Fiddling with Monetary Policy

It is a sign of the desperation in Labour’s ranks that both Mallard and Cullen are now hinting at abandoning the 20 year consensus on monetary policy being used to keep inflation low.

Using the cash rate to keep inflation low is not perfect. People accept that. In fact one of the best criticisms I have seen of the model came at the Business Roundtable Retreat of all place.

But just as Winston Churchill said democracy is the worst way to choose a Government, except all the other way – the same tends to apply to monetary policy.

Despite what WInson Peters says, there is no evidence at all that having higher inflation will lead to lower unemployment. We have emperical evidence for this in NZ, where we have had one of the lowest unemployment rates and low inflation.

If you go easy on inflation, you may get a short-term economic boost, but in the medium to long-term you are worse off. This is why almost evert OECD country has a similiar monetary policy to New Zealand. Only fringe dwellers seriously disagree with the basics.

Now as I said the status quo is not perfect. The question is whether one can find a better solution. The Visible Hand in Economics is canvassing that issue.

The most appealing proposal I have seen is from Don Brash who has an unorthdox solution that the Reserve Bank be given an additional weapon or lever – the rate of petrol tax. Brash advocates that as petrol consumption is fairly price inelastic, an increase or decrease in petrol tax could warm up or dampen the economy in a similiar way to changing the cash rate. But with the benefit that exporters are not so badly affected by the exchange rate going up due to higher interest rates.

There are constitutional issues around such a move (Brash suggests over the long term it would have to be revenue neutral so the RBNZ is not making profits from it).

I certainly think it is an idea worthy of study. My initial question (and I would love it if an economist could crunch some numbers) is how much would one have to increase or decrease the rate of petrol tax to be equal to say a 25 point change in the cash rate?