Time to drop the "OCR" altogether, make it zero. I was suprised to see that the equivalent was only recently introduced in the USA, citing use overseas (Bernancke op-ed in one of the US papers recently). It's too broad, if it did work, it only works in one direction as if pulling on a string. But the fundamental objection is that it is a taxpayer subsidy to the banks for a zero risk deposit. Zero risk should be zero interest. In one discussion, the answer "we need to be compensated for inflation" . . . . err at the taxpayer's expense?

Fantastic article and succintly sums up the stupid policy settings in NZ which are totally inappropriate to a small trading nation. We no longer need to be so purist and the act needs to take into account NZs economy.
Bollard had to fight a massive fiscal stimulation from Labour who worked against all he was trying to achieve by overspending. This is an ignored but pertinent point because if Cullen had taken some stimulation out of the economy Bollard would not have had to push quite so hard and your members would still be making and exporting stuff instead of building houses.
Labour could also have reformed the RMA and forced councils to open up more land to give Bollard (and the country) a hand.

John well done!

Please can you just double check I am reading this correctly.

The second graph is saying that the OCR has almost no impact on internal inflation but destroys the productive / export sector via interest rates and exchange rates?

That's been my intuitive view now for years and if this graph is saying what I believe it is then it should be on John Keys, Bill English's and Dr Bollards desk tomorrow morning.

We have all been saying that targeting price stability alone is only killing the productive economy and here is the evidence and shows that Bollard can't deal with the CPI without killing the export sector.

Better get the news out quick John as its started already.

Housing prices starting up in Auckland, Dollar going stupid relative to fundamentals and interest rates will soon be under pressure to lift and lift again. All at the expense of exports. Not a drama as its only $200 million per percent not entering our economy.

We won't make that back (just the one percent) even if every MP for the past three years paid back every perk they have had.

Selwyn: The graphs don't demonstrate a causal link but they do show the problem, what we need to do to internalise the fluctuation not load it on our exporters (Singapore). Jacko's problem is to be out of the game before the ponzi stalls. We are in a zero sum game, wealth creation is subordinated to wealth aggregation "“ what a pity.

New Zealand's only developed world future is as a trading nation. As has been pointed out by the Paul Callaghan the NZMEA and others if we can't create high value jobs the only game in town is who gets what of what we have today and I think that trickle up process is well underway.

Wealth creation and trickle down only happens when high value, skilled jobs are created by an economy "“ we are failing to do that.

A farmer recently said to me an overvalued currency is a tax on the productive sector collected by the internal economy.

Draw your own conclusions about the end game.

I am so glad to see somone making sense rather than the rhetoric of degrading Allan B for not raising the interest rate despite the evidence of failure of OCR to control the housing madness. If we continue to do the same we will get the same result again. Simply blaming or expecting people to change their ways wont achieve anything . A breath of fresh air given that the commonest response to current problem is an automatic thought of increasing the interest rate.

PeterR, why don't we question the institution of the RBNZ, and the imposition of an OCR, period.

Great article here:

http://www.csmonitor.com/2009/0803/p09s01-coop.html

End the Fed? A not-so-crazy idea.

Congressman Ron Paul's bill may never pass, but history suggests the US economy would be better off without the Federal Reserve ...

John, we should rename these two islands New Zimbabwe!

Given what is now coming out and creating more perspective, can we ever expect this weakness in monetary policy NZMEA have illustrated and our tax system to be properly reformed for the benefit of tradeables and non-tradeables, in fact, all New Zealanders, not just the asset holding elite who are creaming it and leeching off the rest of us. Useless b*st*rds.

It's an utter outrageous and incredible disgrace, but how can we expect change from the monkeys that are supposed to serve us with their leadership - it seems they have been intent on quite the opposite - serving themselves, as Bernard opines,

http://blogs.nzherald.co.nz/blog/show-me-money/2009/8/6/can-landlords-be...

You'd expect this kind of crap in a banana republic, but we are a small fairly cohesive (I thought) nation supposedly priding ourselves in our recogntion that, "We are all in this together". What crap.

How has it happened?

More importantly, how can it be stopped?

Let's face it, we are likely to get more useful government from external agents like Fitch and S&P, with a down-grade, than we ever will the turkeys who've been running the show since 'Shop-steward' Douglas's days. What a mess.

It don't have to be like this, does it?

The first chart is labled "inflation"...
In fact, it is the CPI Index... which is used to "measure" inflation...
Consumer prices are not the only way that inflation can manifest.. ( and be measured )
In the last 20 yrs inflation has manifested far dramatically thru asset prices.

You have to properly define what inflation is ... before you can make any sense of the charts.

For me, ( after 20 yrs of thinking and reading) , inflation has to do with money supply, and how the results of increasing money supply manifest in , (as it works its way thru) the economy..

In the old days the CPI was a good proxy of inflation because we had a "Closed economy". Increases in money supply lead to increasing consumer goods prices because we had more money (demand) chasing the same amount of goods (supply)....Also lead to increasing wages ...and became a vicious cycle

In todays world ( in terms of the CPI ) increases in money supply leads to increases in the QUANTITY of consumer goods imported ( this is reflected in our balance of payments figures) ... rather than the large price rises of old.
BUT... in things that can't be imported ( Non tradables and Real Estate ) there have been large price rises....

In Graph 2 the most striking thing for me is the dislocation between the OCR and Money supply.

There is a famous quote from a former Central Banker in Canada: "We didn't abandon the monetary aggregates, they abandoned us"

In the 1980s' Central Bankers moved away from controlling monetary aggregates directly... to indirectly controlling the monetary aggregates by influencing the DEMAND for credit... ie.. thru the OCR.. (this link helps explain it....).... and now they aren't even that interested in the monetary aggregates.!!!!!
http://www.rbnz.govt.nz/research/bulletin/1997_2001/1999Jun62_2collinsth...

