A least regrets
approach to
uncertainty:
Hawks, Doves and the
White Heron (he Kōtuku)
By Christian Hawkesby, Assistant Governor
Written with Ashley Dunstan and Ngarimu Parata
Text finalised 15 September
Introduction
For a long time it has become common for followers of monetary
policy to categorise central banks as 'hawks' or 'doves', and for their
decisions to be seen as 'hawkish' for signalling higher interest rates
or 'dovish' for signalling lower interest rates.
In Aotearoa, New Zealand, our equivalent bird life are the kahu (the harrier hawk) and the kererū
(the wood pigeon).
But when it comes to making monetary policy decisions under uncertainty, it may be that the
kōtuku (white heron) provides a much more fitting metaphor.
In Māori culture, there are two whakataukī (proverbs) involving the kōtuku that capture how its
behaviour must change depending on the environment, outlook, risks and uncertainties:
"Tapuwae kōtuku" refers to taking "considered steps".
•
"He kōtuku rerenga tahi" is loosely translated as "a white heron's flight is seen but once", and
•
can also be interpreted more generally as a call that "once ready, open your wings and commit
to flight".
In this speech, I would like to:
Outline the types of uncertainties that we face when navigating monetary policy decisions.
•
Introduce a risk management approach to bring together these uncertainties into our
•
decision making.
Illustrate how we applied this "least regrets" approach over the past 18 months in response
•
to the threat to our mandate from COVID-19.
Reflect on what we have learnt about the economy over the past 18 months during COVID-19,
•
and how this influenced the outlook for monetary policy published in the August Monetary
Policy Statement (MPS).
Return to the kahu (harrier hawk), kererū (dove) and kōtuku (white heron) to relate this all back
•
into a metaphor for our least regrets approach, and how this helps us navigate uncertainty.
However, first, let's start at the beginning, with the Bank's purpose and mandate, which ultimately
guides all our monetary policy decisions.
Purpose, Mandate and Monetary Framework
Our purpose at Te Pūtea Matua is to enable prosperity and wellbeing for all New Zealanders: Toitū
te Ōhanga, Toitū te Oranga.
Monetary policy contributes to this purpose by providing stability in the general level of prices and
supporting maximum sustainable employment. This dual mandate is captured as the operational
objective set out in the Remit of our Monetary Policy Committee.1
Our main monetary policy tool is the Official Cash Rate (OCR). The seven members of the Monetary
Policy Committee (MPC) decide where to set the OCR. More generally, as banker to the banking
system and Crown, we have the ability to influence the current and expected level of interest rates
in the economy, in pursuit of achieving our mandate.
Given the many months that it takes for changes in interest rates to impact economic activity,
employment and inflation pressures, we are forced to continually look into the future.
For the past 30 years now, the Bank has practiced what is commonly called "forecast targeting"
when making monetary policy decisions.2
Applying this approach, we develop economic projections to assist our current monetary policy
decisions, and provide a clear sense of the likely direction, magnitude, and timing of future decisions.
The Monetary Policy Statements that we publish quarterly use these economic projections to explain
our policy decisions and to reinforce our commitment to achieving our targets.
Typically, the projections we publish will show that we are taking actions now to give us confidence
that we will achieve our mandate in 18 to 24 months' time, when the full effects of our actions work
through the economy.
The Role of Uncertainty in Monetary Policy
We are very aware that there is uncertainty around any projection for the economy - the outlook
could turn out to be better or worse than our forecast.
Former Chairman of the US Federal Reserve, Alan Greenspan, summed it up nicely when he
said, "uncertainty is not just a pervasive feature of the monetary policy landscape; it's the defining
characteristic of the landscape".3
The uncertainties faced when setting monetary policy are typically placed in three different
categories4:
The first challenge is gaining an understanding of the
The starting point for the economy:
•
current state of the economy. Economic data measuring the overall state of the economy are
sometimes subject to significant revisions and often released with a long delay. Furthermore,
many of the variables that guide our policy decisions are not measured with precision. For
example, we assess the level of maximum sustainable employment based on a wide range of
imperfect indicators.
