There is a BIG contradiction in Matt Nolans article.

He says... "The purpose of keeping inflation low and stable is such that the future general price level in the economy is predictable. By ensuring that inflation stays at a set rate, people can make decisions and plan spending and investment with more certainty "“ both in terms of government policy regarding the general price level and on the basis of lower variability in general prices."

He goes on to say... "However, the gain from printing dollars is only temporary. The employers that have been tricked into hiring and producing on the basis of false price signals will, in time, lower their production again. In the end, the economy ends up back where it was "“ except that we face the permanent cost of having higher and more variable inflation rates as the central bank loses credibility."

Matt.... How do you explain this graph of money supply growth.????
http://www.interest.co.nz/charts/gallery2-60.asp

How do you reconcile this with what you call inflation...???

Maybe that is what Phil Goff is alluding too...????

Do you see the paradox that you have stated but not explained....?????

You express the dangers of increases in the quantity of money, but you say, implicititly, that that is OK because inflation ( your measure of ) is under control.

Sounds like a contradiction.... don't you think..?????
Why has there been a disconnection between money supply growth and inflation..??
( that is, inflation as u define it... ie.. CPI )

cheers Roelof

I think you are trying to advocate tinkering and repairs to an old wreck that is beyond repair. For those of you who would like to read a very sound and brilliant article on the current state of global monetary affairs (looking primarily at the USD), then please read this:

http://online.wsj.com/article/SB1000142405274870434240457457576166048199...

It clearly shows, in my opinion, that most contemporary politicians and economists have no clue as to the problems that they have created and are continually creating. They are just making the hole bigger by the day.
I have to say it's the synopsis of the current malaise in the system that I've read in a long time.

I believe the Reserve Bank has taken their eye off the ball.
They have been playing the Man .. not the Ball.
( excuse the metaphor.. I'm into rugby).

Monetary policy is just that..... MONETARY..... MONEY.... MONEY SUPPLY

With the benifit of hindsight is is obvious that Central Banks have abandoned paying attention to Monetary aggregates.
Their ONLY concern has been to keep the CPI within a certain range.

The result has been incredible growth in money supply... globally.

Matt asks these questions... "If it is true that the housing market is bubbly, and if it is true that the exchange rate is higher than fundamentals suggest, then we should be asking why "“ what factors in the real economy are driving people to spend too much on housing, and what factors are pushing our dollar up to this level? "

I actually believe that part, if not most, of the answers to these questions can be found by looking at Monetary policy in a "globalization" context.
An example is the carry trade.... What was the global impact of Japan having interest rates at close top 0% for a long time .... What is the impact of USA having interest rates at close to 0%...

What is the impact of Chinas monetary policy of keeping their exchange rate artificially low..???? What global distortions occur..?? How might that affect consumer prices..???/

Hi Matt..
Thanks for responding
I was trying to link to m2 and m3.... that graph has tabs.

The point I'm trying to make is that Inflation IS NOT the CPI.
The CPI is a way we try to measure Inflation.

Matt said : "Money is not a real economic variable "“ it is an arbitrary thing that we use to picture the relative value of real goods. Policies that manipulate the use of money for short-term gains will merely mess up the real price signals in the economy and cause long-run economic hardship"

YES..... But even more so the QUANTITY of Money.... If Central Banks allow the Supply/Quantity of money to be completely elastic... then how will that affect the "pricing signals"...????

cheers

Roelof

"...there is work on such a thing in the US at the moment"
That notation is enough to put the willy's up me!
And,
Great link, Ludwig.

Matt and Roelof. Great exchange.

I understand what your point of the article was, Matt, but it is also obvious that you have no answers to these fundamental matters which Roelof points out - all you can say is that you agree.

Okay, so, if you agree then how, without amendment of the Reserve Bank Act, do you propose that we manage these global externalities?

We can hardly sit here and moan about how all the big economies overseas screwed up "the consensus" and hence stuffed us up.

Don't you think we have to have a plan to counter these externalities? Or do you think we should just 'wait it out' whilst holding firm to our late 80s ideological principles?

