Adrian Orr: Monetary policy challenges for a small open economy during Covid-19
Central bank: rbnz | Type: speech | Date: 2020-12-02

## Monetary Policy Challenges for a Small Open Economy during COVID-19Sir Leslie Melville Lecture: A speech delivered to Australia National University in Canberra, AustraliaOn 2 December, 2020By Adrian Orr, Governor

## IntroductionTēnā koutou katoa, welcome everybody.

Thank you for the privilege and opportunity to deliver this

year's

Sir

Leslie

Melville

lecture.

Joining

today

via

video

conference

provides

the appropriate backdrop to the theme of my speech - implementing monetary policy during the COVID-19 pandemic.Today I will outline the focus Te Pūtea Matua, the Reserve Bank of New Zealand, maintained throughout

our

response

to

the

pandemic

crisis.

Our

legislative

mandate

and

operational independence put us in good stead to act swiftly and with confidence to provide effective assistance in buffering the economic impact of the virus here in New Zealand.The team at the Reserve Bank remained focused on maintaining low and stable consumer price inflation, contributing to maximum sustainable employment, and promoting a sound and efficient financial system.I

also

outline

how

the

Reserve

Bank's monetary and financial policies provided significant mutual support for the Government's fiscal initiatives.

The support was direct through lower interest rates and financial regulatory efforts, and indirect via our market operations.Not all has been plain sailing of course, and I am immensely proud of our team as to how they responded to rapid change with innovation and commitment.New Zealand, like most OECD countries, commenced the pandemic response with nominal interest rates near an effective lower bound.

To be successful in our recent work we were tasked with both building and operating new means of implementing monetary policy.

Our goals remained the same, our tools evolved.In

hindsight, the development of new monetary policy tools was simple, not easy.

It is the communication challenges with our stakeholders and broader public that

remains

work

in progress.As is the case internationally, central bankers must continually explain what they can and can't do - that is, where the limitations of monetary policy rest.

I will conclude by outlining the work we have ahead of us on communication and research, so as to best ensure that the Reserve Bank of New Zealand remains effective and well understood.

## Current Economic EnvironmentThe recent news of the efficacy of several trial vaccines aside, the global economic recovery from the COVID-19 induced recession continues to be highly variable.To date, in New Zealand, the impact of the pandemic has been less dramatic than some of the

extreme

scenarios we envisaged as recently as April 2020.

However, we still faced a historically

large

loss

in

output

and

employment

during

the

year,

with

very

uneven

effects across industries, employment, and demographic and regional groups (Figure 1).Figure 1: GDP and Employment GrowthSource: Stats NZ.Following the initial containment of the virus and the lifting of social restrictions in New Zealand there

has

been

a

rebound

in

domestic

spending

underway.

Considerable

economic uncertainty remains, however, with business investment lagging and significant segments of economic activity stagnant.Until the scientific and distribution solutions for the vaccines are resolved and implemented, we continue to operate in an environment of uncertainty.

It is still assumed by policy makers internationally that the economic impact of the COVID-19 pandemic will be long and variable.

As such, we need to retain a medium-term focus on our efforts, beyond the immediate bounce back in spending that monetary and fiscal policy have provided.Outlined in our most recent Monetary Policy Statement is our view that economic risks are still skewed to the downside. 1

This of course does not rule out upside scenarios; it is more a statement of relative risks.What we are observing internationally, and here in New Zealand, is a scarring on the economy from the impact of COVID-19.

Pervasive uncertainty has dramatically reduced businesses' preparedness to invest and employ.

And, we observe unemployment rising at the same time as increased skill shortages.

Redeploying labour is not a straightforward activity.The impact of the pandemic on peoples' confidence may prove to be the longest lingering impact on the economy. 2Similar to international experience, in New Zealand domestic social restrictions have eased with the containment of COVID-19.

However, international borders remain tightly controlled (Figures 2, 3). 3 41

Monetary Policy Statement November 20202

Ibid.3

Industry, Age and Unemployment Risk During a Pandemic Recession, Graham, J., Özbilgin, M., RBNZ Analytical Note, 2020 (Forthcoming)4

Monetary Policy Statement November 2020Figure 2: Cross-country Lockdown ComparisonsFigure 3}euoTeUse}UySJEAuueThe implications of closed international borders have meant that service export industries, such as tourism, will operate well below capacity for a prolonged period.

