By Roger J Kerr
The most telling piece of information is last week’s RBNZ monetary policy statement was the chart on page 18 (Fig 4.15) which confirmed a major inflation problem for the NZ economy that the RBNZ seem unable or are unwilling to address.
Non-tradable inflation (that is, domestic prices not influenced by the exchange rate or interest rates) has tracked well above 2% per annum over the last four years and substantially above 3% per annum for the nine years prior to 2009 (black line in the chart below).
The overall CPI measure of inflation (red line below) has been kept artificially low over the last two years by off-setting price deflation in the tradable sector (gold line below).
The high NZ dollar value pushing tradable inflation down over recent years has disguised and hidden unchecked non-tradable inflationary pressures in the domestic economy.
The danger is that the RBNZ have become reliant on the high NZD to stay compliant with their 1% to 3% inflation speed limit in the policy targets agreement.
They will be standing in the tide with their swimming togs around their ankles if the NZ dollar was to sharply depreciate.
The problem is that interest rates and exchange rates have very little influence over price-setting behaviours in large parts of the NZ economy.
The RBNZ can ramp interest rates up to slow the economy and ultimately reduce inflation pressures, however that does not seem to change price-setting behaviour in the non-competitive sectors that make up the non-tradable component of the CPI.
The RBNZ cannot control these non-tradable price increases as most product/service providers are rent-seeking monopolies or duopolies, and thus there is a lack of market competition to provide price discipline.
What is disappointing is that the RBNZ do not really analyse the issue and merely state that limiting capacity utilisation will reduce inflation risks.
It has to be said that the export sector is unjustifiably taking the brunt of the pain as the RBNZ seek to control overall inflation through a high dollar.
As the guardians and stewards of stable and low inflation (i.e. the purchasing power of our combined savings) the RBNZ seem reluctant to address the elephant in the room in the form of persistently high non-tradable inflation.
The RBNZ may correctly argue that Government regulatory and competition policy is outside their mandate/remit, however you would think they would be making more of a noise towards Government to create greater transparency and competition.
As the second chart below displays, the serial offenders of high non-tradable inflation are:-
- House rentals (dark pink) – despite lower landlord costs in the form of lower mortgage interest rates over recent years, rents continue to increase due to market supply shortages.
- House construction costs and property maintenance (red and yellow) – dominant material suppliers are being looked at by the Government; however strained resources from the earthquake rebuild will keep upward pressure on prices.
- Local Government rates (black) – increases moderating, however always present as there is weak discipline over cost increases.
- Electricity and gas (grey) – Lower wholesale electricity market prices are unable to be passed through to consumers due to higher network costs and environmental lobbies prevent the building of new generation (the cheapest form) i.e. hydro dams.
- Insurance and services (black with white dots) – again earthquake related of late, however the consistent historical price increase suggest a serious lack of competition in the sector.
Economies of scale disadvantages in the small and isolated NZ economy is always a counter-argument to this issue, however we could help ourselves with better analysis, exposure and understanding of the fundamental causes of inflation.
Addressing the persistent supply-side constraints should be a major focus of our inflation guardians, however that is difficult and it is easier for them to influence the demand side.
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No chart with that title exists.
Roger J Kerr is a partner at PwC. 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
19 Comments
People have been saying this for a long time, but it needs to be mentioned as often as possible Roger. Bernard even mentioned in yesterdays article. I guess it takes time for economists to change a view - still welcome though.
Currently the RBNZ bashes the tradeable sector to to control inflation and has little effect on non-traded.
This is a good way to sink this country down a hole.
About time the RBNZ got some new targets and tools.
The RB can't hence Bernard's article Monetary policy needs mates....
Bang on. Well done Roger, very well explained, needs to be said again and again,
On a lighter note, you could say that our Reserve Bank Leadership are acting like a Soviet era manager of a nail factory- "tell me the target and I will do whatever it takes to achieve it"- in the case of the Soviets it was either very large nails, or millions of small nails but never what people actually wanted. Central planning targets can often end up being gamed like this and New Zealand has been gamed by the RB for years
Great stuff.
If you look at the local government inflation it is probably largely targeted at the commercial sector. The figures are massaged to make the average increase seem less unreasonable. I know of one property in Nelson that is unchanged since 2003 yet rates have gone up from $7700 in 2004/5 to $18,900 in 2012/3. It is occupied by a hairdresser, an accountant, a couple of small charities and a bar. The tenants pay the rates but have no political clout, thus the local council can pretend that rate rises are only 3-5% per annum.
Why is Nelson so extremely anti small business, and is the whole of NZ like this?
See my comment below. That $7,700 turns into $13,000 if you apply the civil construction index deflator to it. Not all council costs are civil construction related but then they have also experienced large price rises in big ticket items like energy and insurance over the same time.
As Roger notes Council Rates and local authority costs ( sometimes called administered costs) are again part of the problem in the non-tradeable sector .
This is not a recent phenomenon .
We should be sending a strong message to City Councils to LIVE WITHIN THEIR MEANS just as every Kiwi family must
Exactly, but don't worry, the council will have lots more money coming into it's pockets in the next few years guaranteed. From the Auckland Council website:
General revaluation 2014A region-wide valuation of all Auckland properties to revise the Auckland Council valuation roll will be published in late 2014.
The new valuations will not necessarily affect your future rates (do you believe it?) and you will have the opportunity to make an objection to any value that we assess for your property, once we publish the revised roll.
