The Origins of Inflation Targeting in New Zealand with Don Brash

- This is the Capitalism and Freedom in the Twenty-First Century Podcast, an official podcast of the Hoover Institution Economic Policy Working group, where we talk about economics, markets, and public policy. I'm Jon Harley, your host Today my guest is Don Brash, who is governor of the Reserve Bank of New Zealand for 14 years, from 1988 to April, 2002, where he was the first central banker to pioneer inflation targeting across the world. He also was leader of the opposition and leader of New Zealand's National Party from October, 2003 to November, 2006. Thanks so much for joining us, Don. Very welcome. It's a, it's a real honor to have you on and really, you know, I I think inflation targeting, you know, is, is often seen as, as a huge, massive policy success on the par of Central Bank, but, but I think a lot of people aren't fully aware of its origins. So I wanna get first into your personal origins. How did you originally get interested in economics? Growing up in New Zealand, going on to do a, a, a PhD and, and play a role in economic policy in the 1980s and 1990s, sort of at a key time of, of market reforms in advanced and emerging economies. There was a lot going on in the, the 1980s and just from, from a market reform standpoint, New Zealand, there's, I think floating the New Zealand dollar, reducing tariffs and so forth. I also know that you're a Kiwi farmer. You also, I think, share some policy and farming cross interests with ho was very young, Victor Davis Hansen, who farms the almonds. And, and you also have an autobiography called Incredible Luck. I'm curious about your, your personal origins. You know, were there any other New Zealand accounts that you looked up to? For those that aren't aware, bill Phillips, who's the namesake of the Phillips Curve, is also a New Zealand economist. I'm curious, how did you first get interested in economics?

- Well, I was mainly interested in foreign policy. I was very much preoccupied with the causes of war. 'cause I grew up in the immediate aftermath of the Second World War, and I was working out how I could possibly make a difference in international foreign affairs. So my undergraduate degree was mainly in history and economics, equally actually. But history was a much stronger faculty at the time. And, but when I finished my, my bachelor's degree with a history, very good marks and so on, I couldn't see much history, much, much prospect for my career in, in history. So I thought I better get into economics. And I went to the Australian National University to do a PhD having done a master's thesis in New Zealand saying how bad and awful and terrible foreign investment was or external debt was. And I went to, to the Canberra Australian National University, convinced that I should do a much more in-depth study of the effects of foreign investment. And by chance I got the opportunity to do a detailed study on a hundred American affiliated companies in Australia. I started off in tent to prove how bad they were for Australia. And to the great embarrassment of many of my friends, I reversed 180 degrees and I realized that American investment had been enormously beneficial to Australia. And that sort of started me off on a, on a pro market track. I went from there to the World Bank. I spent five years there, learned a great deal at the time that Robert McNamara was president of the World Bank. I learned a lot from him. And

- You were working in the us

- In the US in Washington DC Wow. A part of that time I was on the staff of what became known as the Pearson Commission in full Commission on International Development, but named after Lester Pearson, the former prime Minister of Canada, who chaired that commission. There were six or seven of the, of the good and great of the world on that commission. And there were 12 staff of whom I was lucky enough to be one. And I was the person advising them on the role of private foreign capital in economic development. So that, in a sense, that started me off on a, on an economic track rather than a foreign policy track. I came back to New Zealand, ran an investment bank for 10 years, affiliated with Wells Fargo Bank. So I had a connection there again with the United States. Then at that point, I, I made a, a, a false attempt to get into politics. Didn't, didn't work. So then I got out right out of banking and became chief executive of what was then called the Kiwi Food Authority, which coincided with the fact that I had just bought a piece of land and planted it in, in Kiwi fruit vines. And that explains why to this day, I still have a, an interest in a kiwi fruit orchard. It's a, it's a great product. I was then asked to, to amalgamate effectively what in America would be called savings and loan institutions. There were, there were nine of these rather weak institutions and I was asked to put them together. And I was, had done that for two years when all of a sudden I was asked to be governor of the Reserve Bank. I should say that during that previous time, I was at the Kiwi food industry, the, the labor government, which is our ostensibly our left wing party asked me, or the finance minister asked me to do a number of things for the government in the economic policy space. And the most significant of these was,

- This was Roger Douglas, who's the finance manager,

- Correct. That that's right.

- Known for market reforms. At that time, I, I guess floating the, the key, the, the New Zealand Dollar Terrace finish deregulation

- Quite right. He was the most market oriented finance minister in New Zealand history to that point. And did things which I thought were inconceivable for center right government, let alone a center, a left government. The, I was mainly involved in that particular period as far as government policy was concerned on tax policy. And he asked me to chair a three person committee to design our value added tax, which we call a goods and services tax. Now, you can debate the merits of taxation, but if you're gonna have tax, a goods and services tax or value added tax is about as good as it gets. But most countries are tempted to create exemptions, different rates, et cetera, for different goods. So you exempt, for example, children's clothing or books or food. And in no time at all, you have a much more complicated system to implement than we had in New Zealand. Thanks to Roger Douglas. More than, more than, more than thanks to me. As, as chairman of the committee, we have A GST, which is as good as any in the world with a possible exception in Singapore. Both countries have a, a goods and services tax evaluated tax, which is equal across everything with no exceptions, which makes it extremely simple to implement. And, and that was my, to that point, my, my greatest, greatest contribution to policy. But then, as I say, Roger Douglas asked me to be governor of, of the Reserve Bank, and that's of course when I started getting involved in monetary policy and, and inflation and so on.

