Episode 66. The Origins of Inflation Targeting in New Zealand with Don Brash

"Capitalism and Freedom in the 21st Century" Hoover Podcast Episode Transcript

Jon Hartley and Don Brash discuss Don’s career as a central banker at the helm of New Zealand’s central bank, helping to start the world’s first inflation targeting regime in New Zealand, New Zealand’s 1980s market reforms and floating the New Zealand dollar, Brash’s time as a politician and leader of the National Party, unaffordability in New Zealand housing and Auckland’s successful zoning reform, and whether there is a need for market reforms today internationally.

Listen to or watch the full Capitalism and Freedom in the 21st Century Podcast episode with Don, which is hosted at the Hoover Institution Economic Policy Working Group.

Jon Hartley: This is the Capitalism and Freedom in the 21st 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 Hartley, your host. Today, my guest is Don Brash, who was 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.

Don Brash: Very welcome.

Jon Hartley: It’s a real honor to have you on, and really… You know, I think inflation targeting, is often seen as a huge, massive policy success on the part of central banks, but I think a lot of people aren’t fully aware of its origins. So, I want to get first into your personal origins. How did you originally get interested in economics growing up in New Zealand, and going on to do a PhD and play a role in economic policy in the 1980s and 1990s, sort of at a key time of market reforms in advanced and emerging economies? a lot going on in the 1980s, and just from a market reform standpoint, New Zealanders, 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 Hoover’s very own Victor Davis Hanson, who farms almonds. And you also have an autobiography, called Incredible Luck. I’m curious about your personal origins, you know, were there any other New Zealand economists 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?

Don Brash: Well, I was mainly interested in foreign policy. I was very much preoccupied with the causes of war. Because 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 bachelor’s degree with a history, very good marks and so on, I couldn’t see much history, much prospect for my career 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 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 100 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 pro-market track. I went from there to the World Bank. I spent 5 years there, learned a great deal. It was the time that Robert McNamara was president of the World Bank. I learned a lot from him.

Jon Hartley: You’re working in the U.S, right?

Don Brash: In the US, in Washington, D.C.

Jon Hartley: Wow.

Don Brash: A part of that time, I was on the staff of what became known as the Pearson Commission on International Development, but named after Lester Pearson, the former Prime Minister of Canada, who chaired that commission. There were 6 or 7 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, started me off 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 made a false attempt to get into politics, didn’t work. So then I got 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 kiwifruit vines. And that explains why, to this day, I still have an interest in a kiwifruit orchard. It’s a great product. I was then asked to amalgamate what in America would be called savings and loan institutions. There were 9 of these rather weak institutions, and I was asked to put them together. And I was… had done that for 2 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 Labour government, which is our… ostensibly our left-wing party, asked me, or their 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 the… This is because Roger.

Jon Hartley: Roger Douglas, who’s the finance minister.

Don Brash: That’s right.

Jon Hartley: Known for market reforms at that time, I guess, floating the kiwi dollar, the New Zealand dollar, tariffs, financial deregulation.

Don Brash: 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 a center-right government, let alone a center-left government. 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 going to have tax. A goods and services tax, or a value-added tax, is about as good as it gets. But most countries have attempted to create exemptions, different rates, etc, 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 thanks to me 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 goods and services tax, or valuated tax, which is equal across everything with no exceptions, which makes it extremely simple to implement. And that was my, to that point, my 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 inflation and so on.

Jon Hartley: Fantastic. So, 1988 is when you became governor of the Reserve Bank of New Zealand. I’m curious, in inflation targeting, the inflation targeting regime was put into place in 1990. I’m curious, tell us the story of how this all came together. I know there was a famous interview in which you went on TV, and you said, you know, you, I think favored a 0% to 2% target. I’m curious, you know, was there a lot of academic. thinking, or was it more, you know, personality-driven? I’m just curious, how did this whole, idea to have an inflation target come about? I know, like, you know, prior to inflation targeting, explicit inflation targeting regimes. You know, for example, the U.S. briefly had a monetary policy targeting regime that was going on in probably around the same time, in the late 1980s, I think, in the Volcker Fed. I’m curious, like, what was being discussed at that time? You know, did… the central bank and the government at the time, at least, you know, did they buy into, sort of, Milton Friedman’s idea that inflation was always and everywhere a monetary phenomenon, which it wasn’t exactly 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?

