By Elizabeth Kerr
NCIS, The GC , The OC, LAPD, The OCR, CSI and JAG.
Question: Which one of the above is not a TV Show?
“Correct”! The OCR.
Officially it stands for the ‘Official Cash Rate’.
And while our financial system might seem more CSI than we would like, the topic for this weeks’ column came from a reader who questioned: “What is the OCR, what does it mean and why should I care?”
So, never one to shy away from a challenge this is my attempt to make it seem as simple (think The GC) as possible so everyone can understand.
The money box for our banks
The OCR is the interest rate that the central bank (in our case the Reserve Bank of NZ - RBNZ) charges on money that it gives to NZ commercial banks. In this instance the RBNZ is like a money box for the commercial banks to borrow from.
*this is my example... don’t shoot me for not showing every NZ bank in my diagram
If you want to buy a home or take out a personal loan from your personal bank then the amount of ‘OCR interest’ the bank is paying back to the RBNZ will have an effect on the interest rate that they would make you pay back to them.
If the RBNZ changes the OCR % rate UP then the banks will usually pass that increase onto you by increasing the amount you have to pay them in interest.
The same usually happens when it goes down.
If you haven’t fixed your mortgage, and the OCR rate changes then chances are that you may receive a polite letter indicating your flexible repayments may be increased or decreased depending on what rate the RBNZ has imposed on the banks money.
This is at its most basic level how it might effect you, but the OCR is actually capable of a lot more than this.
Keep reading….
Inflation
Inflation in this context has nothing to do with cup-sizes or tyre pressures, but instead refers to the buying power that our money has.
For example, let’s say today you can buy a Pizza for $10.00. If inflation is just 1% then next year you can expect to pay $10.10 for the same pizza.
The RBNZ has the important job of keeping inflation in-between 1% - 3% per year; and it can do this by moving the OCR up and down depending on what we as a country need to be doing – spending or saving.
Cheap money is good money right?
Wrong!
If the OCR is low (today it is just 3.5%), and banks don’t have to pay much to use that money, then they can lend it out to you relatively cheaply.
When that happens you might feel a little flush and be tempted to pay more for things that you really want, or buy things that you don’t really need. If this goes on for too long, then prices would eventually start getting out of kilter and your favourite Big Mac Combo might set you back $12 instead of $8.90 all because your money is cheaper to come by, and thus its purchasing power diminishes.
Back to the Future
In 2008 when RBNZ had OCR interest rates at 7%, the interest on our mortgages from the bank hovered around 10%, therefore you may have only afforded a $350k house by taking into account the cost or repayments on that loan.
But now interest rates are 3.5% from the RBNZ and between 5-6% at our banks so you feel more confident about splurging on an extra bathroom and a few extra bedrooms in a better suburb because the cheaper interest rates means you can afford it.
Reading the future
Now what if you got wind that the OCR was going to stay the same, or even get lower for the near future?
Well you’d probably feel more optimistic about putting your extra-best-stretch-price on a tender document for a house you’ve got your eye on, and you might feel quite optimistic about your spending and earning powers.
So if you’ve kept reading this far you can see that the OCR affects the NZ economy by affecting the amount we are happy to pay for something, and in turn keeps inflation under control.
Big Brother is watching….
The RBNZ checks in on us approximately eight times a year to see how we as a country are performing.
No one ever knows for sure if the rates are going to be moved up or down but economists usually have a good crack at guessing what the RBNZ will do a week or so before the announcement.
If this conjures up images of Groundhog Day the movie then you wouldn’t be far wrong because the RBNZ hasn't changed the OCR rate since July last year. (click here to see all the rate changes since OCR stick was introduced in 1999)
SO, why all the fuss over Auckland House prices and the OCR?
People are feeling really spendy-bendy for a number of reasons and the cheap cost of borrowing money from the bank only adds fuel to this price rising inferno in Auckland.
If the RBNZ increased the OCR rate to the banks and thus made it more expensive for someone to borrow money for housing, then that might bring down people's appetite to take on too much debt.
But what about the rest of the country then, nowhere else are experiencing such dramatic house price rises… so why should we all be slugged with a higher cost of borrowing just to rein in Auckland house prices, you ask?
And therein folks lies a problem with no clear answer….
The OCR and my money machine?
As always, everything comes back to your money machine. What is a money machine again? Repeat after me: “A money machine spits money at you, to fund your lifestyle, without having to go to work” (unless you want to). Imagine the tree that your parents said didn’t exist when you were growing up…..well they kind of lied… it’s not a tree at all, it is a well planned and diversified machine instead.
If you’ve managed to siphon money away to fund your future lifestyle then you want that money to have some kick-arse purchasing power and not be reduced to chump change because of inflation. It would suck to have saved so diligently only to have to part with $5000 just to get your weekly groceries. It’s for this reason that the OCR is such an important tool for the RBNZ so that it can prolong our money's purchasing power for our lifetime.
SO, I hope dear reader that I’ve gone part way to making the OCR seem a little more relevant to you personally.
(Just a reminder that I’m not a Financial Advisor and anything I write should be taken with a grain of salt … or better still to your nearest AFA if you are contemplating making any financial changes, cheers!)
16 Comments
Quite right, a lot of bright people wrap their minor insights in long words to make them seem deeper than they really are. Their ponderous stylistic decisions absorb the maximum mental effort in order to ensure there is no unused mental capacity to question their cogitations. In short, they try to use all your mental bandwidth so you just go along with them. Good copywriters do the opposite and great copy is very valuable.
If you're able to pay $12 for the big Mac, then that is not a problem. In Fordism, it's actually a good thing - it means the Big Mac workers might actually be getting a decent wage.