The structure of the economy: The way economies behave, including how the economy
•
responds to our policy decisions, are the result of thousands of complex decisions by
individuals, households, businesses, financial institutions and government agencies. Even
where the structure of economic relationships is widely accepted, there is uncertainty about
the speed and strength of these relationships. The structure of an economy can also change
through time.
Finally, the outlook for the economy is always subject to news and events.
Future events:
•
That is a key reason why we update our projections every 3 months. It is just a reality that
unexpected developments will occur that force us to reassess the outlook. The outset of
COVID-19 or the timing of the Global Financial Crisis (GFC) are more extreme example of this.
However, in practice, many different shocks will hit the economy over time, from floods or
droughts to international events or changes in technology.
There are a couple of main ways that we incorporate an appreciation of uncertainty into our
longstanding "forecast targeting" approach.
The first is to emphasise that our projections are a communication device and decision-making
tool, rather than a crystal ball.
Our projections provide us with an opportunity to explain the underlying assumptions we are
making about the economy, and how the outlook might change under different assumptions.
This approach is intended to provide the public and financial markets with a more complete guide
to how we are likely to react in the future. This helps them to more accurately gauge the monetary
policy outlook as new information comes to light, whether good or bad news.
Second, our published projections typically assume that we will move interest rates on a smoothed
path. This reflects the fact that the economic outlook and the required path of interest rates are
uncertain, and a smoothed path for interest rates can provide more time to assess our assumptions
about the economy before taking policy actions.
In other words, our central projections are designed to deliver small considered steps - tapuwae kōtuku.
Risk Management and a Least Regrets approach
When it comes to lessons from the academic literature, there are no hard and fast rules about how
to make monetary policy decisions that are robust to periods of heightened or extreme uncertainty.
The earliest theoretical research suggested taking small steps was most appropriate, but
subsequent research has found a range of circumstances where it is appropriate to make large
and rapid changes in the policy stance, highlighting that the answer depends on the specific
circumstances.5
While the academic literature is mixed, there is, however, a long tradition among central banks
globally of applying a risk management approach to monetary policy decisions under uncertainty.6
Although most of the time actions will be based on the central bank's view of the most likely
outcome for the economy, a common feature of these risk management approaches is that policy
will occasionally be set to mitigate the risk of a very bad outcome for the economy that threatens
the central bank's ability to achieve its mandate.
Indeed, research of the decisions made by the US Federal Reserve show traits of this type of risk
management approach in around 25 percent of cases between 1987 and 2008.7
In the same spirit of these risk management approaches used by central banks globally, in recent
years our Monetary Policy Committee at Te Pūtea Matua has developed a language around its
"least regrets", to complement the signals from our published central projections.
This least regrets approach is a way to test that our policy stance provides a high degree of
confidence that our mandate of low and stable inflation and maximum sustainable employment will
be achieved across a range of possible scenarios for the economy, particularly during periods of
rapid change in the economic outlook and heightened uncertainties.
It involves identifying the most likely ways that the economy could evolve differently than in
our central view, and what our mandate implies about our "regret" if these risks eventuate. The
language of least regrets - the mirror of maximising our chances of success - conveys our humility
about being able to accurately predict the future.
It's important to emphasise our least regrets approach is not designed to be applied in a rigid or formulaic
way. Rather, it is where the science of macroeconomics meets the art of policy decision making.
Applying a Least Regrets through our COVID response
To bring this to life, I would now like to turn to how we have applied this approach over the past 18
months in response to the threat from COVID-19 to our ability to achieve our mandate.
The COVID-19 virus, and the response by governments to manage the health impacts, were an
unprecedented shock to the starting point for the global and domestic economy. Along with other
forecasters, through the first phase of the crisis, we faced substantial uncertainty about the impact
on the New Zealand economy.
However, our judgement was that the size of the starting point shock was significant, and the risks
were skewed towards a further material deterioration in the economy, presenting a significant
threat to our employment and inflation mandates. We published scenarios for the economy that
involved unemployment reaching between 8 and 12 percent, and an extended period of inflation
below 1 percent (figure 1).