- Fantastic. So, so 1988 is when he became governor of the Reserve Bank of New Zealand. I'm curious in, in inflation targeting, the inflation targeting regime was put into place in, in 1990. I'm, I'm curious, tell us the story of how this all came together. I know, you know, the, there was a famous interview in which you went on TV and you said, you know, you I think favored a a zero to 2% target. I'm, I'm curious, you know, was there a lot of academic thinking or, or was it more, you know, personality driven? I'm just curious, how did this whole idea to, to have an inflation target come about? I, I know like, you know, prior to inflation targeting explicit inflation targeting regimes, you know, for example, the US briefly had a, a monetary policy targeting regime that was going on in, in probably around the same time in the late 1980s, I think in, in the Volker Fed. I'm curious, like what was being discussed at that time? You know, did the Central bank and, and the government at the time at least, you know, did they buy into sort of Milton Friedman's idea that inflation was always in everywhere, a monetary phenomenon, which wasn't exactly a, a common belief in the 1970s, for example, when there were a lot of price controls and things like that. I'm curious, how did this whole idea to start inflation targeting come together?

- Well, the background was that we had, had inflation, which by developed country standards was, was, was quite high. Not, not like Turkey or not like South Africa, not like Zimbabwe, but nevertheless, fairly high double digits between 10 and 15% for several years in the end. And poor growth. And that was a useful exercise in one sense because it showed that tolerating more inflation did not give you more growth. Our growth was quite modest by developing country standards despite, or because of this, this, this fairly high inflation. But, but let me go back one, one step prior to 1989, and I say 89 'cause that's when the act was passed. There were two kinds of central banks in the world. There were the completely independent central banks, so at least notionally the Fed being the most obvious one, but also the Bonders Bank in Germany, Swiss National Bank and Switzerland and so on. But that was about all, there weren't very many of 'em, most central banks were effectively, effectively a branch of the Treasury. They did as the government of the day, told them to do. And that meant that monetary policy was quite cynically manipulated by the government in power. And, and the 1989 legislation pioneered a new track. The government said, look, the inflation rate is something which the government should decide. What, what rate does the government tolerate its currency devaluing? In other words, what, what inflation rate are they willing to accept? It's a political decision, but how they deliver that should be up to the technocrats in a central bank. And the unique thing about the New Zealand framework at the time was that it left the inflation rate choice in the hands of the elected government and told the bureaucrats in the central bank to deliver it. And, and the, the, the inflation rate, which the government wanted, had to be public in writing and everyone knew what the, the target was. The government couldn't fudge it and the Central bank had to deliver it. Now, when I said Central Bank, when the 1989 legislation was fi first drafted, it involved a contract between the Minister of Finance and the governor personally. And I recall saying to the minister as it was being drafted, surely you want a contract with the reserve bank? And he said, no, we can't fire the Reserve Bank. We can't even fire the Reserve Bank board, but we sure as hell can fire you. And it was therefore a very personal responsibility for the governor at that time. It's changed more recently, but at that time, and for the next 20 years or more, the responsibility was on the governor to deliver a contract, which was in writing where the government chose the target inflation rate. Now the beauty of that is that if government, if the central bank is a tight monetary policy is doing it because the government has mandated the inflation rate, which the, the gov the reserve bank must deliver. So unlike the situation situation you have in the United States right now, where, where the president can criticize the Fed for not dropping interest rates, he'll be the first to complain if inflation gets outta control. But, but in the New Zealand framework, the government can't really criticize the central bank as long as the inflation rate is is within the mandated target. So that, that, that's created a totally new framework. And it's the framework which has been adopted of course since that time, by Australia, by Canada, by Sweden, by uk. But it's where the government has responsibility for nominating the inflation rate and requiring the central bank to deliver it, or our case originally the governor of the central bank to deliver it. So that was a unique framework, but when you go to structure a framework, framework like that, you have to have in some sense a numerical target. What, what does the government want for the inflation rate? Well, the zero to two, I think came out of an interview with Roger Douglas on television shortly after the New Zealand inflation rate dropped below 10% for the first time in some years. And the television reporters hit that, Roger Douglas, aren't you satisfied now you've got inflation under 10%. And Douglass replied, no, no, I'm looking at like zero or zero to two. And it was a flippant off the cuff remark when he sort of made the zero to two comment. And it became, of course, holy gospel, when I became governor some six months later, that was the target I was told I had to meet. Now at that point, it was an informal target and it, when the legislation was passed in 89 requiring a written instruction to the central bank on the inflation rate, that's when we formally adopted the zero to two by 90 92. 'cause we were at a higher rate of inflation by that time in, in the early 1990. Yeah,