Don Brash: Well, the background was that we had had inflation, which by developed country standards 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 fairly high inflation. But… but let me go back one… one step. Prior to 1989, And I say 89 because that’s when the Act was passed. There were two kinds of central banks in the world. there were the completely independent central banks, at least notionally, the Fed being the most obvious one, but also the Bundesbank in Germany, Swiss National Bank in Switzerland, and so on. But that was about all. There weren’t very many of them. Most central banks were 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 rate does the government tolerate its currency devaluing. In other words, 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 if the inflation rate choice in the hands of the addicted government. And told the bureaucrats in the central bank, to deliver it. And the inflation rate, which the government wanted, had to be public in writing, and everyone knew what the target was. The government couldn’t fudge it. And the central bank had to deliver. Now, when I said central bank. When the 1989 legislation was 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 has a tight monetary policy. It’s doing it because the government has mandated the inflation rate, which the, the Reserve Bank must deliver. So, unlike the situation you have in the United States right now, where the president can criticize the Fed for not dropping interest rates, he’ll be the first to complain if inflation gets out of control. But in the New Zealand framework, the government can’t really criticize the central bank. As long as the inflation rate is within the mandated target. So, that’s created a totally new framework. 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 in our case, originally, the governor of the central bank to deliver it. So, that was a unique framework, but when you’re going to structure a framework like that, you have to have, in some sense, a numerical target. What does the government want for the inflation rate? Well, the 0 to 2 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 reporter said to Roger Douglas, aren’t you satisfied now? You’ve got inflation under 10%. And they just replied, no, no, I’m looking at, like, zero, or zero two. And it was a flippant, off-the-cuff remark. when he sort of made the 0-2 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 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 0 to 2 by 1992, because we were at a higher rate of inflation by that time. In the early 1990s, you know.

Jon Hartley: So, if I guess… my understanding is, and later it shifted, from, you know, 0 to 2 to, I think it’s 0 to 3, and then, and then eventually 1 to 3. So, eventually, you know, 2% became the middle of the band. I mean, it’s fascinating how like, one, I guess 2%, which we hear about today, and 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 want to say randomly thrown out there as a number, but is there any information in terms of any kind of academic input into this? Was there… or was this just a sort of arbitrary set of numbers that Roger Douglas 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 is it… was it just really a kind of an arbitrary thing that we’ve now all sort of coalesced around?

Don Brash: Initially, it was rather arbitrary in the way I’ve described. Subsequently, we rationalized it as 1% measured inflation. is probably akin to actual inflation. Yeah, actual inflation. Is it zero? 1% measured inflation is probably equivalent to price stability, because of biases in the measurement of the consumer price index. I think that you had a Senate committee in the United States, I think it was the Boskin Committee. Which is…

Jon Hartley: named after Hoover’s very own Michael Boskin, who’s a senior fellow on the staff here still.

Don Brash: Okay, okay. And I think, from memory, that committee estimated at a 1% bias in the US measurement of the CPI. I think, actually, that took place after our 0 to 2 was established, but we rationalized it subsequently as being Genuine profitability, plus or minus one. That’s where we rationalize 0 to 2. Now, subsequently, we decided there are so many exogenous shocks. Which hit a small economy in a trading environment. That the target was undesirably narrow. So he toyed with the idea of having a target of minus 1 to 3, In other words, same midpoint of 1% measured inflation, which we regard as tantamount to price stability, but a slightly wider brain before the governor was at risk of losing his job. Then we thought, actually, if measured inflation was tracking below zero. The chances are we’d be easing pretty aggressively. So we decided minus 1 to 3, while it had the symmetry of being… retaining the 1% target. Was a bit artificial, so we changed it to 0 to 3 after political negotiations in the mid-90s 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 target was eventually changed to 1 to 3, hence the midpoint of 2.

Jon Hartley: Well, it’s… I mean, it’s fascinating, that, one, I guess, the arbitrary nature of it… so, one, the Boskin Commission, I think, didn’t have until maybe 1995, 1996, a good number of years later.

Don Brash: Of course.