The question becomes, can Burger makers keep up supply in order that all workers can afford the luxury? Can all workers get an equitable wage (or return on investment) that makes Big Macs, sustenance food, sustenance shelter, sustenance rates contribution that supports a $12 or $8 or $3 Big Mac. the number itself doesn't matter, the ratio vs income and ratio vs disposable income which is important.
Also As you'll note: the OCR has no effect on people and businesses not in debt. or in debt to private or foreign sources. Which is why it has become a completely ineffective tool - back when much of the country relied on banks, especially The Rural Bank, it was a good tool. Now it's just a punitive ineffective flag waving. It goes down, cheap money, borrow big. it goes up, refinance offshore.
I disagree entirely with the statement 'OCR has no effect on people and businesses not in debt.'
The rate effects savings interest rates, and also takes its toll on the way the Stock Markets and Exchange rates tend to tilt. So while not directly effected, there is no argument that indirectly the OCR effects the country and therefore every individual in the country (unless of course you manage to live in the bush with no rate payments, petrol costs, or food to pay for).
If the OCR is high, savings are generally higher, therefore conservative savings like term deposits offer as good or better returns than shares in some cases. However, as we see now the lower OCR lowers savings rates turning investors to shares and therefore offering higher returns (generally) than term deposits - subsequently the businesses that are invested in can expand because their lines of credit are cheaper - potentially lowering overall prices to those with/without debt.
In short, OCR does effect each of us regardless of our situation.
You have to think about the relevance of the OCR at a time when mortgage rates are hitting record lows, yet the OCR is 40% higher then a year ago. This time last year the OCR was 2.5% today it is 3.5%. 10 years ago I would have agreed that interest rates affect credit rates. Today things have clearly changed, and instead of living in the past, you have to be able notice that things have changed. You have to be able look at the old models that are no longer working, understand why they are no longer working, and develop new models that actually reflect reality. So much stuff that used to be true, is no longer relevant today, and you have to adapt to the new reality. Too many decision makers living in the past, flogging the same old dead horse.
You have probably answered the simple questions you set out to answer but there is far more to the OCR than that. The OCR can have no bearing without knowing how money is created?
Where does the RBNZ get all its money from?
Why do we measure M1, M2 and M3 money supply?
Why do we not have the physical money other than M1?
Why is most of the money only a book entry and Why does this money which is not in existence attract interest? Why forward pay?
Then there are the inflation questions.
You have described inflation as a change in the price of goods (fair enough) however that covers- up what inflation really is.....and the significance of the M3 money supply in measuring inflation.
Why measure M3?
What effect does the M3 money supply have on inflation?
Why do we allow the value alteration of money by a central bank?
Why is the RBNZ so concerned about house prices?
Why are so many resources put into measuring Growth?
RBNZ pays the Government a dividend.
How does the RBNZ generate income to pay dividends?
Let's take $1 billion at 3.5% or $2 billion at 2% and here's why the OCR has to go down.....it also explains why house prices have more than doubled.
Inflation is actually a tax so people should care a lot about the OCR.
notaneconomist
Its a pretty innocuous process, really. I don't know why Austrians get their knickers in a twist about fractional reserve banking when it provides a such an indispensable service to the entrepreneur by allowing them draw a lien on future revenues in order to make capital investments and in return agrees to the creditor to make periodic deferred payments. In return the borrower pays an charge in proportion to his loan (interest) to compensate the risk the bank takes in extending credit.
I think the antipathy towards the banking have anti-Semitic roots. The portrayal of Jewish people as grasping, unscrupulous, avaricious in popular culture date back to Marlowe's The Jew of Malta and Shakespeare's the Merchant of Venice.
"It gradually dawns on the goldsmith that it is not really necessary to have a unit of gold for each outstanding receipt. This idea must have come as a revelation, an epiphany. To be sure, the strait-laced would recoil at the idea of issuing more receipts than one had gold, but if no one [sic] ever withdraws the gold, then what possible harm? "
http://blog.turgot.org/public/documents/Selgin_Goldsmiths.pdf
"In reality, although the process outlined in the previous sections could occur, cash balances in bank vaults no longer act as a constraint on bank lending in the way that they might have up until the latter part of the 20th century. It is not surprising if the popular characterization of Jews as unscrupulous informed later understandings and portrayal of the practice of fractional reserve banking.
The key constraint nowadays is banks need to settle the large volume of customer and other
transactions on their own account with each other on a daily basis. This occurs through the
payments system, as outlined in the next chapter (see 5. THE PAYMENTS SYSTEM).
Banks settle transactions with each other through their accounts with the Reserve Bank,
with these accounts having to remain in credit.
This means that, when a bank makes a new loan, the proceeds of which might be credited to an account at some other bank, it needs to make sure that it raises enough funds, either in the inter-bank money markets or from customer deposits to ensure that its net cash outflows will remain near enough to zero, and so that its position in its account at the Reserve Bank will remain in credit."
http://www.johnpemberton.co.nz/Banking_in_NZ-06-final.pdf
think The GC
Your choice of acronym is somewhat unfortunate in the realm of short term financing arrangements dictated by the OCR.
Wtiness the term GC (General Collateral) confirmed by the RBNZ at yesterday's OMO.
Whilst the OCR does matter a recent book by Nate Silver who is one of the best predictors and statisticians in the world shows that most economists are hopeless at predicting the direction let alone the top or bottom of the interest rate cycle Look at NZ We were in for 4 interest rate rises a year ago now two cuts!
Best if you borrow allow a large margin of safety Only look at how quickly the NZD has retreated from parity with the AUD Same could and probably will with interest rates at some stage
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