This is despite what we are witnessing in New Zealand at present, with Kiwis enjoying 'staycations' as a substitute for international travel; relaxing in our own backyard (Figure 4). 5Demand for New Zealand's education and tourism services is being significantly suppressed by

fewer

international

arrivals.

Prior

to

the

COVID-19

outbreak,

international

tourism

and education accounted for around 6 percent of nominal GDP.

Receipts from these and other services

fell

40

percent

in

the

June

quarter

2020,

and

are

only

being

partially

offset

by increased local spending.This spending weakness will affect incomes in the wider economy for years to come.

An early taste of this will occur in early 2021, when the seasonal influx of international tourists fails to show up at our doorstep.5

Monetary Policy Statement November 2020Figure 4: Current vs. historic net flows in/out of NZWhile there are significant areas of economic stagnation amongst economies globally, many sectors have proved more resilient than expected at the outset of the pandemic.New Zealand economic activity has benefitted from commodity prices and export volumes for our

exports

of

goods

holding

up.

Internationally

people

have

continued

to

demand

New Zealand's soft commodities (Figure 5).

Asset prices globally have also risen, assisted by low interest rates and pockets of significant outperformance in the technology-driven sectors.Figure 5: Commodity Indices & PricesSource: ANZ, Global Dairy TradeDomestic consumer spending has recovered for many goods and services, consistent with patterns internationally (Figure 6). 6

Underpinning the rebound in domestic

spending patterns have been significantly lower interest rates and increased government welfare payments and wage

subsidies.

We

have

also

witnessed

significant

workplace

innovation,

with

many businesses proving adaptable to working from home.

Finally, asset prices have also been on the rise - in equity and residential property markets especially.

In New Zealand, equity in home ownership

is

a

key

component

of

overall

household

wealth.

Rising

house

prices

have increased our perception of wealth and heartened our expenditure.6

Monetary Policy Statement November 2020Figure 6: Electronic card spending 2020The rebound in economic activity from the depths of our recent social-lockdown is pleasing to see.

New Zealand entered the pandemic in a sound economic position, so we should not be overly surprised.

However, downside economic risks will remain as long as the spread of the virus persists.

The virus remains rampant globally, and especially so at present in Europe and the United States - key trading partners.The sustainability of the global economic recovery remains in question.

## Our Policy Response to COVID-19Early in 2020, the Reserve Bank's Monetary Policy Committee (MPC), when confronted with the COVID-19 facts, was quick to significantly ease monetary conditions i.e., lower interest rates.

It

was

very

clear

that

the

virus

posed

a

significant

negative

economic

shock.

The Committee's 'least regrets' approach to policy meant it was better to risk doing too much too soon, than too little too late when it came to easing policy.

The scale and duration of the COVID-19 economic shock was unprecedented and unknown.We were not alone in this action.

Globally, monetary and financial stability policy responses, and fiscal expansion policies, were quickly put to work collaboratively to provide economic support.Across the

OECD countries

the

adopted

policies

were

all

broadly

similar,

including

some combination of: ensuring credit and cash is appropriately affordable and accessible, increased government spending and investment, support for employers to retain their employees and access credit, and enhanced health and economic welfare support.

All countries designed their policy responses for their local conditions, commencing with the tools that were most operationally ready to deploy.While the front-line economic response to the COVID-19 pandemic is fiscal policy, the Reserve Bank of New Zealand provided significant assistance by ensuring interest rates were reduced to a level consistent with maintaining low and stable inflation, and contributing to maximum sustainable employment.Consistent with our dual monetary policy mandate and our financial stability mandate, we acted to support economic and financial activity.