Jon Hartley: You’re right, I think… 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’m just curious, I know some of the history in the U.S. and Canada, that, you know, for example, Paul Volcker. you know, through the rest of his life, you know, favored a 0% inflation target, and he was, I think, a very big critic of 2% inflation targeting for many decades. I mean, obviously, you know, very few central banks heeded those words, I think, but, But I’m curious, I know, like, John Crow at that time, who was the governor of the Bank of Canada. He favored a 0% inflation target originally, or a lower one, I guess, maybe 0-1% inflation target. And then at the time, I think what had happened was, you know, there was a Liberal government in power in Canada, the early Chretien government, and essentially the, the Chretien-Martin government wanted a higher inflation target because, you know, they sort of believed in the Phillips curve sort of concept that you could maybe create more jobs by letting inflation run a little bit hotter. And in the U.S, you know, the Fed never really even announced its official inflation target until 2012 under the Bernanke Fed, even though, sort of, it was, I think, a… pretty well, known, poorly kept secret that 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 increasingly similar 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 was going on that sort of eventually lost out, or… and I’m curious, another thing that you often hear, like, from folks like Ben Bernanke, when he was chairman of the Fed, defending the 2% inflation target in the 2010s, when people were bending over backwards, you know, because the inflation was running below 2%, and how some people made the case it was sort of an emergency that that we weren’t hitting a 2% target. I’m curious, like, 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 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 sort of inflation… early inflation targeting regimes were being set up?

Don Brash: I don’t remember them, to be honest. We were so pleased to get inflation below 2 and regularly around 1, 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 Fed, it seemed to me, was that they had an inflation target, but were scared to mention it. And I think that’s odd, because for me, the inflation target plays a very important role in expectations, and therefore in behavior. 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 pretty important, and they’re important also in terms of the social cost of delivering an 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 of monetary policy that much easier.

Jon Hartley: You know, at that time, in the late 80s, early 1990s. Were there surveys established yet at that point that could track long-term inflation expectations? Like, in the U.S, 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’s many other expectations measures now that exist, and surveys that exist. Policymakers 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 break-evens, but I’m curious. What sorts of data were you paying attention to in your 14-year governorship? What were you paying attention to make sure that you knew that inflation expectations were being better anchored by the inflation targeting machine?

Don Brash: You’re stretching my memory a bit here, Jon. I can’t remember exactly what particular indicators you watched carefully, but we did have some indicators of inflation expectations, both short-term and medium-term, which we were influenced by, but I guess To a large extent, we were focused on what the inflation outcomes actually were, because those played a very important role in conditioning expectations. And, I mean, I… 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 a 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. 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 head of the Council of Trade Unions in New Zealand, And he understood that 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 countryside talking to trade unions, saying, guys, if you want to get interest rates down, monetary policy pressure reduced. then you’ve got to moderate your wage demands. And it was sort of self-reinforcing.

Jon Hartley: That’s, that’s fascinating. I’m curious, like, you know, one thing, I guess, 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… I mean, some people say there’s a triple mandate and stable interest rates, but, you know, the core sort of dual mandate concept that’s been enshrined in law since the Humphrey-Hawkins Act, which is an act passed in the 1970s. basically, you know, price stability, you know, 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 cent… when you’re leaning a central bank. that only has 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 the, 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, and kind of may even have some sort of… unspoken of dual mandate, but I guess there’s also this thing that economists call the divine coincidence, where you can kind of target inflation and end up sort of targeting both, inflation and low, stable inflation, low inflation, and stable unemployment as well. I’m curious what you… what you think about that, or what are the things that, I guess, as a mono-mandate central bank, or those challenges, you know, as you mentioned, speaking with the trade unionists, how does that sort of come about? I mean, I think during your tenure, it 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 since in 2020, even further, you know, more central banks are engaging in quantitative easing, doing other things to keep interest rates. low for the express purpose 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?

Don Brash: 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. And I think that’s now widely accepted, and I suspect Alan Greenspan and the Fed guys would accept that, too. They go through the pretense of having a dual mandate, because that’s what the law requires of them. For a brief period, the New Zealand Labour Government, just a few years ago, introduced a dual mandate for the Reserve Bank of New Zealand, because the Fed does it, the Reserve Bank of Australia does it, so 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 twin objectives will be consistent with the same policy. If unemployment is very low, chances are that your inflation rate will be pushing towards the top of your target. And vice versa. But if unemployment’s going up. and inflation rate is too high, then you’ve got no choice but to make a choice between those two objectives. And there’s no doubt at all that in our case, our primary objective, as indeed our… formerly our only objective, is controlling inflation. So, we reject the logic of the dual mandate. We think the dual mandate is a fiction, which fetus to go along with, because that’s what the law says, but, yeah.