- So, so if, if, I guess my understanding is, and and later it shifted from, you know, zero to two to, I think it's zero to three and then, and then eventually one to three. So eventually, you know, 2% became the middle of the band. I mean, it's fascinating how like one i I guess 2%, which we hear about today in 2% inflation targeting why it's important that we target 2%. Originally it was the upper part of this band that was somewhat, I don't wanna say randomly thrown out there as a number, but I mean, I'm just curious, like is it, I mean, is there any information in terms of like, was there any kind of academic input into this? Was, was there, or or was this just a a a sort of arbitrary set of numbers that that, that Roger Douglass had come up with? I mean, was there any ahead of that TV interview, was there kind of any, I guess, discussions between the central bank or economists or I guess folks in the legislature or, or is it, was it just really a, a a kind of an arbitrary thing that we've now all sort of coalesced around?

- Initially it was rather arbitrary as in the way I've described subsequently we rationalized it as 1% measured inflation is probably ac akin to actual inflation. Yeah. Actual inflation is zero 1% measured inflation is probably equivalent to price stability because of biases in the measurement of the consumer price index. I think you had a senate committee in, in the United States, I think was the Boston Boston committee, which

- Estimated, yeah, and after Hoover's very own Michael Boskin, who's, who's a senior fellow on the, on the staff here still.

- Okay. Okay. And I think from memory, that committee estimated about a 1% bias in the US measurement of the CPI. I think actually that took place after our zero to two was established, but we rationalized it subsequently as, as being genuine priceability plus or minus one. That, that, that's where we rationalize zero to two. Now, subsequently, we decided there were so many exogenous shocks, which hit a small economy in a trading environment that the target was undesirable narrow. So we toyed with the idea of having a target of minus one to three, in other words, same midpoint of 1% measured inflation, which we, we had as tantamount to price stability, but a slightly wider range before the governor was at risk of losing his job. Then we thought actually if measured inflation was, was tracking below zero, the chances are we'd be easing pretty aggressively. So we decided minus one to three, while it had the symmetry of being retaining the 1% target was a bit artificial. So we changed it to zero to three after political negotiations in the mid nineties between political parties. Subsequently, we, it was also agreed that, and bear in mind the fact that the target is mandated by the elected government that were inflation tracking towards zero again, would be easing fairly aggressively. So the, the target was eventually changed to one to three against the mid point of two.

- Well, it's, I mean it's it's fascinating that, that one, I guess that the arbitrary nature of it, so one, the, the Boston Commission I, I think didn't happen until till maybe 19 95, 19 96, a good number of years later. And that's correct. Right. I think the, the Reserve Bank of New Zealand, I think figured out what they had figured out years, I think years later that, you know, there is this, you know, maybe 1% bias. But I I I'm just curious, I I know some of the history in, in the US and Canada that, you know, for example, Paul Volker, you know, through the rest of his life, you know, favored a 0% inflation target. And he was, I I think a, a a very big critic of 2% inflation targeting for many decades. I mean, obviously, you know, very few central banks. He did those words, I think. But, but I'm curious, I, I know like John Crow at that time, who's the governor of the, the central or Canada Central Bank, the Bank of Canada, he favored a, a 0% inflation target originally, or, or a lower one, I guess maybe zero 1% inflation target. And then at the time, I think what had happened was, you know, there's a li a liberal government in power in, in Canada, the, the early crutch and government and, and essentially the, the, the Crunch. And Martin government wanted a higher inflation target because, you know, they sort of believed in this, you know, Phillips curve sort of concept that, you know, you could maybe create more jobs by letting inflation run a little bit hotter. And then in the US you know, the Fed never really even announced its official inflation target until 2012 under the Bernanki fed, even though sort of, it was, I think a pretty well known, poorly kept secret that the, the Fed was targeting 2%. But I'm curious, you know, when you were a central banker at that time, I mean, when sort of the, the 2% consensus hadn't formed yet. I'm curious, what were those conversations like with other central bankers? I mean, was there sort of a, I mean we, nowadays we have these sort of cross country macro debates now about all these things, you know, what should our monetary regimes look like? And often our shocks are, are increasingly similar and, and more globalized it seems. But I'm curious, like what were the conversations like back then? Was there a battle for 0% inflation targets that, that, that was going on that sort of eventually lost out? Or, and, and I'm curious, another thing that you often hear, like from folks like Bernanke, when he was chairman of the Fed defending the 2% inflation target in, in the 2010s when people were bending over backwards, you know, because the inflation was running below 2% and, and how, you know, some people made the case, it was sort of an emergency that, that we weren't hitting a 2% target. I'm curious, like it was one of those arguments that people make is that, well, you know, we should be afraid of deflation and if we had negative inflation that people would be saving tons more and and reducing their consumption and this could make economic contractions much worse. Were there any sorts of conversations like that happening back in the late 1980s, early 1990s when the, the sort of inflation, early inflation targeting regimes were being set up?

