By Roger J Kerr
A lot is being written lately about the need to change the model for managing inflation in an economy by means of monetary policy.
The argument is that with inflation and interest rates at zero in several economies, monetary policy management of cutting interest rates and printing money is not really working to lift economic activity levels to generate higher inflation through demand/supply mismatches. These problems are really confined to Europe and Japan who have been slow and reluctant to introduce major fiscal and micro-economic policy reforms.
It would be dangerous to extrapolate the unique situation in Europe and Japan as also automatically applying to the US, Australia and NZ.
These economies are much more competitive with deregulated industrial and labour markets compared to the dinosaurs of Europe and Japan.
It may be hard to see rising inflation above 0% in Europe and Japan, however the annual inflation rates in Australia and the US are already much higher and would go higher still if oil prices reversed upwards.
The RBNZ are currently struggling to get inflation higher in a free and open economy like NZ as foreign investors like our relative economic performance and keep pushing the NZ dollar higher and ignore the slow/timid interest rate reductions designed to force the currency lower.
However, the RBNZ’s lack of success to date in this regards does not mean we suddenly abandon inflation targeting with monetary policy for some other lofty objectives. If oil prices were to increase back to where they came from at US$100/barrel and that fed into second-round price increases in the NZ economy, the RBNZ would be more worried about the 3% upper limit than being below the 1% lower limit.
Both the Government and the RBNZ are currently rejecting calls to abandon the Policy Targets Agreement to keep inflation between 1% and 3% and they should continue to do so.
Technology advancements are causing the prices for many household items and services to fall.
What would be more useful on the inflation front is a comprehensive study of this impact and also whether the current basket of goods/services that Statistics NZ apply to measure the CPI is still appropriate.
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Roger J Kerr contracts to PwC in the treasury advisory area. He specialises in fixed interest securities and is a commentator on economics and markets. More commentary and useful information on fixed interest investing can be found at rogeradvice.com
8 Comments
Right on Roger. EC101 a free market satisfies demand at the lowest possible price coupled with the obvious fact that advancing technology is continually finding ways to produce goods cheaper and cheaper. This means that prices in general should be getting cheaper and cheaper. Our economic imperative that inflation must be 2-3% is completely at odds with with what our economy should be doing. We have had 8 years of flogging a dead horse all round the world with low interest rates and still seem little further ahead. It can almost be taken as proof that under these conditions this approach does not work and it is past the time that our leaders faced the facts of this and applied some fresh thinking. I suspect that the only reason that they stick with the present model at the low end of the inflation spectrum is for the benefit of the banking sector. No arguments with the model at the high end of the inflation range where it has been proven to work.
Can we reverse the 150 bps OCR cuts until the TPTB work out what is from what "should be"? Repeatedly transferring wealth from one cohort of society to reward another on the basis of unobservable confirmation of prior predictions is ideology at best, and tantamount to theft.
Stephen,
I know from reading many of your posts that you have a considerable technical knowledge of the financial market. Can you tell me what you think the effect on NZ would be if the OCR were raised by 150bps?
By how much would the $ appreciate against all major currencies and what would be the consequent effect on exporters? What might the net effect on employment be?
For the RBNZ to be targeting 1-3% in the currently world economic environment is nonsense they have failed to continue to cutting rates is not going to change the CPI but simply distort many other already highly challenged parts of the economy. In the highly unlikely event of $100 oil (perhaps a war) deal with it then
Roger, am afraid I don't agree with many assertions you make in your article. Firstly, Japan is by most measures doing very nicely. They have the lowest unemployment in the world, and have printed themselves to trillions of the world's assets while keeping their currency at a competitive level. Japan's current account remains positive even with the electricity shock caused by their tsunami. They have also printed away over half of their government debt. Japan hasn't caused inflation because they don't really care about inflation; they only pretend to do so; while they are laughing themselves to all the free assets mentioned above. The world should be screaming at them to lift consumption, which would be relatively easy to do. Did they need to go to negative rates? Only to keep their currency competitive- it was nothing to do with inflation really.
Separately you talk of technology led deflation, when really deflation has been caused by massive over investment, largely in China, but also elsewhere, supported by the very low interest rates the world sees.
In NZ the interest rates have manifested themselves in booming property prices.
Here it would seem very helpful to consider other targets- in my view fullish employment, a balanced current account, and an inflation target.
More importantly, the RBNZ should have the flexibility to drive how and how much money is printed, and broadly what that printed money is spent on. The current paradigm forces all our printed money through the mortgage system, and that is neither efficient nor does it have the desired effects much of the time.
Japan is not perfect, but we could learn some things from them.
QQE has been worse than the Great Recession for the Japanese. View graphic evidence and read more
I agree Japan has effectively printed wealth where as we have indebted ourselves to create money with our property bubble.
Few though ask the question about the reliance on central planning for the running of a free market economy.
and whats so wrong with deflation I got a 0.5% pay rise I can't handle any inflation.
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