Jon Hartley: Well, that’s fascinating. I’m curious to get, some further thoughts on some of your own, you know, thinking on, you know, monetarism, and… I know you crossed paths with Milton Friedman, who was a Hoover Senior Research Fellow, one of the most famous economists of the 20th century, and, a pioneer of monetarism and free markets in general. I know you crossed paths with him several times. I’m curious. What your interactions with him were like, and when these interactions took place?

Don Brash: Yes, I mean, it’s a curious contact. My first contact with Milton Friedman was very odd. I was running this investment bank, as I mentioned to you, in the 70s. 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 some media coverage, and I said, how can I upstage my friend? I thought, the best way I’m getting… bring this 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 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 wife, Rose. No fee required, as long as you show me around the South Island for a week. with my wife, which is what we did. We traveled that part of New Zealand, the more scenic places, and he gave 3 major speeches in New Zealand, our main… 3 main cities. And that began a good friendship 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 Auckland, the main city 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 people.

Jon Hartley: That’s, so fascinating, and it’s amazing, I mean, seeing their influence around the world is, you know, I think military truly is, you know, undeniably, you know, perhaps alongside Keynes, the most influential comes the 21st century. or, sorry, the 20th century. We’ll, you know, we’ll see about the 21st century 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, again, you know, the Fed at the time was very focused on targeting monetary aggregates. Was this 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 macroeconomic research, you know, the whole concept of money is largely absent. And I think part of why the Fed abandoned targeting monetary aggregates was that money demand wasn’t very predictable. There’s questions about what is money, and this, you know, does Treasury bills count and things like that, but I’m curious, back in the 1980s, when, you know, Milton Friedman and some of his thinking was, I think, at his peak. at the Versus Bank of New Zealand, was money something that was often talked about, or at least sort of used as a reference point in predicting inflation? I’m curious, how do you think about money and monetarism?

Don Brash: Short answer is we did not pay much attention to money aggregates, and that was partly because following this 5- or 6 year period of extraordinary economic policy change, we didn’t find anything very consistent or predictable in the money overgrids, 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 bore you with the details of it, but it was quite unlike any other policy anywhere else in the world, as far as I know. But 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 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 big effect. 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 system’s collective accounts with the central bank, every night. And we kept that number very low when we wanted 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 would sort of clear our throat and say, inflation’s not quite where it should be, and almost instantaneously. interest rates all over the economy would go up and vice versa. It was a… it was an odd framework in terms of implementation, but it… but it certainly worked. In the mid-90s, 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 2 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 didn’t have it calibrated correctly. But in a small economy, both the exchange rate and interest rates have an effect On… on inflation, both, both as… as measured and, and, longer-term, more deeply-seated factors. And of course, in 1999, We adopted a more conventional implementation regime, where we set a cash rate Which we pay on balances with the central bank. And raise and lower that as required.

Jon Hartley: Interesting. So there’s… now, since the 1990s, there’s been a policy rate that’s sort of a lower floor on interest rates. That’s fascinating. Prior to that, I guess the central bank would do open market operations to try and name.

Don Brash: Oh, yeah.

Jon Hartley: These various rates and exchange rates and so forth.

Don Brash: Yep.

Jon Hartley: That’s fascinating. Yeah, it’s amazing how… and then now, you know, fast forward post-2008 in the U.S, and post-2020 in an ample reserves regime, where, you know, you have… you know, the money supply curve’s moved so much to the right that, you now sort of have to use, these sorts of policy rates as a floor and have these, you know, sorts of corridor systems in the U.S, like you’ve got. The reverse repo system (ON RRP) is sort of the lower Band, and then you’ve got, interest on excess reserves on the higher end, and you kind of need to pay interest on reserves in order to even move these interest rates around. So it’s interesting how just the policy tool regime has changed over the years, and it’s really fascinating 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 how it evolved in the late 80s, you know, and how it’s evolved since, you know, I think one thing people don’t really realize is how how recent I think central bank independence is, as a concept. And even Milton Freeman wasn’t really, I think, you know, there’s not maybe a perfectly accepted definition of what central bank independence means. But, you know, I think Milan Freeman was, at some level, a bit of a critic of independence, in that he kind of argued that, you know, in the U.S, like, the president kind of gets the monetary policy they want, because they’re the one making the appointments. But he also sort of argued for, you know, a central bank money growth target, sort of to remove 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 five… I think a lot of them now have these five-year framework reviews. In particular, in Canada, you know, it’s sort of a back and forth between the Ministry of Finance and the central bank. Within the U.S. at the Fed, it’s very much internal. That is, you know, the U.S. Treasury doesn’t get to have a say in terms of what The Fed’s, you know, framework review should be, there’s been a lot of controversy in the U.S. 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?