Figure 1
Scenarios for the unemployment rate and inflation from May 2020 MPS
Unemployment Inflation
Source: Stats NZ, RBNZ estimates.
7 This statistic is based on Evans (2015), who review the minutes of the meetings of the Federal Open Market Committee for evidence that the
Committee appealed to uncertainty to justify positioning the funds rate at a different level than implied by the staff forecasts alone. 31 out of 128
minutes included an appeal to uncertainty, while 14 out of 128 minute cited insurance against adverse outcomes being an important consideration
in the stance of policy. Along with Caggiano et al (2017), the paper also provides formal empirical evidence that the Fed sometimes takes risk
management considerations into account in its policy decisions.
Our fear was that the need to shut down the economy to avoid a health crisis could create a
deep and prolonged recession. There was a risk that the downturn in the economy could create
a vicious circle, where weakening household and business finances and declining asset prices
hampered any recovery. And although we had confidence in the resilience of our banking
system, the impact could have been worsened if financial institutions became overly cautious and
restricted access to credit to households and businesses.
As a result, there was a significant threat to maximum sustainable employment if these fears
materialised. A protracted downturn in the labour market could have resulted in permanent labour
market scarring where unemployed workers find it difficult to re-enter the labour market once the
economy recovers.8
Furthermore, after around a decade of CPI inflation being below the 2 percent mid-point of our
target range, we were also concerned that inflation expectations could become unanchored
below our target. In an environment of already low interest rates, the looming threat of deflation
had the potential to seriously reduce our ability to stimulate the economy in order to achieve our
employment and inflation mandate.
In response to these factors, during the early phase of COVID-19 the MPC decided that "a least
regret approach is needed, delivering stimulus sooner rather than later, and thus minimising the
risk that the stimulus delivered turns out not to be enough".
During the early phase of COVID-19 the Monetary Policy
Committee decided that "a least regret approach is needed,
delivering stimulus sooner rather than later, and thus minimising
the risk that the stimulus delivered turns out not to be enough".
This strategy involved rapidly cutting the OCR by 75 basis points to 0.25 percent in March 2020,
committing to keep it at that level for at least 12 months, and launching an alphabet soup of
schemes and facilities designed to keep interest rates low and the financial system functioning.9
As we progressed further through 2020 and into early 2021, we had a considerable amount of
monetary stimulus in place to support our objectives, and the immediate economic impact of the
virus was less severe than we had feared.
Nevertheless, we continued to judge the risks to the economy were biased to the downside. In
particular, we faced uncertainty about the extent of the global economic recovery following the
emergence of COVID-19. It was also unclear how the domestic economy would cope with the
expiry of Wage Subsidy support, and the absence of international tourists through the traditional
peak summer period.
In response to these developments, by February 2021 the Committee reformulated its least regret
by agreeing that "it would not change the stance of monetary policy until it had confidence that it is
sustainably achieving the consumer price inflation and employment objectives".
By February 2021 the Committee reformulated its least regret
by agreeing that "it would not change the stance of monetary
policy until it had confidence that it is sustainably achieving the
consumer price inflation and employment objectives".
A Least Regrets approach 18 months through Covid-19
Fast forward to the current period, and we are now able to draw from almost 18 months of
experience about how COVID-19 affects the New Zealand economy, and the lessons we have
learnt about its impacts on both the demand and supply side of the economy.
On the demand side, the early discovery of vaccines against COVID-19 has supported a
strongerthan-expected recovery in the global economy (figure 2).
Figure 2
Economic recoveries in selected trading partners
(as at February 2020, level of expenditure GDP indexed to 2019Q4, seasonally adjusted)
Source: Haver Analytics, Stats NZ.
More generally, demand for our goods exports has fared much better than during previous global
downturns. The impact of COVID-19 has seen a shift in global demand away from services such as
travel and tourism towards goods, including the dairy, meat and seafood exported by New Zealand.
