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Staying ahead of the pack

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Staying ahead of the pack.

A country's overnight interest rate or 'cash rate' is typically set by its central bank. Here in New Zealand it is the Reserve Bank who controls the Official Cash Rate. Charged with steering the economy toward price stability (read: 2% inflation) the central bank sets what it believes to be the ideal cash rate to ensure the economy is neither running too hot nor too cold.

Should the economy be deemed to be facing sufficient headwinds as to put the central bank's medium-term inflation target at risk, they will be inclined towards a lower, more stimulative, cash rate setting. With this in mind and at first glance, the axe that our Reserve Bank has recently taken to the cash rate could be construed as an alarming sign of economic weakness ahead.

So how concerned should we be?

In a world where abnormally low interest rates are now the norm, your starting point is far more important than the direction you're going. In this regard, New Zealand's cash rate remains one of the highest in the developed world, giving the Reserve Bank considerable capacity to invigorate the economy through lower borrowing rates and (hopefully) a lower currency. It also allows the Reserve Bank to be proactive, in essence staying in front of the uncertainty ahead.

This is a privilege many countries don't have. The contrast is no more apparent than when you compare the New Zealand economy to that of the United States — a country that is widely expected to soon be raising its cash rate. Here all number of economic indicators including growth, inflation, retail sales, and industrial production show the US is still lagging behind New Zealand.

This epitomizes the dilemma a number of less fortunate central banks face. At some point there will be another recession. If the US does not get their cash rate above 0% sometime soon they will find themselves entering the next downturn in the unenviable position of not having any conventional monetary policies left in its arsenal to ward off the deflationary effects it will likely bring.

For them, it's a matter of need rather than want. New Zealand is in the fortunate position of having the flexibility to breathe life into our economy when warranted.

 

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