Don Brash: Well, I mean, you’ve got a very different situation in the US, where clearly the fear, at least notionally, is fully independent of the Treasury and the administration and so on, even though the president does get to appoint the federal governors, and the chairman, I think, from memory too, is he appointed the chairman? I think he… does he?

Jon Hartley: He does. 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.

Don Brash: Bye.

Jon Hartley: the Fed Board, still has sort of some veto power over those.

Don Brash: Right.

Jon Hartley: a presence.

Don Brash: Right. I must say, 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 the responsibility where it should lie. 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 they must be forced to tell the public what that depreciation of the currency is going to be. If I’m going to 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 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 overtime them if they don’t? That seems to me, in a democracy, the right framework The situation in the US, I think, is, in terms of monetary policy, a terrible one, 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 brain the Fed for higher inflation. I mean, it’s… it’s… It’s not a good situation.

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

Don Brash: That’s correct. That’s correct. And, I mean, the first time we went outside the bounds was caused by the first Gulf War. caused a spike in international oil prices. 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 1996 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? Because clearly, fiscal and monetary policy interact with the inflation rate. And the framework recognizes that interaction. If the government wants Easy monetary policy, and a given inflation rate, they might well have to do something with fiscal policy.

Jon Hartley: That’s fascinating, and I mean, today, you know, the fiscal monetary interactions 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 the U.S, you’ve had some pretty big shifts in debt management policy. Here in the U.S, the U.S. Treasury decides what the maturity of the newly issued debt’s going to be. And, Obviously, you know, that decision upon, you know, the finance ministry to issue more or less long-term debt is basically isomorphic or equivalent to 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 the Finance Ministry of the U.S. Treasury. So, I mean, it’s so interesting how these things are very much connected, and absolutely, you know, accommodative or tight fiscal policy, you know, can be moving in the opposite direction as monetary policy. I mean, it’s fascinating how the you know, the frameworks of the 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, but at some level, you know, there’s also, maybe this is a good thing in the sense that there’s more coordination around these sorts of policies and in going after, you know, stable inflation. I’m curious, I want to pivot a little bit toward, because you served as opposition leader, you were an MP for many years, and leader of the National Party. I’m curious, you know, what you think about New Zealand from a cost of living zoning, you know, trade policy standpoint, I’m just curious, you know, I’ve heard a lot of things about land use regulations in New Zealand and places like Auckland and Wellington making It’s 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 the U.S. has had one, largely in its coastal real estate markets. I’m curious what you’re thinking around that, as well as sort of New Zealand’s role in international trade. Obviously, it’s much closer to China and Australia, and those are big trading partners for New Zealand. I’m curious. What your take is on New Zealand, where it’s at today, 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?

Don Brash: Well, the land use regulations you refer to 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, etc, which have similarly tight controls, have similarly outrageously expensive housing. Successive 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 to the median household income was about 11 a few years back. It’s now down to about 8.5. So it’s come back quite a bit, and the government seems intent Gradually, on deflating that bubble. I’m strongly in favor of what they’re doing in that area. Where they can get away with it politically is another question, of course, because more people own houses than don’t, and people don’t like seeing their major asset decline in value. But that it needs to decline of value is beyond doubt. And, as I say, the government… current government’s making some… some modest progress in that regard.

Jon Hartley: Huge political economy problem, you know, just…

Don Brash: It is, I’m…

Jon Hartley: like entitlements in the U.S. as well, you know, people don’t want to lose their benefits or their home values.

Don Brash: Yep, exactly right. And, I mean, for us, the model housing market, I think, not sure if it still is, but Houston was the model we looked at and said, my gosh, they’ve got house prices which are a very modest multiple of household income. And they’ve clearly got it right, and of course, as you well know, in Houston, there are no land restrictions at all. You can build whatever you like. And that’s got some appeal. We are a country of 5 million people, roughly, on an area somewhat larger than the UK, an 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 fundamentally, our house prices have been outrageously high. We have a fiscal problem, which is not unlike that in most other developed countries. It’s better than some. Our current government debt-to-GDP ratio is about 40%. Which is a long way, short of where the US 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 health expenditure, which is projected to rise. strongly as the population continues to age, and again, 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 the Oxford Union just a couple of weeks ago, earlier in the month, and in the 1950, two-thirds of New Zealand’s exports went to the United Kingdom. In 1970, it 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 tariff policies, which affect everybody, you know.

