was too rigid. In all but the most rudimentary economic theories the relationship between the exchange rate, interest rates and inflation are exceedingly complex. Not every movement in an exchange rate will have consequences for prices and not every movement in interest rates will have the same impact on the exchange rate. The world is not that simple.
When the Asian crisis hit, the NZ dollar should have been allowed to fall further and interest rates should have been allowed to fall. Under the MCI this could not happen. The aggressive easing in monetary policy by the RBNZ was too little and too late to avoid recession.
What will the new cash rate be?
It is likely that the RBNZ has not yet made up its mind about the level of the OCR. Market expectations range from 3.5 per cent to 4.75 per cent, the higher level being the same as the current cash rate targets in Australia and the US. In our view, the OCR will be set at the lower end of the band. This may see bank bill rates fall somewhat from current levels of around 4.25 - 4.35
How will the change impact on returns?
It is likely that bank bill yields will trade in a comparatively narrow range around the target cash rate, with actual adjustments in the target the main source of volatility (in contrast to movements in the NZ dollar under the MCI). There should therefore be less volatility in returns.
The new monetary regime will be very similar too the current system in Australia.
Wayne Fitzgibbon a division director with Macquarie responsible for managing the cash and cash plus portfolios.
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