- I don't remember them to be honest. We were so pleased to get inflation below two and regularly around one that the idea of getting it below zero didn't really have much appeal or any public currency either. One of the strange you mentioned the Greenspan Fed, one of the strangest things about the, the Fed, it seemed to me was that they had an inflation target was scared to mention it. And, and I think that that's odd because for me, the inflation targets plays a very important role in expectations and therefore in behavior. And, and one of the great things about a small country, which of course the US is not, is that the governor can and could and did spend a lot of time going around talking to rotary clubs and farmers groups and church groups, anyone who would listen to convince the public that we were deadly serious about getting this inflation to the target because expectations are, are, are pretty important. And they're important also in terms of the social cost of delivering a inflation target. If people genuinely believe the inflation rate is going to be 1% or 2% or whatever the target is, their behavior tends to some degree to gravitate to that kind of target. It makes the job monetary policy that much easier.

- Now, at that time in the late eighties, early 1990s, were there surveys established yet at that point that could track long-term inflation expectations? Like in, in the US for example, there's the University of Michigan surveys that we have here that have been going I think since the 1960s or quite some period of time. And I know, I mean there, there's many other expectations measures now that exist and surveys that exist. Policy makers obviously follow this very closely. They also follow, you know, maybe inflation linked bonds, which have been around really only since the late 1990s and there's risk premium in that. So that's not a perfect measure of, of inflation either looking at inflation breakevens. But I'm curious, what sorts of data were you paying attention to in, in your 14 year governorship? What were you paying attention to to make sure that you knew that inflation expectations were being better anchored by the inflation targeting

- Machine? Especially my memory a bit here, Jon, I can't remember exactly what particular indicators he watched carefully, but we did have some indicators of inflation expectations, both, both short term and, and medium term, which we were influenced by. But I guess to a large extent we were focused on, on what the inflation outcomes actually were. 'cause those played a very important role in, in conditioning expectations. And I mean, I I, when, when this tag was first introduced and we had monetary policy, very tight interest rates, very high unemployment going much higher than it had been since the 1930s, it reached the peak of 11%. One of the tasks I had was convincing the unions, particularly that I was indifferent to the unemployment rate, my focus was on inflation. And if they wanted to get the unemployment rate down, they had to ensure that wage and salary demands were consistent with that inflation rate because otherwise unemployment would stay high. So we actually had a had a major discussion with the, the head of the council of trade unions in New Zealand, and, and he understood that if if wage demands and inflation started being more consistent with the target, then monetary policy pressure would reduce. And to my astonishment and many others, astonishment too. And to his great credit, he went around the country side talking to trade unions saying, guys, if you wanna get interest, interest rates down, monetary policy pressure reduced, then you've gotta moderate your wage demands. And, and it was sort of self-reinforcing.

- That's, that's fascinating. I, I'm curious, like, you know, one thing I guess that, that makes the Fed the Federal Reserve so different from other central banks around the world, I think some people may not realize is that it's very, the Fed is very unique in that it has a dual mandate that is in, I mean, some people say there's a triple mandate and stable interest rates, but you know, the, the core sort of dual mandate concept that that's been enshrined in loss since the Humphrey Atkins Act, which is an act passed in the 1970s, basically, you know, price stability, you think stable inflation, low and stable inflation and you know, full employment, you know, unemployment rate that's close to so-called, you know, full employment or you know, unemployment that's low. I'm curious, like as a is leading when you're leaning a central bank that only has a, a mono mandate that is to target inflation. I mean, does, you know, these sort of other unemployment, full employment concerns ever come, you know, front of mind? You know, for example, you know, I guess we had, you know, the great recession, my sense is that some of these mono mandate central banks like the Bank of Canada is kind of focused on both and kind of may even have some sort of unspoken of dual mandate. I guess there there's also this thing that economists called the divine coincidence where you can kind of target inflation and end up sort of targeting both in inflation and low stable inflation, low inflation and, and stable unemployment as well. I, I'm curious what you, what you think about that or, or what are the things that I guess as a mono mandate, central bank or those challenges, you know, as, as you mentioned speaking with the, the trade unionists, how does that sort of come about? I mean, I think during your tenure was a pretty stable time macroeconomic wise, but I, you know, I think about, you know, 2008 where, you know, central banks really kind of went all out to, and, and since in 2020 even further, you know, more central banks are engaging in quantitative easing, doing other things to, to keep interest rates low for the express purpose of, of really trying to simulate the economy, revive economic growth and bring down unemployment. I'm curious how that sort of thinking kind of works.

- Well, I mean, I'm trying to recall the name of the well-known economist, I should note offhand, who says you cannot have more than one goal per instrument.

- Hmm.