We have also benefited from a robust recovery in the Chinese economy, our largest trading partner.
Equally important, has been the resilience of demand within New Zealand's closed borders.
Initial health measures were able to largely contain the virus, with most households and businesses
able to return to more normal activities in a space of time that was shorter than feared.
Together, monetary and government spending policies have supported a strong recovery in
spending. The government's Wage Subsidy Scheme is a policy that has been particularly effective
in supporting the wider recovery.
By supporting business income, it has allowed many businesses to maintain staff levels and has
provided confidence in job security. As a result, at a national level household incomes were
largely maintained through COVID-19 lockdown periods. This has provided a financial buffer that
has helped to stimulate spending when households have emerged from lockdowns. Business
investment has also picked up as the economy has recovered.
The recovery phase has also seen house prices grow rapidly from already elevated levels.
This is partly explained by the stronger than expected domestic economy and associated
improvement in job security. Looking ahead, we see the level of house prices as unsustainable
relative to their fundamental drivers, and have tightened our macro-prudential settings to limit
risks to financial stability.10
While the demand side of the economy has been more resilient than expected when COVID-19
arrived, the disruption to the supply side of the economy has also been more prolonged than
anticipated.
It has been much harder and more expensive to source finished and intermediate goods from
overseas and within New Zealand. There have been significant disruptions to supply chains,
particularly related to the shipping industry.
COVID-19 has also made it more difficult for firms to source labour.
The highly uneven impacts across sectors - with the tourism and customer-focussed sectors
hardest hit - have made it harder to match employers and employees. International evidence has
also illustrated a hesitancy of some to return to the workforce after periods of lockdown, especially
in customer facing roles. Along with reduced access to migrant workers, these developments are
likely to have reduced the level of maximum sustainable employment.11
All of these factors limit the productive capacity of the economy. Given the emergence of more
transmissible variants of COVID-19, disruptions to the movement of goods and people globally
looks more likely to continue over the medium term, even once a significant proportion of the
global population is vaccinated.
In response to these lessons on the impact of COVID-19 on both the demand and supply side of
the economy, in the latest Monetary Policy Statement we noted that we had more confidence that
employment was already at its maximum sustainable level (Figure 3) and that pressures on capacity
would feed through into more persistent inflation pressures over the medium-term (Figure 4).
Figure 3
Indicators of Maximum Sustainable Employment (MSE)
Source: Stats NZ, MBIE, ANZ, NZIER, RBNZ estimates.
Figure 4
Measures of core inflation
Source: StatsNZ, RBNZ estimates.
In response, the Committee agreed that their "least regrets policy stance is to further reduce the
level of monetary stimulus so as to anchor inflation expectations and continue to contribute to
maximum sustainable employment."
In August 2021, the Committee agreed that their "least regrets
policy stance is to further reduce the level of monetary stimulus
so as to anchor inflation expectations and continue to contribute
to maximum sustainable employment".
This formulation of our least regrets signalled a return to being guided by our central projections
and how these evolve with new information (Figure 5), aided by:
a better understanding of the starting point of the economy,
•
more balanced risks to the outlook, and
•
the threat of consumer price deflation having abated.
•
Finally, the Committee also noted that whether or not a monetary policy response would be
required in response to future health related lockdowns would depend on whether there was a
more enduring impact on inflation and employment. This will involve continuing to deepen our
understanding of the persistent impacts on both demand and supply.
We are in a good position to navigate the period ahead, with the labour market operating at
maximum sustainable employment, inflation expectations well-anchored at our target, and financial
markets functioning well.
Annex 1 outlines how the Committee's least regrets evolved through time in relation to its
assessment of the economic environment.
Figure 5
Official Cash Rate projections
Summary: The hawk, dove, and
white heron (he kōtuku)
Finally, lets return to the kahu (harrier hawk), kererū (dove) and
kōtuku (white heron) to relate this all back into a metaphor for our
least regrets approach, and how this helps us navigate uncertainty.