The existing mechanisms might have a chance of working if the data they used to measure "inflation" was accurate. Many people on this site, myself included, bemoan the absurdly high price of housing in this country and the drag it creates on the rest of the economy. Central bankers, Greenspan and Bernake in particular, claim you cannot see bubbles forming, you can only ameliorate the effects of them after they have burst. So obvious inflation in all types of financial assets, including unfortunately housing, has been ignored as they are not adequately represented in the CPI that bankers use as their benchmark for judging inflationary pressure. The relative rent component is an inadequate measure of housing inflation when rental yields are in some cases 2-5%. Bubbles in the stock market are ignored all together as markets are supposed to be rational and self correcting (although corrections on the downside are rarely allowed to play out because of the fear the debt used to build bubbles will be liquidated)

As we have seen here and overseas, it is possible for the CPI to be 2% and house price inflation to be 15-20% pa and stocks to be 10% pa. If for whatever political reason only the CPI is used as a guage of inflation it gives bankers a reason not to raise rates. If asset markets were also included and given enough weighting, the current monetary policy would kick in higher rates much sooner.

It worries me when politicians like Peters and Goff say the RB should relax on inflation as what they are really doing is perpetuating the staus quo of debt binging and hoping it will be inflated away.

Matt said..."Completely agree "“ although CPI growth is one of the closest measures we've got to underlying inflation in the economy."

How about a chronic balance of payments and trade deficit.??????

As the quantity of money increases.. the price of goods don't go up... We just import MORE..

Globalization has resulted in BIG Distortions, that we have not experienced before.
Inflation Manifests in different ways... and impacts on our economy in different ways...

REALLY.... Money should be a simple thing.
It sould be a medium of exchange, a unit of account, and a store of value.

By allowing Money Supply to increase at rate of ..8..10...12...15% per year, we
undermine these 3 things.

The resulting distortions and tranfers of wealth lead to, in my opinion, a lower standard of living for a Country... and a distraction from what really creates wealth and prosperity.

roelof - if we really want to get better control of money supply, and debt, we need to get better control of money and debt/credit issuance. That requires system change/reform as others and I have been discussing in this thread:

http://www.interest.co.nz/ratesblog/index.php/2009/11/20/special-report-...

So from that point of view, I think the likes of Goff, Cunliffe and Gould opening up the debate on at least policy reform is useful. Hence the usefulness of the Opposition's banking inquiry.

Matt Nolan:

At its heart, the consensus between the two main parties was to do with the target of monetary policy "“ monetary policy must be implemented by an independent Reserve Bank to ensure that inflation remains within a low and narrow band.

The purpose of keeping inflation low and stable is such that the future general price level in the economy is predictable. By ensuring that inflation stays at a set rate, people can make decisions and plan spending and investment with more certainty "“ both in terms of government policy regarding the general price level and on the basis of lower variability in general prices.

Lets use a reasonable time frame for inflation (50 years) and look at the 'consensus' behind politicians setting the RBNZ's inflation targets. Over that 50 year time frame they were changed by Labour in 1999 from 0 -169% to 64-338% (0-2% pa to 1-3%pa).

Do you really believe your statement that "monetary policy must be implemented by an independent Reserve Bank to ensure that inflation remains within a low and narrow band"?

Hi All,

Sorry I can't comment too much right now - lots of data is out which makes work busy. Will try to slap up the odd thing when I can.

"I understand what your point of the article was, Matt, but it is also obvious that you have no answers to these fundamental matters which Roelof points out "“ all you can say is that you agree."

I wouldn't say I don't have suggestions for the fundamental issues - but it isn't really my place to say how we should change tax policy, or what type of prudential policy is appropriate.

My underlying goal was to defend monetary policy in of itself, not to say all policy is optimal.

"Okay, so, if you agree then how, without amendment of the Reserve Bank Act, do you propose that we manage these global externalities?"

I would say that an appropriate response to global externalities of this sort is prudential policy, such as the sort the RBNZ is introducing. I'm not the biggest fan as I see this as a type prisoner's dilemma - but at least doing it this way would be transparent.

In such a case we don't need to change the Reserve Bank Act. The RBNZ will still set an OCR with the sole goal of keeping inflation expectations anchored.

"Many people on this site, myself included, bemoan the absurdly high price of housing in this country and the drag it creates on the rest of the economy"

Now this suggests that there is an issue with the housing market right. We should be asking what it creating these incentives in the housing market, and more importantly how this is impacting on the stability of the financial sector.

The first question suggests that we need to look at policy and incentives for housing (say tax), the second suggests that there may be a role for prudential policy (to lessen societies exposure to systematic risk).

Again there is no attack on monetary policy from this issue.

"Controlling capital ratios offers aroute to target a second quantity (I agree that you only need/want as many variables as targets) despite the fact that it is not entirely independent of interest rates."