Our actions included:-  Instigating a significant reduction in retail interest rates;-  Ensuring there was ample liquidity for the banking system;-  Supporting the functioning of New Zealand's foreign exchange and debt markets;-  Bolstering community access to cash; and-  Facilitating a variety of Government and industry-led initiatives to allow the financial sector to remain customer-focused.On the latter, the Reserve Bank worked with the Government and financial sector to implement a

mortgage

deferral

scheme,

business

financing

schemes,

and

a

reprioritisation

of

our regulatory

work to

ensure

banks

were

able to

use

their capital to support

their

customers (Figure 7).Figure 7: Mahi Tahi: Working together to ensure cash-flow and confidenceSource: Mahi Tahi: Working together to ensure cash-flow and confidence (PDF 318KB)Our actions assisted the New Zealand economy to remain on track to experience low and stable consumer price inflation, a lower unemployment rate than otherwise, a New Zealand dollar exchange lower than otherwise, and ongoing financial stability.

Our debt and foreign exchange markets also performed robustly and our financial system remains sound.

## Same challenge, new toolsAgain, as in many OECD countries, at the outset of the COVID-19 pandemic New Zealand's nominal interest rates were approaching an effective lower bound.

Globally, as inflation and inflation expectations have declined, so have nominal interest rates.We were forward looking enough during 2019 to initiate thinking on what alternative monetary policy tools are available for us if we could no longer rely purely on the Official Cash Rate (OCR) to deliver our policy goals. 7

Our work assessed the merits of various tools for achieving our monetary policy goals against principles of effectiveness, efficiency, operational capability,7

See: About Alternative Monetary Policy Tools, RBNZ, government balance sheet stability. 8

What we didn't realise at the time is how quickly we would need to use this playbook.And, as in many other OECD countries, we ended up with two jobs to do simultaneously: building and operating new monetary policy tools to achieve our desired monetary conditions.

This multi-tasking has proved more of a communication challenge than an engineering one.We were quick to lower the OCR to 0.25 per cent and commit publicly that it would remain at this level for at least a year.

However, we also committed our local banks to ensuring they would be operationally ready to manage negative wholesale interest rates by the end of this period.

We wanted to provide some immediate certainty to the public about the path of the OCR while also creating future policy optionality - the right but not the obligation to implement a negative OCR if future conditions necessitated this.

We remain true to these commitments.We subsequently implemented a Large Scale Asset Purchase (LSAP) programme aimed at lowering and flattening the New Zealand wholesale interest rate curve.

The purpose of this was to drive retail interest rates lower, to be consistent with our dual monetary policy mandate.

This action has proved effective (Figure 8).Figure 8: Change in New Zealand interest rates (change since beginning of 2020)Source: Bloomberg, interest.co.nz, RBNZNote: Data for business loans reflects the change in the average interest rate on outstanding business loans.

Other rates are based on advertised and market ratesWe

have

more

recently

moved

to

supplement

the

LSAP

programme

with

a

Funding

for Lending Programme (FLP).

The FLP is designed to provide domestic banks with an additional source

of

wholesale

funding

at

interest

rates

commensurate

with

achieving

our

monetary policy mandate.

Lower bank funding costs should embed the retail borrowing and lending costs we need to be successful.Our

communication

challenge

remains

ongoing

despite

the

successful

implementation

of these new monetary policy tools.

We challenge with other central banks. 9The impact of the LSAP and FLP on the government's balance sheet differ to that of moving the OCR up and down to implement monetary policy.

It is this difference that can blur the8

For an overview, see: Navigating at Low Altitude: Monetary Policy with Very Low Interest Rates, Speech by Adrian Orr, Governor RBNZ, March 2020, 

What has central bank independence ever done for us?, Haldane, A., Bank of England Speech, November 2020distinction

between

monetary

and

fiscal

policy

in

the

public's

mind

-

or

in

the

parlance

monetary financing of fiscal spending versus monetary policy quantitative easing .Our LSAP - or quantitative easing - is the Reserve Bank purchasing government bonds in the secondary market to reduce market interest rates.

We will always be limited by how much of this we can achieve through our monetary policy remit.

We must, by law, aim to keep annual consumer price inflation between 1-3 percent and support maximum sustainable employment.

The Government, meanwhile, continues to finance its spending through the issue of fixed term interest bearing government bonds.Monetary financing, by contrast, occurs when government spending is financed by a central bank

being

instructed

to

issue

irredeemable

fiat

non-interest

bearing

liabilities

to

the Government.

This activity sits outside of the Reserve Bank's mandate and is unrelated to the Bank's inflation and employment remit.Our new tools remain purely for the purpose of ensuring interest rates in New Zealand are consistent with achieving our mandate.