I believe they got it wrong.... ( they lost their way)

Milton Friedman said.. "Inflation is always and everywhere a monetary phenomenon"... and I believe he was right.
BUT because modern economists have somehow been "mesmerized" to believe inflation IS the CPI index... they have come to all sorts of wrong ideas and conclusions...as a result ( in my view).
SO for them, a 20% increase in the money supply in 2001 (eyeballing the chart)...was nothing to worry about..... as long as the CPI was within target.

BUT because of the "Global economy", and in particular China, consumer prices were actually going thru a natural deflationary cycle. ( there were a number of deflationary forces at work)....
SO large increases in the money supply did not manifest in the way they did in the 1970s'... peoples incomes did not grow much, prices of goods were cheap.

It is the double digit growth in money supply that is the cause of inflationary pressures.
Maybe the non tradables is a better measure of inflation than the CPI..???
OR maybe we need to create a COST OF LIVING index to better measure inflation (Rafs' idea.. I think).

To allow double digit growth in Money Supply... is very Negligent in my view... ( most of that money supply growth is in the form of Credit ).... This becomes a burden of debt on the country... as well as being distortionary, and causing instability.

Chart 2 shows just how little control the central bank has over money supply... there is a very loose relationship between the OCR and M3...... At times raising the OCR lead to an INCREASE in Money supply.... ( because banks could borrow offshore more easily as domestic deposit rates went up)... AND as people behaved irrationally in booming asset markets.

David Preston alludes to some of this in his presentation.... but I feel we should go back to first principles ... and start from there again.. otherwise we might end up with more distortionary solutions.

I think it is time for our economists to revisit some of their premises... that they take as gospel.

The David Preston article is a good read.....
It is kind of ironic that he concludes :
"Accordingly, the suggestion of this paper is that some appropriate form of monetary or credit targeting be reintroduced."

We have come full circle.... It has taken us 30 yrs to figure it out.

In 1990 M3 was about $50 billion ..... Today it is $210 Billion... thats more than a 400% change..

An interesting way to look at the impact of increasing money supply is to use the metaphor of a ... "drug addict"...

How much of a "fix" does it take to get the same "high".

How much of an increase in money supply does it take to get the same GDP growth..
(GDP is measured in dollars)

Over time...(like any drug addict ) it takes an increasingly large "fix" to get the same "high".... ( at some point his body says... "no more" )

It is fools Gold.... Of course an increase in M3 of 400% is going to lead to good looking GDP growth figures over 30 yrs.....

A drug addicts health and quality of life is not measured by the "intensity or level " of his high.... we just know a drug addict is in bad shape and on the wrong track.

YET we are doing just that in the way we percieve, look at, and measure our own economy...We think that if we get a good "high".. ( good GDP growth)... all is well.

We don't see that we have "health issues"... and that the "highs" we have are largely the result of "drugs"... and not natural, productive, healthy growth.

Just my views and maybe a different way of looking at things .... cheers

Fully agree with roelof "“ the most striking feature of the second graph is the intermittent surges of money supply completely independent of the OCR. Its totally irrational to expect these bulges to pass down the pipeline without inflating asset values somewhere (in our case its houses) yet the responsible parties are never held to account.

Here's the good oil on this from Mish Shedlock:
http://globaleconomicanalysis.blogspot.com/2006/02/inflation-what-heck-i...

The logical outcome of the above discussion is that a proper definition of inflation or deflation must be built on the foundation of a sound definition of money supply that distinguishes between money itself and credit. The definition should also ensure that the horse and the cart are in their proper places.

With the above in mind:

"¢ Inflation is best described as a net expansion of money supply and credit.
"¢ Deflation is logically the opposite, a net contraction of money supply and credit.
"¢ Government mandated solutions to problems best left to the free market is the root cause of money supply expansion.
"¢ With no enforcement mechanism such as a gold standard to keep things honest, and with no desire to raise taxes, governments simply approve programs with no way to fund them. The FED has been all too willing to play along by printing the money needed for those government programs. To make matters worse, the fractional reserve lending policies of the FED allows an even greater expansion of credit on top of the money printed. Eventually those actions result in a crack-up-boom and debasement of currency.
"¢ Changes in "Purchasing power" required to buy a basket of goods and services can not be accurately measured because of the need to continuously add new products to the basket, because the measurement of quality improvements on existing products is too subjective, and because it is impossible to pick a representative and properly weighted basket of goods, services, and assets in the first place. Furthermore, such measurements are highly prone to governmental manipulation at private citizen expense. Endless bickering over the CPI numbers every month should be proof enough of these allegations.
"¢ Measurement of equity price fluctuations poses a particularly difficult problem for those bound and determined to put the cart before the horse as well as those that think such assets belong in any sort of basket.
"¢ Price targeting by the FED is doomed to failure because a representative basket of goods and services can not be created, because prices can not properly be measured, and because price targeting puts the cart before the horse.
"¢ Expansion of money supply (typically to accommodate unfunded government spending) and expansion of credit (via GSEs, fractional reserve lending, and other unsecured debt issuance) are two of the biggest problems. Targeting the outcome (prices) can not possibly be the solution.
"¢ Ludwig von Mises describes the endgame brought on by reckless expansion of credit: "There is no means of avoiding the final collapse of a boom brought about by credit (debt) expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit (debt) expansion, or later as a final and total catastrophe of the currency system involved."
"¢ The FED should have been listening to Mises all along. Instead they have put their faith in "productivity miracles", "new paradigms", and their own hubris. Those actions have accomplished nothing other than delay the eventual day of reckoning.

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