Rodney Responds: Economists need to understand how things work

In our continuing series looking at how interest rates work, Rodney Dickens responds to comments from a number of economists who criticised his approach to help keep rates stable.

Monday, July 11th 2011, 10:21AM 4 Comments

Some of the points raised by the economists Jenny Ruth interviewed in her article on www.goodreturns.co.nz dated 29 June 2011 warrant comment. 

The economists Jenny interviewed were more interested in branding my idea of keeping the OCR more stable as "left field" or clinging to the tradition of how things have been done than they were in looking at the facts.  No wonder economics is called the dismal science. 

Any reasonable consideration of the facts reveals that the way the Reserve Bank (RBNZ) operates monetary policy creates major instability in interest rates and economic activity, and massive instability in housing market activity.  Most importantly, this instability has little if anything to do with the RBNZ achieving its medium term inflation target.   This is contrary to what the RBNZ is supposed to be doing and more importantly it has a major negative impact on everyday Kiwis and Kiwi businesses.

If some of the economists took more notice of how things actually worked in the economy rather clinging to how monetary policy is currently operated because that is how it has been done for a long time it would be refreshing. 

There was quite a long period when electric shock treatment was the done thing for treating people with psychological disorders, but this didn't make it a good idea then or now.  The fact that the RBNZ and central banks all over the world have been marching interest rates up the hill, only to march them back down again for a long time doesn't mean it is either a good idea or the best way to operate monetary policy.

It is worth noting that if the RBNZ marches interest rates up and down, it makes the role of economists more important.  We should be asking business people and borrowers who face the instability created by the RBNZ whether it is a good idea rather than the economists who have a vested interest in no change.

Some of the economists Jenny interviewed defended the RBNZ's economic forecasting track record on the basis that it was "as good as, if not better than, most".  Asking economists if the RBNZ is any good at forecasting or whether operating a forecasting-based approach to making OCR decisions is a good idea is a bit like asking financial advisors if they did a good job advising clients about the risks of investing in third-tier finance companies.  As readers are probably already well aware, the fact that the RBNZ has a marginally better forecasting track record than most of the economic forecasts is, unfortunately, just testimony to how bad the economic forecasters are at predicting the economic outlook.  If truth be known, banks don't employ economists because they have a proven track record at predicting the economy.  Banks really employ economists because it is a cheap way of getting regular publicity for the banks. And, unfortunately, despite the bank economists having a poor track record at predicting the economy, the media keep giving them coverage.

Psychology has some interesting insights that are relevant here. When people are asked about their ability in a range of fields 80% answer that they are better than average (i.e. we have a built-in overconfidence in our ability). The RBNZ and the economists have the same over confidence in their ability to forecast the future and fine tune the OCR in a useful manner. Such overconfidence must be useful from a survival-of-the-species perspective otherwise it wouldn't exist, but it is a curse for the people who have to face the consequences of overly confident economists playing god with the OCR.

The only true test of the consequences of the way the RBNZ operates monetary policy is to consider the facts rather than the opinions of economists, which is what I have done in my three reports on monetary policy.  The reports can be accessed via the following link to our website: http://www.sra.co.nz/pdf/Ravings.pdf.  A fitting follow-up article would be if Jenny asked borrowers how much fun it is managing their personal finances in the face of interest costs that go up and down by 20-30% on a reasonably regular basis. And asking chief executives what it is like managing a business in the likes of the residential building industry when the RBNZ is kicking your revenue up and down 20-30% per annum on a regular basis.  For everyday Kiwis this is the real world they live in thanks to the good-intentioned but harmful tinkering by the RBNZ.

There is this bizarre idea that floats around in economist circles without any foundation that keeping something in the economy more stable inevitable means more instability elsewhere.  It seems that a number of the economists Jenny interviewed suggested that keeping the OCR more stable would inevitably mean more instability in some other parts of the economy.  This is nonsense.  It is like saying that keeping the accelerator depressed at the same level rather than jerking it up and down will result in the car travelling at more erratic speeds.  If the primary drive of economic cycles is more stable it is a no-brainer that economic cycles will be more stable, which includes inflation and probably also the exchange rate.

The debate over the impact of monetary policy on everyday Kiwis and Kiwi businesses is too important for it to be dominated by the prejudices and self-interests of economists.  It is time for Kiwis to let the RBNZ and government know that they have had enough of the RBNZ making the challenging of earning a crust much harder than it needs to be.

Rodney Dickens
Managing Director
Strategic Risk Analysis Limited

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Comments from our readers

On 12 July 2011 at 8:38 am om1 said:
This response begins with a put down, continues by arguing by analogy and employs emotive language. I am none the wiser as to the merits or otherwise of the respective policies as the issues were not discussed.
On 12 July 2011 at 10:24 am Steve said:
Rodney makes some very sound arguments. The way things are at present it feels like the sword of Damocles is waiting to drop every time the RBNZ makes an announcement about the ecomonmy and what the OCR might be doing. How an earth we are supposed to plan a sound future with the yo yo effect of interest rate "intentions" is beyond me. It can only serve to make the banks alot of money surely.
On 12 July 2011 at 10:35 am Tony Ryburn said:
If the bank staff who approve loans got it wrong as often as their economists do the bank would not survive long
On 22 July 2011 at 1:18 pm Tracy said:
How refreshing. Some commonsense for the common person, living with the reality of trying to juggle personal and business finances. This has been the worst year for each of the many small business owners we know. We all feel dread everytime the OCR rate announcement is due and economists try to tell us the economy is recovering - not for us. We are just trying to survive here and keep paying our employees, without laying people off. It seems we keep being stung over and over again. Rising costs in petrol and consumables teamed with greater competition with lower cost offshore production and even the extra 1% on Kiwisaver, while may not sound a lot,it all means any fat we manage to make is instantly gobbled up by rising overheads. Most businesses like ours have used their rainy day funds, downsized where they can and are holding on by the skin of their teeth. Come on RBNZ don't keep threatening to kick us in the teeth and give us some stability to hold on for that brighter future!
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