- And I think that's now widely accepted and I suspect a Greenspan and the Fed guys would, would accept that too. They go through the, the pretense of having a dual mandate because that's what the law requires of them. For a brief period, the New Zealand labor government just a few years ago introduced a dual mandate for the Reserve Bank of New Zealand because the Fed does it, the Bank of Reserve, bank of Australia does. It says we should too. Now we've reverted to a single mandate where inflation control is the only objective of monetary policy. Now, of course, frequently the object, the twin objectives will be consistent with the same policy. If unemployment is very low, chances are that your inflation rate, we are pushing towards the top of your target and vice versa. But if unemployment's going up and inflation rate is, is too high, then you've got no choice but to make it make a choice. But between those two objectives, and it's, there's no doubt at all that in our, our case, our primary objective is indeed our formally our only objective is controlling inflation. So we, we reject the logic of the dual mandate. We think the dual made mandate is a fiction which, which the fed us to go along with because that's what the law says. But, but yeah.

- Well, that's fascinating. I'm curious to, to get some further thoughts on, on some of your own, you know, thinking on your monetarism and, and I know you crossed paths with Milton Friedman, you know, who's Hoover senior research fellow, one of the most famous accounts of the 20th century, you know, pioneer of monetarism and, and free markets in general. I know you, you crossed paths with him several times. I'm curious what your interactions with him were, were like and, and when, when these interactions took place.

- Yes. I mean it's a curious contact. My first contact with Milton Freedom was very odd. I was running this investment bank, as I mentioned to you in the seventies, and one of my competitors, a close personal friend was running a competing investment bank. And he brought to New Zealand some American economist, I can't recall who it was now, and it got got some media coverage and I said, how can I upstage my friend? I thought the best way getting, bring us the best American economist, namely Milton Friedman, and everyone knew who he was and his status was fantastic, a very long shot, but I'll, I'll try to see if he'll come to New Zealand and invited him by good fortune. He said, I'm coming to Australia later in the year, happy to come across to New Zealand with my, with my wife Rose, no fee required as long as you show me around the south island for a week with, with my wife, which what we did, we traveled the part of New Zealand, the scenic places, and he gave three major speeches in New Zealand, our main three main cities. And that began a, a, a good friendship with, with Milton and Rose. Subsequently, I had a meal at their home in San Francisco on several occasions, and we talked about it. He visited New Zealand later, in fact, not long before they both died, they visited New Zealand on a cruise ship. And when they were in, in Auckland, the main city of, of New Zealand, my wife and I hosted them to dinner at our home. I think they were both 93 at the time. And I've just enormous admiration for him and indeed for Rose, both of course as an economist, but also as, as people.

- That's so fascinating and and it's amazing. I mean, seeing their, their influence around the world is, is, you know, I think truly is, you know, undeniably, you know, perhaps alongside Kane's, the most influential comms, the 21st century, or sorry, the 20th century, we, we, you know, we'll see about the 21st century as as it plays out. I'm curious, you know, you, you know, took the helm of the Central Bank of Reserve Bank of New Zealand in the late 1980s. And I'm curious, you know, you know, again, you know, the Fed at the time was very focused on targeting monetary aggregates, was something, you know, following money. Was that something that the Reserve Bank of New Zealand was doing a lot of, you know, was it already focused on using interest rates as a policy tool, like how most central banks use them today? I mean, if you look at a lot of central bank discourse today and, and macroeconomic research, you know, the cool concept of money is, is largely absent. And I, I think part of why the fed abandoned targeting monetary aggregates was that money demand wasn't very predictable. You know, there's questions about what is money and, and this, you know, does treasury bills count and things like that. But I'm curious, back in the 1980s when, you know Milan Friedman and some of his thinking was, I think at, at his peak what at the Virgin Bank of New Zealand was, was money something that was often talked about or at least sort of used as a reference point predicting inflation? I, I'm curious what, how do you think about money and monetarism?

- The short answer is we did not pay much attention to money aggregates. And that was partly because following this five or six year period of extraordinary economic policy change, we didn't find anything very consistent or predictable in the money, money aggregates. So we didn't spend much time watching them. In fact, we had a sort of some arcane monetary policy framework. I'm not sure that I'll bo bore you with, with the details of it. But it was quite unlike any, any other policy anywhere else in the world as far as I know. But we, we focused very heavily on convincing the public. We were serious and we kept tightening monetary policy when inflation was out of the, out of the, out of the target. Now when you say tighten monetary policy, what we did was we had an absolutely minuscule lever, but for some reason they had a, had a big effect. We, we targeted the aggregate of balances with the central bank, which the whole banking system had. There had to be this numerical aggregate in the banking systems, collective accounts with a central bank every night. And, and we kept that number very low when we wanted the, the policy to be tight. But the amazing thing was we hardly ever had to change it. We just had to imply that we might, we sort of clear our throat and say inflation is not quite where it should be. And, and almost instantaneously interest rates all over the economy would, would, would go up and, and come vice versa. It was a, it was an odd framework in terms of implementation, but it, but it certainly worked in the mid nineties we followed the Bank of Canada, which you may recall had a monetary conditions index, which was a mix of, of interest rates and exchange rate, both of which in a small economy of course have big effects on, on, on the, of the measured inflation rate. We made the mistake of publishing that index at that time the Bank of Canada had not done so, and we also made the mistake, we didn't have it calibrated correctly. So within 18 months or two years we abandoned it, it was just accredited in the market and it's regarded as one of our mistakes. As I say, I think the problem was, we, we didn't have it calibrated correctly, but in a small economy, both the rate and interest rates have an effect on, on inflation. Both, both as as measured and, and longer term, deepest deep more deeply seeded factors. And of course in 19 19 99 we adopted a more conventional implementation regime where we set up a, a cash rate, which we pay on balances with the central bank and raise and lower that as as required. Interesting.