For a long time, followers of monetary policy have developed a shorthand to categorise central
banks and central bankers as either 'hawks' or 'doves'.
The origins of these terms can be traced back to descriptions used to capture the attitudes of
leaders to war, with a hawk more inclined to go to war, and a dove more inclined to seek peace.
In the midst of the Vietnam War, these terms found their way into monetary policy and were used in
the minutes of a US Federal Reserve meeting in May 1966.12 In this context, a hawk was determined
to bring inflation down by having interest rates higher than otherwise, and a dove more inclined to
tolerate bouts of higher inflation with a preference to keep interest rates lower than otherwise.
As time has passed and inflation has remained relatively low and stable for past 25 years, this
original definition has evolved into a shorthand used by market participants where any decision
by a central bank that results in interest rates higher than expected is "hawkish" and any decision
where interest rates are lower than expected is "dovish".
In Māori culture, the hawk (kahu) and the dove
(kereru or native wood pigeon) both have
prominent roles.
The kahu represents strength and dominance
as the most powerful bird in the environment.
The kererū represents eternal life, and was
once traditionally offered as a sacrifice to
Papatuanuku (the earth mother) to promote life
and growth in the forest of Tane Mahuta. For
these reasons, the feathers of both the kahu
and kererū are highly regarded and prominent
on the Korowai (cloak) of Māori chiefs.
However, when it comes to our approach
to making monetary policy decisions under
uncertainty, it may be that another bird - that
is also sought after on the cloaks of chiefs -
provides a more fitting metaphor: the kōtuku
(white heron) that adorns our $2 coin.
A key feature of our least regrets approach
is responding to the environment, risks and
uncertainties, including:
the starting point of the economy,
•
the balance of risks, and
•
threats to achieving our mandate.
•
It requires an approach that is adaptable, sometimes moving with caution in slow, small steps, and
other times moving with confidence, quickly in large steps to remain successful.
In Māori culture, there are two whakataukī (proverbs) involving the kōtuku that capture this trait of
responding to the environment around you.
The saying "he kōtuku rerenga tahi" loosely translates to "a white heron's flight is seen but once".
This whakataukī expresses an idea that "once ready, open your wings and commit to flight".
Applying this to the protocols of a marae (meeting house), it is used as a reminder that when it is your
opportunity to speak, you may only get one chance, so you must take your chance and be bold.
In the world of setting monetary policy, this proverb translates to those times when:
the outlook for the economy has been subject to large and uncertain changes,
•
the risks are heavily skewed in one direction, and
•
there is a material threat of not achieving your mandate.
•
In that situation, the path of least regret is to move quickly and take large steps to provide more
confidence that policy settings will be appropriate if the risks to the outlook eventuate. As
described above, this approach is consistent with our actions (and other central banks globally)
through the early stages of COVID-19.
By contrast, the saying "tapuwae kōtuku"
signifies a different mode of operation.
It translates roughly to "considered steps",
and is an expression often used to describe
the way to walk as a visitor onto a marae. The
idea is to take small considered steps as you
assess the environment around you. You are
walking in the right direction, but slowly in case
your assessment changes quickly (are your
hosts friends or foes?).
In the world of setting monetary policy, this translates to having confidence in the outlook for the
economy, and inching in the right direction based on how the economy is likely to evolve. This is
consistent with the observation that when there is a typical amount of uncertainty, and the risks are
evenly balanced, then central banks globally tend to follow a smoothed path and keep their policy
rate unchanged or move in 25 basis point increments.
There is another reason that the kōtuku is prominent in Māori culture.
In traditional Māori oral history, around 1000 years ago Kupe is said to have journeyed from
Hawaiki, the ancestral homeland of Māori, to become the first person to navigate the dangers and
challenges of Te Moana-nui-a-Kiwa (the Pacific Ocean) and discover Aotearoa, New Zealand. The
kōtuku is associated with Kupe in artwork capturing the significance of his journey.