The LSAP and FLP instruments - like the OCR - can be altered to achieve our legislated purpose.

Their design and implementation remain at the call of the Monetary Policy Committee.Many other central banks have taken similar approaches in dealing with impact of COVID-19, albeit starting from a different market structure.

For instance, the Reserve Bank of Australia and Reserve Bank of New Zealand have now both entered large-scale asset purchases and funding

for

lending

programmes. 10

We

have

also

both

provided

significant

liquidity

to

the financial markets to ensure orderly functioning.

And we have both reduced the OCR to a rate near zero, with forward signalling data dependent. 11Another common theme in New Zealand, the UK, Australia, Canada and the United States has been the pros and cons of using negative official interest rates (e.g., a negative OCR) relative to other monetary instruments.

We focused on being operationally ready to implement a negative OCR if necessary.

Its actual use will always depend on the economic context at the time, and its relative efficacy.

## Selecting the appropriate policy mixThe past few months have shown remarkable adaptability and resilience by policymakers internationally, and in New Zealand.

As is appropriate, starring in the times of COVID-19 have been health, fiscal, and regulatory policy responses.When economic confidence is low, governments are able to directly spend and invest, and ensure

that

economic

resources

are

mobilised

and

redeployed.

In

New

Zealand,

the Government has supported households and businesses directly by helping people maintain access to credit and cash flow - through business credit schemes and income support - and assisting ongoing employment via wage subsidies (Figures 9, 10). 12Our research suggests that the Government's wage subsidy scheme significantly improved job

retention

by

approximately

2.5%

of

the

total

labour

force. 13

The

scheme

also

most10

Monetary Policy in 2020, Debelle, G., Speech to the Australian Business Economists Webinar, November 2020, 

Ibid.12

Financial Stability Report (FSR), RBNZ, November 202013

Industry, Age and Unemployment Risk During a Pandemic Recession, Graham, J., Özbilgin, M., RBNZ Analytical Note, 2020 (Forthcoming)benefited

those

in

the

service

sectors

which

is

heavily

dependent

on

female

and

younger workers, some of the most vulnerable to economic downturns. 14Figure 9 Number of jobs covered by wage subsidy scheme181614°°:820-Mar17-Apr15-May12Jun10Jul\_™Originalm=ExtensionResurgence07-Aug04-Sep02-0Source:Ministry ofSocialDevelopmentmMinistryDevelopment,

## Employment and Labour market ConnectednessOverall, to date, the New Zealand labour market has proved relatively resilient to the COVID19 economic shock.

This positive outcome can be explained by both the Government's fiscal measures and other factors such as: 15-  Labour shortage existed prior to the COVID-19 outbreak;-  Domestic spending resumed rapidly after social restrictions were eased, suggesting that a critical mass of New Zealanders were sound financially; and-  Businesses favoured reducing the paid hours worked, rather than reducing the numbers employed, due to the temporary nature of the lockdowns (Figure 11). 16The easing in monetary conditions also had a significant role to play in retaining jobs.

When setting

monetary

conditions,

the

Monetary

Policy

Committee

was

kept

aware

of

the Government's fiscal policies' purposes and desired impacts.

We were thus able to calibrate our response appropriately.

Coordination worked well.The most recent New Zealand data shows annual consumer price inflation currently at 1.4% (compared

to

our

1-3%

target

range)

and

the

unemployment

rate

is

at

5.3%

(above

our estimate consistent with maximum sustainable employment). 17We estimate that in the absence of our recent monetary policy actions, unemployment would be higher still (nearer 6.0%), inflation expectations would have continued to decline, and the New Zealand dollar trade-weighted exchange rate would have risen by around 7%. 18

In other words, monetary policy has been effective to date in supporting both inflation and employment as intended - at least at the aggregate level.14

Ibid.15

Drawing on internal RBNZ analysis, T.

Bohm, 202016

Internal RBNZ analysis, 202017

Monetary Policy Statement November 202018

Internal RBNZ analysis, 2020Figure 11: Employment rate and hours workedManaging the dual mandate - inflation and employmentTo date, there has been no need to consider any trade-off between meeting our employment and

inflation

targets.