- So there's now, since the 1990s, there's been a, a po a policy rate that, that since sort of a lower floor on, on interest rates. So that's fascinating. Prior to that there, I guess the central bank would do open market operations to try and influence these various rates and exchange rates so forth.

- Yep.

- That's fascinating. Yeah, it's amazing how, and then now, you know, fast forward post 2008 in the US and, and post 2020 in, in a ample reserves regime where, you know, you have, you know, the money supply curves moved so much to, to the, to the right that you now sort of have to use these sorts of policy rates as, as a floor and, and have these, you know, sorts of corridor systems in the us like you've got the one RP is sort of the, the lower band and then you've got interest on access reserves on on the higher end and, and you kind of need to pay interest on reserves in order to even move these interest rates around. So it's, it's interesting how just the policy tool regime is, has changed over the years and, and it's, it's really fascinating to, to see how that's evolved. I'm curious, I guess we talked a little bit about this before, but I'm curious about your thoughts about the state of Central Bank independence today, you know, and, and how it evolved in the late eighties, you know, and, and how it's evolved since. You know, I think, so one thing people don't really realize is how, how recent I think Central Bank independence is as, as a concept and even Milman Freeman wasn't really, I think, you know, there, there's not maybe a perfectly accepted definition of what central bank independence means, but you know, I think Milton Freeman was at some level but of a critic of, of independence and that he kind of argued that, you know, in the US like the president kind of gets the monetary policy they want because they're the one making the appointments. And then, but he also sort of argued for, you know, a central bank money growth target sort of to remove or the politicians from it in a sense, I guess if it could somehow be written in the Constitution or something like that. I'm just curious, you know, some central banks around the world, you know, have these fi I think a lot of 'em now have these five year framework reviews in, in particular in, in Canada. You know, it's sort of a back and forth between the Ministry of Finance and the central bank within the US at the Fed. It's very much internal that is, you know, the US treasury doesn't get to have a say in terms of what the, the fed's, you know, framework review should be. There's been a lot of controversy in, in the US about the 2020 flexible average inflation target regime that the Fed adopted right before inflation spiked. And the idea was, you know, that inflation had run so low in the 2010s that they should try and make up for it. You know, having some sort of averaging wasn't clear about how long they would average over and so forth. But I'm curious, like, do you think that this model of having sort of input on these framework reviews from, you know, between both the Central bank and the Ministry of Finance, do you think that's optimal?

- Well, I mean you've got a very different situation in the US where, where clearly the fair that least notionally is fully independent of, of the treasury and administration and so on. Even though the president does get to appoint the governor, federal governors and, and, and the chairman I think from memory too, does he point the chairman? I think he does. He

- Yeah, he does. He, yeah, the president gets to appoint essentially, you know, the entire Federal Reserve board. They don't get to appoint the president doesn't get to appoint the regional Fed presidents, but the Fed board still has sort of some veto power over those right. Regional presidents.

- Right. I i, I must say I, I prefer the New Zealand framework to any other framework anywhere. I mean it's adopted of course, as I said earlier, by Australia, by Canada, by Sweden, by uk. It puts responsibility where it should lie. The, the government of the day has and should have the decision about how fast their currency devalues. That's a political judgment. But the delivery of that and, and they must be forced to, to tell the public what that depreciation of the currency is gonna be. If I'm gonna depreciate my, if I'm the prime minister, I want my currency to depreciate fast, I should tell the public so they can adjust their, their decisions in the light of that, that information. But once that's decided, the central bank should be free to run monetary policy as they judge appropriate in order to deliver that target. And we'll be time 'em if they don't, that seems to mean a democracy, the right framework. The, the, the, the situation in the US I think is, is a, in terms of monetary policy, a terrible one when, when the president clearly is unhappy with interest rates, but if the Fed reduces interest rates and inflation takes off, he'll be the first to blame the Fed for higher inflation. I mean it's, it's, it's not a good situation.

- Well, I mean it's it's fascinating how I, I think you, you mentioned earlier about how the, the Reserve Bank New Zealand for original framework, if I understand correctly, was that if the inflation target had sort of got outside its bound, then that was kind of a fireable offense.

- That's correct. And, and, and I mean the first time we went outside the bounds was, was caused by the, the first Gulf War caused a spike in international oil prices. The, the measured CPI went above the range. The board had responsibility to write to the minister saying, notwithstanding the fact that this is outside your target, we recommend you don't fire the governor because these exogenous factors have caused this, this spike, the interaction between fiscal and monetary also comes into play in the 90 96 period when the government was very keen to reduce tax rates. The Minister of Finance wrote to me as governor saying, if we cut tax rates by X, would it require dramatic tightening of monetary policy? 'cause clearly fiscal and monetary policy interact on the, with the inflation rate and the framework recognizes that interaction. If, if the government wants easy monetary policy and a given inflation rate, they may well have to do something with fiscal policy.