Indeed. And when we set capital ratios in this way we should ask "why are we doing it" and "what market failure are we trying to solve by doing this". We NEED to be able to answer these questions when introducing instruments.

On top of that I agree interest rates aren't independent of capital ratios in any sense of the word. In the same way fiscal policy and interest rates aren't independent. However, the reasons for setting these things should be described independently - in order to provide transparency of policy.

For example, the Bank current sets interest rates GIVEN the level of fiscal stimulus - in the same way the Bank would set interest rates given some level of other instruments chosen, and would describe why independently.

The fundamental important thing is that the targeting of inflation through monetary policy remains transparent - so that inflation expectations can be anchored. Hence why the Reserve Bank Act does not need to change.

"How about a chronic balance of payments and trade deficit.?????? "

These aren't measures of inflation, they are measures of:

1) The countries willingness to borrow to invest/consume given expectations of future growth and current interest rates,

2) An indication of a potential imbalance

"As the quantity of money increases.. the price of goods don't go up"¦ We just import MORE.."

To import more we have to sell NZ$ on world markets which will lower the currency and increase the price of imports - hence why a flexible dollar is awesome as it gives us price signals.

If people are willing to sell us imports really cheaply, so cheaply that making things at home seems absolutely ridiculous, we should be asking what the structural issues are that is causing this - and whether this actually constitutes a problem.

"To import more we have to sell NZ$ on world markets which will lower the currency and increase the price of imports"
I know the theory. I also know that that isn't what happens when the volume of external speculative FXTrade in the NZ$ is 200 times trade flows. Over the last 5 years the NZ$ exchange rate has had everything to do with global risk appetite and **** all to do with trade flows to and from NZ.

" hence why a flexible dollar is awesome as it gives us price signals."
Yes, signifiacnt NZ dollar devaluation will probably be our ultimate parachute out of the present debt situation. But the nation will be poorer as a result and global trust in the NZ$ will take a bit of a beating. Also, once we're there we need to have the investment already inplace to pull ourselves out again as we won't be able to afford expensive productivity-enhancing capital investments at that point.

Chris B ... how did u do the quotes in Italics..??

cheers Roelof

Hi Roelof,
Wordpress uses XHTML mark-up language. Difficult to type in as it hides the syntax - check here (scroll down for full instructions)

http://webdesign.about.com/od/htmltags/p/bltags_i.htm

Matt N says:

"The fact is that the one monetary policy instrument that exists (changing interest rates) can only target one goal "“ and ultimately the only target it can achieve successfully is that of the level of inflation."

""¦ we don't need to change the Reserve Bank Act. The RBNZ will still set an OCR with the sole goal of keeping inflation expectations anchored."

Ganesh N says:

"Received wisdom explains that inflationary pressures must be reined in by increasing the OCR and thereby reducing demand across the various sectors of economic activity. However, this process has exhibited perverse effects in New Zealand. In particular, increases in the OCR, and so the 90-day rate, have increased the rate of money (and credit) supply (refer Figure 4). Such an easing of monetary conditions is totally contradictory to that necessary to control inflation."

If Matt N refers to the BERL Submission to the Parliamentary Banking Inquiry http://www.berl.co.nz/1050a1.page he will find any number of reasons as to why current monetary policy needs to be reformed.

Matt,

You are quite correct that increasing the quantity of money without increasing the supply of goods and services will cause inflation. That is a lesson Spain learned the hard way when the drastically increased the supply of gold by looting the New World. Instead of making Spain rich, it did quite the reverse.

A couple of questions:

The Monetary Policy consensus depends on the assumption that the OCR controls the money supply. How does it do that?

The consensus also depends on the assumption that the OCR is the best instrument to control money supply. What arguments are there to show this?

testing

les
"Are You a Charlatan?" is that booklet available online..??

sorry les... wrong person... it was sally who read the book

"Overall, my main point in this article was that deviating from thinking about inflation and trying to get monetary policy to do a myriad of other things without thinking about what monetary policy is, and how it works, is a mistake. Saying that the consensus was over was part of this mistake."

Agree, Im glad you spelled it out....MPolicy is a limited tool designed for one purpose....RB needs more tools if its going to do more things, however my concern would be mutually exclusive requirements.

I think that the Govn carries a lot of responsibilty and duty to do "good" things that help NZ, and not the RB. The RB is sort of there for a specific and limited purpose, it cant and shouldnt be the Govn that then gets critised in hindsight by Pollies too gutless to say and do the right thing because it costs them votes.