Both

employment

and

inflation

have

been

below

our

target

remit, necessitating an easing in monetary conditions.

However, we have had to remain humble in our ability to both assess and influence the level of employment in the face of the COVID-19 economic shock.The COVID-19 economic impact has seen economic output across sectors of the economy, and

employment,

vary

considerably

(Figure

12). 19

We

are

seeing

some

sectors

of

the economy experience labour and specific skill shortages, while other sectors are experiencing layoffs and surplus labour.It is unlikely these supply and demand issues are going to be resolved quickly - as not all people are alike and labour mobility is constrained.

People live in their communities.

As a result, we are likely to see longer-term unemployment become embedded side-by-side with labour shortages at the national level.Figure 12: Employment by Industry - change since March quarter 2020Source: Stats NZ, RBNZ estimates.Preliminary

research

also

indicates

that

downturns

in

employment

last

a

lot

longer

than downturns in output.

Even if economic activity picks up over 2021, unemployment will remain19

Monetary Policy Statement November 2020elevated for quite some time. 20

And certain demographic and ethnic groups are more likely to experience

the

lingering

negative

effects

of

the

current

recession

than

others.

This

effect occurs due to location, skills training, experience in the labour market, and broader roles in society such as caring for dependents.

For example, we already observe that:-  The

pandemic

shock

has

disproportionately

affected

the

service

sector

in

many economies, with New Zealand as no exception.

It is the service sector that employs most youth.-  Younger workers are also likely to have lower wages and less savings (Figure 13). 21

And their labour market separation rates (redundancy

or leaving the workforce) are considerably higher than those of older people. 22 23-  There is a greater impact on female than male unemployment during economic downturns (Figure 14). 24 And,-  Maori and Pasifika are much more negatively exposed to labour market fluctuations than Europeans (Figure 15). 25 26Figure 13: COVID-19 Employment Impact by Age (change March quarter 2020 to September quarter 2020)Figure 14: COVID-19 Employment Impact by Sex (change March quarter 2020 to September quarter 2020)Figure 15: Increase in Jobseeker/COVID-19 Income Relief Payment numbers February to October 2020 vs. Indicative Share of Working-age PopulationThe economic impact of the COVID-19 is also geographically uneven.In

New

Zealand,

less

populated

regions

have

been

more

exposed

to

labour

market fluctuations than the large regions, in large part due to industry concentration. 27 There is also evidence that this geographical variation can have a 'contagion' effect, whereby unemployment in one region may spill-over to other regions. 28 29

For instance, in New Zealand there is a strong link between two neighbouring - densely populated - regions, Auckland and Waikato.

Jobs created or

lost

in

one

region

leads

to

the

same

in

the

other

region

due

to connectedness. 30What this work confirms is that the concept of 'maximum sustainable employment' is complex and context dependent.

This is why we rely on a suite of measures to understand whether we are at or near our optimal monetary policy setting.This complex relationship between output and employment underpins why many central banks are now adjusting their policy decision-making to remain 'lower for longer'. 31

Central bankers are increasingly wanting to stare employment in the whites of the eye before making their decision.It

is

also

why

we

believe

it

is

better

to

do

all

we

can

to

avoid

lower

inflation

and

higher unemployment in the first instance, consistent with our Monetary Policy Committee's 'least regrets' strategy.The Reserve Bank's dual mandate - of price stability and maximum sustainable employment -has ensured we remain cognisant of the impacts of our activities, and that our dual mandate27

COVID-19 and the Labour Market: What can history tell us, Markham, S., Özbilgin, M., Robinson, F.

RBNZ Discussion Paper, 2020 (Forthcoming)28

Regional Labour Market Spillovers, Haworth, C., RBNZ Analytical Note, 202029

Changes in employment levels in one region can affect other regions, though the impact varies around the country e.g. changes in unemployment in the North Island may affect the rest of the country more than changes in unemployment in the South Island.30

Regional Labour Market Spillovers, Haworth, C., RBNZ Analytical Note, 202031

New Economic Challenges and the Fed's Monetary Policy Review, Jerome H.

Powell, Speech delivered to economic policy symposium, Jackson Hole, Wyoming (August 2020).