- That, that's fascinating. And, and I mean today, you know, the fiscal monetary interaction certainly get a lot of discussion given, you know, the quantitative easing that's going on, you know, central banks going out and buying long-term government bonds. And then you also in, in, in the US you've had some pretty big shifts in debt management policy here in the us The US Treasury decides what the maturity, the maturity of the newly issued debt's going to be. And obviously, you know, that that decision upon, you know, the finance ministry to issue more or less long term debt is basically isomorphic or equivalent to the, the central bank buying or buying or selling more long term bonds. So, you know, quantitative easing, quantitative tightening, you know, can very much be offset by issuance policy from, from the fines ministry of the US Treasury. So, I mean, it, it's so interesting how these things are, are are very much connected and absolutely, you know, a con accommodative or tight fiscal policy, you know, can be moving in the opposite direction as as monetary policy. I mean it's fascinating how the, the, you know, the, the frameworks of Reserve Bank of New Zealand, I mean, in some respects some people might say that, you know, that there's less independence in that respect for the central banks. And, and, but at some level, you know, there's also, maybe this is a good thing in the sense that there's more coordination around, around these sorts of policies in, in, in going after, you know, stable inflation. I'm curious, I wanna put a little bit toward, 'cause you know, you served as opposition leader, you are an MP for many years and, and, and leader of the National Party. I'm curious, you know, what you think about New Zealand from a, a cost of living zoning, you know, trade policy standpoint. I am just curious, you know, I, I've heard a lot of things about land use regulations in, in New Zealand and places like Auckland and Wellington making it, it very unaffordable there. I think New Zealand has had a housing sort of affordability crisis in the same respect that Canada has had one with land use regulations and, and the US has had one largely in its coastal real estate markets. I'm curious about your thinking around that as well as sort of New Zealand's role in international trade. Obviously it's much closer, closer to China and, and, and, and and Australia and those are big trading partners for, for New Zealand. I'm curious what your take is on, on New Zealand where it's at today as a, as an open economy and how some of these cost of living issues that are common around the rest of the world, how they manifest themselves in New Zealand?

- Well, the land use regulations you refer to have has been a major headache in New Zealand. We've had tight land controls around our major cities and the consequence has been exactly as you found them in the United States. Places like Portland, Oregon, Seattle, San Francisco, New York, et cetera, which have similarly tight controls have similarly outrageously expensive housing success of governments have said, we'll fix the housing crisis. And successive governments have failed to do that, but the current government is actually making some progress and whereas in Auckland, the ratio of the median house price, the median household income was about 11 a few years back. It's now down to about eight and a half. So it's come back quite a bit and the government seems intent gradually on, on deflating that that bubble, I'm strongly in favor of what they're doing in that area. Where they can get away with politically is another question of course, because more people own houses than, than don't and people don't like seeing their major asset decline in value. But, but that it needs to decline in value is is beyond doubt. And as I say, the government current government's making some, some modest progress in that regard.

- Huge political economy problem. You know, it just, it is like entitlements in the US as well. You know, people don't wanna lose their benefits or, or their home values.

- Yep, exactly right. And, and I mean for us, the model housing market, I think, I'm not sure if it still is, but Houston was the model we looked at and, and said, my gosh, they've got house prices which are a very modest multiple of household income and, and they've clearly got it right. And of course, as you well know in Houston, there are basically no land restrictions at all. You can build wherever you like and, and that's got some appeal. We, we are a country of 5 million people roughly on an area somewhat larger than the UK and area. So we're not short of land. There are all kinds of arguments about good land and bad land and what have you. But, but fundamentally our house prices have been outrageously high. We have a fiscal problem, which is not unlike that in, in most other developed countries it's better than some. Our, our current government debt to GDP ratio is about 40%, which is a long way short of where the US and, and, and Britain and France and Germany and Japan are. But it's, it's not good for, and for the same reason our populations are aging and we have have social security and, and health expenditure, which is projected to rise strongly as the population continues to age. And, and again, in, in a democracy, it's very, very hard to change those lines. So we've got problems that are very similar to other countries. Additional problem you alluded to in the trade pattern, I was giving a speech in, in the Oxford Union just a couple of weeks ago in earlier the month, and in, in the 1952 thirds of New Zealand's exports went to the United Kingdom in 1970 was 35% as the common market was looming. Currently Britain takes 2.6% of our exports. China takes 26%, which is exactly 10 times as much. Australia's our second biggest trading partner, the US is our third. And of course we have to live with the administration's tax tariff policies, which, which affect everybody. Yeah.