The 2014 revaluation will encompass the valuation of 525,000 properties including:
- residential
- commercial
- industrial
- lifestyle
- rural and community use properties.
Our valuation team and Quotable Value Ltd (QV) will carry out the valuations.
Due to the size of the revaluation, we have put in place clear processes to ensure consistent and accurate values across the region.
Independent registered valuers will review value levels for specialist properties, such as commercial, industrial and rural properties.
Councils do live within their means; the trouble is they get to define what "their means" are, a luxury no-one else has not even the government.
In all seriousness the reason is in the Statistics NZ data series (S2GC). The ten years 1 Jan 2004 - 31 Dec 2013 saw a 28.6% rise in consumer prices and a 48% rise in civil construction prices. Councils don't go the supermarket to buy bread and butter, they buy roads and pipes. So their costs are going up 68% faster than the average householder's.
Now if our government wanted to find out why we pay over the odds for building materials, civil construction, imported goods etc that would be helpful. Even if it means asking their best friends some awkward questions.
Actually Roger is publishing deceptive data and owes this site an apology.
Council rates are made up of those other components like Electricity & Gas, Insurance Services, Construction, Property Maintenance. Roger is double dipping when he adds Rates on top of those items.
Tend to agree with Kumbel on this one, if you want to track the actual cause, you need to go two steps back and look at the council cost breakdown. Now, for all we know from Roger's figures councils may have been epically trying to contain construction and power costs but not quite totally suceeding- I'm not quite motivated enough to dig through council reports to see how they are all doing on that front (and I suspect some councils are better than others rather than it being uniform) but for tracking the root causes there is double dipping (though for a 1 step away analysis, Roger's article is a reasonable shot at first level analysis, and I think it is a good article on that basis)
It's a high school error not even Econ101. Those categories are not independent so you can't do what Roger has done and just pile them up and say, "Look 4% inflation in the non-tradeable sector." It's a nonsense.
Council's don't *epically* do anything; they tender out 80% of their expenditure each year and, in theory, they get the best market price on the day. Other than squeeze some more out of charges or debt-fund they can only hold rates down by stopping doing something = no library, manky roads, dirty water.
Again, instead of constantly tarring and feathering councils, I wouldn't mind if the government investigated the root causes of the rises in council inputs.
Kumbel.
Coming to an amphitheatre near you. You should have a close read of the SMH article below. It's not about "civil construction prices" but it goes pretty close. It even describes how privatising public services goes right around in a full circle and the privatised entity becomes a political donor to those parties that created it.
Second, one of the major players in this shakespearian play is caricaturised in the cartoon following item 1 of Chastons top-10 for today
ICAC heard that Nick Di Girolamo, a prominent Liberal Party fund-raiser and associate of the Obeids, helped transform Australian Water from a not-for-profit venture into a commercial operation charging exorbitant "administration costs" to the state-owned Sydney Water. The costs charged to Sydney Water included tens of thousands of dollars in donations made by AWH to the Liberal Party. "From records I have seen it seems that Sydney Water has - unwillingly, unknowingly - been a principal Liberal Party donor," Mr Watson said.
http://www.smh.com.au/nsw/icac-arthur-sinodinos-stood-to-make-tens-of-m…
The amount of money at stake was $200 million
One parliamentarian - Sinodinos - stood to make $20 million
I think everyone can remember being told off by the Electricity Authority in January for imagining we were paying too much for our power, when Electricity companies still hadn't made back what it cost those companies to build the power stations had they built them.
http://www.nzherald.co.nz/business/news/article.cfm?c_id=3&objectid=111…
We should all just be thankful we are not paying more.
Roger,
Mostly a good article, although there is a cause and effect argument to be had.
The high NZ dollar value pushing tradable inflation down over recent years has disguised and hidden unchecked non-tradable inflationary pressures in the domestic economy.
The implication is that the high non tradeable inflation is independent of the exchange rate, inflation in the tradeable sector, and monetary policy generally, and that if we hadn't had the negative inflation brought about by the exchange rate, that inflation would have breached the 3% threshold because of the non tradeable area.
There is in my view a strong argument that the savings in consumer spend on imported goods causes the void to allow non tradeable prices to rise. To put numbers on it, suppose for every $100 someone had to spend, they used to spend say $50 on imported goods, and $50 on totally domestic goods and services. Suppose a high exchange rate means they get the same imported goods for $48. Allow that the RBNZ is happy a year later for the whole basket to be $102 after inflation, and there is now $54 to spend on everything else. So the economy raced into that void; especially property and downsteam effects of property.
The solution might still be similar to Roger's implied one; try and manage the exchange rate to a more stable level, and one at which the Current Account is at least in balance. Then there will be a more productive tension between all sectors of the society/economy, (where all sectors would battle for the $102 on an even playing field) rather than a system that rewards property over everything, and punishes exporters and import substituters.
Monetary policy though would not have needed to be tighter or easier; just funded more from internal sources rather than sucking in foreign capital to lift the exchange rate.
.
It seems to me the RBNZ are given an impossible task, to adjust the relative price of everything. Isn't this just like the old Soviet central pricing bureau, Gosplan?
By manipulating the price of interest to below the natural rate (assuming there is such a thing), the RBNZ takes the pressure off central and local government to reform themselves, encourages borrowing against property, discourages saving, and tries to protect the productive economy from destruction by a high exchange rate.
The RBNZ is a straw man, a scapegoat for the weakness of our political process.
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