So for me we are beng blind sided, its for Pollies to stand up and be counted and for voters to think beyond whats best for their wallet short term...

regards

Steven - agreed, the WSJ is on my "don't bother reading" list, up there with 'The Economist'. However, I was drawn to the article through another link, and thought it had its own merit, regardless of medium.

I only have a minute, as the hamster wheel is spinning exceptionally fast at present. I will be back to question Matts dose of the monetarist manual, in the mean time maybe Matt could give me his summary of this:
http://publiccreditorbust.blog.com/2009/08/31/iain-parkers-submission-to...

We are essentially printing money/credit via exactly the same sources that the US are, by allowing those same sources to monetise our government bonds with the very same electronically created credit, how can we claim for one minute to be economically sovereign in our own best interests?

Quite funny to watch isn't it SL..just how bloody thick are the Noddyland peasants?
Off they go and borrow to buy and not a thought about what we know dam well is heading this way...but they will believe the crap and BS the govt churns out....I see Contact have raised gas prices!! but the poodle media fail to notice....must not upset the peasants...let them play down on the beach as the Tsunami rolls in silently...who gives a sh.t!

Hi All,

Hi Neil C,

Just on the note of the BERL submission:

Correlation is not causation. They said that the supply of credit rises as the interest rate increases. However, the demand for credit falls as the interest rate increases - as a result the idea that a higher OCR leads to capital inflows doesn't makes sense persee.

Obviously there was some third factor that "shifted" demand for credit - this isn't the fault of monetary policy, and we should be asking what happened there and what should/should not be done about it (I would put part of it down to the housing bubble, and part of it down to sensible borrowing in the face of rising global productivity and cheap consumption goods from Asia).

Hi Les,

A higher risk premium implies that lenders need a higher rate of return before they will invest with us - this will lead to a reduction in the supply of credit all other things equal.

Over the last decade all other things haven't been equal. As a result, we need to try to understand the factors that have driven the demand for credit inside NZ and see if there has been any "market or policy failures" there. Laying the blame on monetary policy is sort of similar to shooting the messenger.

Hi Matt,

So to paraphrase your response to Les (and I guess to Roelof and my similar comments about the disconnect between exchange rates and trade flows), I think you are saying:

"Look I know that over the last 10 years the evidence is clear that the expected feedback mechanisms between OCR and money (credit) supply, & trade balance and exchange rate haven't eventuated. But don't worry thats just because the world hasn't been working properly. Don't worry the textbook theory is clear that it will all work fine next time. Trust me I'm an economist."

Its not much of an answer is it? Don't you think that perhaps it might be time for us to at least consider some original thoughts on how the system is holding up in the modern globalised financial world?

Matt - following on with Chris B, can you elaborate more on, "....third factor that "shifted" demand for credit" and clarify what you mean by "sensible borrowing"? And, "we need to try to understand the factors that have driven the demand for credit inside NZ and see if there has been any "market or policy failures" there." Might that be what I'm focusing on in this comment?

http://www.interest.co.nz/ratesblog/index.php/2009/11/30/2025-taskforce-...

Cheers, Les.

Matt, what no reply for me, no admission that you have read my banking inquiry submission, what a surprise as it spells out clearly the disconnect between the OCR and the banking network doing what the hell they want.
You imply that lifting interest rates has in some way halted the credit money supply, bulldust, the central banker subsidiaries such as GE, Q Card via their deposit free - 3 yr interest free store credit and all supposedly Australian domestic banks, which are in-fact majority stakeholder owned by private US and European central bankers continuing to dole it out out with honey moon period entrapment no matter the rate.
All the commissioned debt peddlers in between handing out the phone numbers of those who pay them the most and then making out they are connecting the "mark" with those that are in their best interest.
Don't worry Matt I am having trouble getting any politicians to admit they have read my submission to the banking inquiry, because they, like you, know that to admit to reading such a document full of irrefutable evidence from the very mouths of the major players that exposes the banking system of this nation to be in-fact not what monetarist indoctrinated finger puppets(Muppets) like yourself portray it to be, and if they admit to having read it they know full well they can't continue supporting the orthodox without looking like outright liars.

I ask again:
Maybe Matt could give me his summary of this:

http://publiccreditorbust.blog.com/2009/08/31/iain-parkers-submission-to...

We are essentially printing money/credit via exactly the same sources that the US are, by allowing those same sources to monetise our government bonds with the very same electronically created credit, how can we claim for one minute to be economically sovereign in our own best interests?