Jon Hartley: Well, I’m curious about, I guess, it’s fascinating about, Auckland’s zoning reforms and how successful that’s been. I know Minneapolis is trying to do something similar in the U.S. or has been in, in Houston, you know, which doesn’t really have any zoning, is, I think, a model for, for many in terms of what, what land use deregulation can achieve in terms of affordability. I’m curious, I guess just in general about market reforms, and you came into policy and politics 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 policy, in, in laws, in economic policy, laws, in, in general, this manifests itself, I think, in many ways from, you know, deregulation, you know, think in the U.S, deregulating the airlines. You know, thinking about, you know, other industries. You know, in the 70s and 80s, there were many nationalized industries in many countries, and now we, you know, see leaders like, you know, Javier Millay, who’s, you know, going to Argentina, which, you know, suffered under Peronism for many, many decades. And it’s sort of beginning that process now of doing, I think, a lot of the things that countries in the 1970s and 80s were doing, which is, 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, rent controls that are being lifted. You know, I think Javier Milei 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 your mind, are market reform 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 viable economic growth strategy? Liberal economic institutions, in your mind, do countries need to relearn this?

Don Brash: Some do, including New Zealand, though to be fair, as you mentioned, we had big liberalization in the 80s under this Labour government, surprisingly. We had extensive import controls. We didn’t have export controls, we had export subsidies for the sheep industry in particular. Tariffs were high, quantitative controls were high, rent controls, you name it, controls we had. All of those went, all the import control… quantitative controls went, tariffs were reduced drastically. And of course, That’s a traumatic thing, as you will understand, when you do it suddenly. Industries which have grown up after 2 or 3 or 4 decades with high protection suddenly find themselves without protection. In our case, the motor vehicle industry was the best example. We had 10 different international companies producing cars in New Zealand for a total market of 100,000 cars. It was utterly ludicrous. They were essentially 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 suddenly remove that protection, the adjustment process is pretty brutal. And sadly, that period is regarded by many people in New Zealand as a disaster. As an economist, I regard it as fantastic liberation, and set the economy on a much, much better track than it would have been had we stuck with that dopey framework. It was crazy on tariff policy, on regulations, on you name it. One of the things it did, which was in some ways, might be regarded as counter to that. We introduced, I think, the first framework for… Controlling the fishing industry. I think it’s now been copied quite widely, but clearly, fishing in the open ocean is one where you have the 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 do they call it? Individually tradable… quotas, yeah. So you have… you’re allowed to take 4% of the estimated sustainable catch of a particular variety of fish, or 10%, or whatever your quota is, and it’s a tradable… it’s a tradable right. And…

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

Don Brash: And I think we were the first to do it in the case of fishing. But it’s been copied now quite widely, and it’s a good framework. So, yeah, I mean… Should we be doing more liberalization in New Zealand? Almost certainly. The government still owns, or part-owns, things they shouldn’t own. Privatization has been a sort of a political hot balloon… hot, hot, yeah, hot topic. But it’s… it’s a vast improvement of where it was, some decades ago.

Jon Hartley: Well, that’s, fascinating, and, we’ll see how long, you know, how, or what, Javier Milei’s impact, will be. I think he’s only 2 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 one policy area to another very quickly, and I think he’s undergoing some labor market reforms and fiscal reforms now, and we’ll see. You know, it takes time. sometimes these things, if done very suddenly, you know, you can end up in a lot of hot water politically. Maybe, perhaps, you know, Liz Truss being sort of an example of that, but it’s fascinating to see politicians attempting market reforms again, where I think for a long time, certainly after the global financial crisis. that, these things, the free markets were, 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 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 in inflation targeting and ideas. I think it’s safe to say that alongside fellow New Zealand economist Bill Phillips, you know, the namesake of the Phillips Curve. that you’re both, I think, two of the most famous economists in New Zealand history. It’s truly wonderful to get the full history of inflation targeting, how we got, you know, 0% to 2%, and how you implemented it, and how the Reserve Bank of New Zealand has been working up until today. It’s really an honor. Thank you so much for joining us.

Don Brash: Thank you, John, I’ve enjoyed it. Thank you.

Jon Hartley: This is the Capitalism and Freedom in the 21st 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 Hartley, your host. Thanks so much for joining us.