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The Real Reason why the RBNZ did a 75 basis point rise in the Official Cash Rate

So here it is and it's very psychological. The Reserve Bank has been profoundly stung by criticism (see my NZ Herald article) that it didn't react to surging inflation last year and was asleep at the wheel. Now it wants to look tough, talk like it actually does care about inflation and make itself out to be really, really serious about meeting its target of 1 to 3%.


Only problem is - this is probably one gigantic mistake. The Bank is best likened to a drunk driver that has got the economy into skid and now is jerking the wheel in the opposite direction, but in doing so is over-reacting and will end up crashing the car. The car in this story is, of course, the Kiwi economy and everyone who has a mortgage.


Nothing the Bank says adds up anymore. If you buy its line that most of our high inflation is due to external factors (like Putin's war & Covid-related supply chain problems) then both of those issues could easily have disappeared by next year. So why crash the economy on a stupid bet those things will get worse when it's more likely they will improve? I'd have recommended a far more modest rate rise. My view concurs with Nobel Laureate Paul Krugman's and the former Chair of the US President Bush's Council of Economic Advisers, Greg Mankiw, who wrote a Blog last month called "Why I fear the Fed may be overdoing it".


But hey, what does the RBNZ care? Having helped Labour get re-elected last year by printing money throughout 2021, the Bank just went & threw its' re-election chances in 2023 under a bus. But of course the Governor managed to get his contract renewed a few weeks so has already ensured his own job is safe. And even better - he can't now be accused of going too easy on inflation which was his Achilles Heal. This decision has little to do with what is best for the country and a lot to do with what is best for the RBNZ.


If you want to read more about these kinds of psychological explanations for Central Bank behavior then you can read the (late) Julio Rotemberg's (who was one of the world's best-ever monetary economists) article called "Seeking Penitence after Accusations of Error").