At Te Pūtea Matua, it is the role of the Monetary Policy Committee to navigate the right settings
for monetary policy to achieve our mandate for low and stable inflation and contributing to
maximum sustainable employment. This is our best contribution to the ultimate purpose of the
Reserve Bank, which is to enable prosperity and wellbeing of all New Zealanders: Toitū te Ōhanga,
Toitū te Oranga.
Along the way, we need to steer our way through uncertainties and threats to our mandate from
the evolving economic environment. Our least regrets approach is one tool to navigate these
judgements.
References
Bannister, G, Finger, H, Yosuke, K, Siddharth, K & Loukoianova, E (2020) ' Addressing the
Pandemic's medium-term fallout in Australia and New Zealand', IMF Working Paper, 2020/272.
Brainard, W (1967) 'Uncertainty and the effectiveness of policy', American Economic Review, 57(2),
pp 411-25.
Caggiano, E Castelnuovo and G Nodari (2018) 'Risk management-driven policy rate gap',
Economics Letters, 171, pp 235-238.
Conway, P (2000) 'Monetary policy in an uncertain world', Reserve Bank of New Zealand Bulletin,
63:3, pp 5-15.
Evans, C, Gourio, F, Fisher, J., & Krane, S (2015) 'Risk management for monetary policy near the
zero lower bound' Brookings Papers on Economic Activity, Spring 2015, pp. 141-219.
Evans, C (2019) 'On risk management in monetary policy', Federal reserve Bank of Chicago speech.
Ferrero G, Pietrunti, M & Tiseno, A (2019) 'Benefits of gradualism or costs of inaction? Monetary
policy in times of uncertainty', Bank of Italy Temi di discussione, 1205.
Greenspan, A (2004) 'Risk and uncertainty in monetary policy', Federal Reserve Board speech.
Hawkesby, C (2020) 'COVID-19 and the Reserve Bank's Balance Sheet', Reserve Bank of
New Zealand speech, delivered on 20 August.
Kaminska, I (2014) 'What's with the doves and hawks', Video published by the Financial Times,
available at http://www.ft.com/video/62d5bfc4-3b89-39ca-97bf-c19d6fe097fc
Kay, J and King, M (2020) 'Radical Uncertainty: Decision-making beyond the numbers'.
Poloz, S (2020) ' Dealing with exreme uncertainty', Bank of Canada speech.
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New Zealand Bulletin, 82:3.
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Australia speech.
Annex 1: Summary of least regrets monetary policy since the arrival of COVID-19
Source of Immediate post- Initial recovery Most recent
uncertainty COVID period from COVID
August 2021
March-May 2020 February 2021
Uncertainty so heightened Health measures more Although a robust recovery in
Starting point
that central projections were effective in containing spending is underway, there
uncertainty
replaced with alternative COVID-19 than initially feared. is ongoing uncertainty about
scenarios. the impacts of COVID-19
Considerable monetary and
on the supply side of the
fiscal stimulus supporting the
economy.
economy.
Bias of risks to Several published downside Although risks to the outlook Downside risks of a severe
the outlook scenarios highlighted a were becoming less skewed, contraction have declined as
material risk of a severe it was unclear how the evidence has accumulated
economic correction. economy would cope with that demand in the economy
expiry of Wage Subsidy is more resilient to COVID-19
Our ability to stimulate the
support and the absence of than we had feared.
economy could have been
international tourists.
constrained by the Effective Risks assessed as evenly
Lower Bound. balanced.
Risks to Significant threat to A prolonged downturn Increased confidence
achieving our employment mandate if risks could still present a threat that robust demand and
mandate to the economy materialised. to inflation and employment supply constraints will feed
objectives. through into more persistent
A decade of below-target
inflation pressures, and
inflation increased risk of
that employment is at its
expectations becoming
maximum sustainable level.
deanchored on the downside.
Least regrets Deliver stimulus sooner Maintain stimulus until Reduce monetary policy
rather than later, thus confident that inflation and stimulus to reduce the risk
minimising the risk that employment objectives will that inflation expectations
stimulus delivered turns out be sustainably achieved. become unanchored.
not to be enough.