See:

proving

welfare

enhancing. 32

Furthermore, Bank of England research shows that easier monetary

policy

after

the

Global

Financial

Crisis

in

2009

had

significant

welfare

benefits, making the majority of households better off. 33

## Monetary Policy needs FriendsMonetary policy is a blunt tool and best used for the specific purposes outlined by our remit.

There will always be trade-offs when implementing policy, and these must be understood and managed appropriately with the right tools.The Monetary Policy Committee has acted decisively to ensure we head off unnecessarily low inflation or deflation, and unnecessarily high and persistent unemployment resulting from the COVID-19 economic shock.

Our remit has appropriately necessitated low nominal interest rates.Consistently

below-target

inflation

creates

significant

challenges

that

are

best

avoided.

Persistent low inflation can reduce inflation expectations and lead to a deflationary spiral.

At an extreme, a falling general level of prices will significantly hinder economic activity, as people delay their spending in the belief that things will forever be cheaper in the future.

The real (inflation-adjusted) value of debt will also rise, making debt servicing and repayment ever more difficult.However, while low real interest rates are good for investment and employment, they can prompt undue financial risk-taking by people seeking higher nominal yields for their savings.

Taking on more

risk (perhaps unwittingly) for more

returns can promote

financial vulnerabilities.As a full service central bank - that is undertaking financial policy in addition to monetary policy

-

we

are

very

cognisant

of

the

financial

stability

risks

that

can

arise.

We

have highlighted the actual and potential risk-taking issues in Financial Stability Reports over many years.

We

have

also

discussed

the

importance

of

financial

literacy,

financial

institutions' conduct and culture, the benefits of collaborative fiscal support, and the importance of a deep and broad capital market to promote financial soundness.

There is a broad base of work to be done in New Zealand in this area.

## Impact on house pricesA case in point is the challenge New Zealand has with house prices.We recently received a letter from the Minister of Finance seeking our views on ways the Government and the Reserve Bank of New Zealand can work together to address the issue of rising house prices. 34

The letter outlines, amongst other things, the role that low interest rates have had on household investment decisions, leading to increased housing activity and house prices.

We will respond to the letter with careful consideration, outlining the trade-offs that exist and what we can do to assist.The

Monetary

Policy

Committee

takes

asset

prices

(household

wealth)

into

consideration when assessing its policy decisions.

The 'consumption' of housing is also captured in the32

Economic welfare and a dual mandate for monetary policy in a small open economy, Jacob, P., Özbilgin, M., 2020 (Work in progress)33

Philip Bunn, Andrew G Haldane & Alice Pugh, 'Has monetary policy made you happier?', Staff Working Paper No. 880 (July 2020).34

Hon.

Grant Robertson, Letter to RBNZ Governor, 24 November 2020 Price

Index,

including

rents,

rates,

construction

costs,

and

housing

transaction costs. 35

And, we acknowledge that lower real interest rates make residential mortgages more affordable, tempting increased housing purchases and building.However, there are many other factors impacting on house prices outside of the Monetary Policy Committee's influence.

A historic undersupply of housing and restrictions on land supply are

two

widely

acknowledged

issues.

More

recently,

with

the

impact

of

COVID-19, employment prospects have also tended to remain more positive for the traditional homeowning age group, compared to youth.

And, Kiwis who were living overseas returned home in the early stages of the COVID-19 pandemic, and fewer have left since, hence more housing demand. 36Access to affordable housing is an important issue for New Zealand's economic wellbeing, and we are pleased to be requested to assist the Government's thinking on this issue.

## Distributional impact of monetary policyThe impact of monetary policy decisions on wealth and income equality is another important topic for considering overall economic wellbeing.

As Janet Yellen recently noted, despite the fact that the tools of monetary policy are generally not well-suited to achieve distributional objectives, it is nevertheless important that policymakers understand and monitor the effects of macroeconomic developments on different groups within society. 37Here at the Bank we have undertaken an assessment of the international literature on the distributional impacts of monetary policy on wealth and income.

Our work highlights that it is unclear

whether

looser

monetary

conditions

(i.e.,

lower

real

interest

rates)

increase

or decrease income and wealth inequality, on net.