- Well I'm, I'm curious about, I I guess it's fascinating about Auckland's zoning reforms and, and and how successful that's been. I know Minneapolis is trying to do something similar in the US or has been in, in in Houston, you know, which doesn't really have any zoning is is I think a model for, for, for many in terms of what, what and uc regulation can achieve in terms of affordability. I'm, I'm curious, I guess just in general about market reforms and you came in into policy and politics at, at a time of a wave of market reforms across many countries in the 1980s. And you know, what is a market reform, I would say is just, you know, a general appreciation of economic freedom in, in, in policy, in in, in laws and in in economic policy laws in, in, in general. And this manifests itself, I think in many ways from, you know, deregulation, you know, think in the us deregulating the airlines, you know, thinking about, you know, other industries. You know, in the seventies and eighties, you, there are many nationalized industries in many countries, and now we, you know, see leaders like, you know, Javier Malay, who's, you know, going to Argentina, which you know, has suffered under, you know, peronism for, for many, many decades. And is sort of beginning that process of, of doing, I think a lot of the things that countries in the 1970s and eighties were doing, which is you, you know, liberalizing their economies, you know, taking certain industries and deregulating them. So you know, there's, whether it's beef export controls that are being lifted or, you know, rent controls that are being lifted. You know, I think Javier Malay is this sort of new example of many of the things that were going on in the 1980s, including New Zealand. I'm just curious, like in, in your mind is, are market reforms something that countries need to sort of relearn? It's, it's economic growth has fallen, especially amongst advanced economies, you know, is economic freedom a a viable economic growth strategy, liberal economic institutions in, in your mind, do, do countries need to relearn this?

- Some do, including New Zealand though, to be fair, as you mentioned, we had big liberalization in the eighties under this, this labor government, surprisingly, we had extensive import controls. We didn't have export controls, we had export subsidies for the sheep industry in particular, tariffs, high quantitative controls were, were high rent controls, you name it, controls. We had all of those went, all the import control or quantitative controls went, tariffs were reduced drastically. And because that's a traumatic thing, as you will understand when you do it, suddenly industries which have grown up after two or three or four decades with high protection suddenly find themselves without protection. In our case, the motor vehicle industry was, was the best example. We had 10 different international companies producing cars in New Zealand for a total market of a hundred thousand cars and was utterly ludicrous. They were essentially, IM importing packs of cars and assembling them in New Zealand. There's no great skill involved in that, but it employed tens of thousands of people. And of course when you, when you suddenly remove that protection, the adjustment process is, is pretty brutal. And, and sadly that period is regarded by many people in New Zealand as, as a disaster, as an economist are regarded as fantastic liberation and, and set the economy on a, on a much, much better track than it would've been had we stuck with that dopey framework. It was, it was crazy on, on tariff policy, on regulations, on, on, you name it. One of the things that did, which was in some ways might be regarded as, as counter to that we introduced, I think the first framework for controlling the phishing industry. I think it's now been copied quite widely, but clearly fishing in the open ocean is one where you have the sort of problem of the commons. Anything I grab you can't grab if I'm there first. And, and we introduced a system of tradable, tradable, what are they called? IQs, individually tradable quotas. Yeah. So you have, you would have to take 4% of the estimated sustainable catch of a particular variety of fish or 10% or whatever your quota is. And a tradable, it's a tradable, right? And

- Like a cap and trade kind of thing. I, I guess with some of these environmental emissions, and

- I think we were the first to do it in the case of, of fishing, but it's been copied now quite widely and, and it's, it's a good framework. So yeah, I mean, should be doing more liberalization. New Zealand almost certainly the government still owns or part owns things they shouldn't own privatization has has been a sort of a political hot balloon. Hot hot, yeah, hot topic, but it's, it's vast improvement of where it was some decades ago.

- What's fascinating and, and you know, we, we will see how long y you know, how, how or what heavier malays impact will be. I think he's only two years into, into his office as president and he's, you know, just won another mandate with, with the congressional elections there. And, you know, he's, he's moving from one sort of industry to another in, in one policy area to another very quickly. And I think he's undergoing some labor micro reforms and, and fiscal reforms now. And, and we'll see, you know, it takes time and sometimes these things have done very suddenly, you know, you can end up in a lot of hot water politically, maybe perhaps, you know, Liz trusts me for an example o of that. But it's fascinating to see politicians attempting market reforms again, where I think for a long time, you know, certainly after the global financial crisis that these things that free markets were, I, I think perhaps unfairly getting a bit of a bad rap. And I think understanding the history of market reforms in places like New Zealand and, and many, many countries that engaged in market reforms in the 1970s, 1980s, I think is valuable today. A real honor to have you on Don and to hear about your pioneering career, you know, inflation targeting and ideas. I think it's safe to say that alongside fellow New Zealand economists, bill Phillips, you know the name, say the Phillips Curve, that you're both, I think two of the most famous economists in New New Zealand history. It's truly wonderful to get the full history of inflation targeting. How we got, you know, zero to 2% in how you implemented it and how the Reserve Bank of New Zealand has been working up until today. It's, it's really an honor. Thank you so much for joining us.

- Thank you, Jon. I've enjoyed it. Thank

- You. This is the Capitalism Mind Freedom of the 21st Century podcast. An official podcast with the Hoover Institution Economic Policy working group, where you talk about economics, markets, and public policy. I'm Jon Harley, your host. Thanks so much for joining us.