In theory, lower interest rates are capable of both, and empirical studies on this issue are inconclusive.There are four broad means by which monetary policy can have wealth and income distribution impacts (Figure 16). 3835

Items directly reflecting the housing market account for just under 20% of New Zealand's current CPI basket, up from around 15% three years ago.

These items reflect rent and building costs.

Other housingrelated items, such as rates and household appliances, account for about a further 10% of consumers' typical spending basket.36

Monetary Policy Statement November 202037

Macroeconomic Research After the Crisis, Remarks by Janet L.

Yellen at the 60 th

annual economic conference sponsored by the Federal Reserve of Boston, October 14, 2016, Distributional Impact of Monetary Policy , Leong, J., RBNZ 2020 (Work in progress)Figure 16: Transmission Channels of Distributional Impacts in the Empirical LiteratureThe direct wealth channels include:- -Savings redistribution : lower interest payments on debt make net borrowers better off and net savers worse off.

Since lower income households are more likely to be net borrowers, looser monetary policy is likely to decrease wealth inequality.- -Portfolio

composition :

lower

real

interest

rates

increase

asset

prices,

including

house prices.

The overall impact of looser monetary policy on wealth inequality depends on the composition

and

distribution

of

assets

across

the

wealth

distribution.

In

New

Zealand, home ownership is more broadly distributed across net worth quintiles than are financial assets. 39The indirect income channels include:- -Earnings

variation

channel :

the

earnings

of

lower

income

households'

are

determined mostly by: (a) whether they are employed, and if so, (b) the hours they work per week.

In contrast, higher income earners are mainly affected by the rate of their hourly wages.

This means that expansionary monetary policy tends to benefit lower income households most through lower unemployment.- -Income

composition

channel :

By

lowering

unemployment,

lower

interest

rates

tend

to support the incomes of wage earners' more than of those who rely mainly on business profits and capital income.

Again this would tend to reduce income inequality, especially for middle income earners whose main form of income are wages.Empirical studies globally looking at the overall net effects of looser monetary policy on wealth and income inequality have produced mixed results.While the necessary data is limited for New Zealand, we intend to push forward on this work in our research agenda.

Of course, none of these observations are reasons for a government to be unconcerned, or for policy makers to not carefully analyse the data.

Issues arising from39

'The composition of assets varies over the net worth distribution…[r]eal estate is a higher proportion of assets of low and middle net worth households.

The wealthiest twenty percent of households hold mostly financial assets, although this will include real property that is held in businesses and trusts' Reference: Pg. 11, Tax Working Group, Information Release, Distributional Analysis , September 2018, and income inequality need to be understood and, if necessary, managed with the appropriate interventions.

## ConclusionToday we have traversed a lot of issues.

The economic environment, the roles of monetary and

fiscal

policy,

the

challenges

of

building

and

operating

new

monetary

tools,

and

the perennial

concerns

related

to

excessive

financial

risk

taking,

and

income

and

wealth inequality.We have been reminded that with low global inflation and hence low neutral interest rates, our new monetary policy tools will become increasingly mainstream.

And that these new tools do not mean we have new targets or policy objectives.

Price stability and contributing to maximum employment remain the targets for monetary policy.We have also been reminded that fiscal and monetary policy coordination remains critical to economic

wellbeing.

In

New

Zealand

our

institutional

relationships

are

strong,

providing complementarity of fiscal and monetary actions.

This collaboration has been supported - not deterred - by clarity around the Reserve Bank's purpose and operational independence.

Work must be done to ensure that the operational aspects of our new monetary tools do not interfere with this clarity.Finally,

we

have highlighted how important it is to have clarity and collaboration on fiscal, monetary and financial policy when considering equity and distributional aspects within an economy.Monetary policy decisions appropriately target aggregate measures - inflation and maximum sustainable employment - while being attuned to equity considerations of our policy actions.

However, we do not have the tools to manage any desired equity implications of our actions.

There are additional decision-makers and tools for such tasks.

That said, these are complex and ambiguous issues, and at the Reserve Bank a lot of work is ongoing to understand the transmission mechanisms for, and the wider implications of, monetary policy, particularly in relation to the new suite of tools I have just mentioned.Thank you for listening and for the privilege of delivering this speech.