Is the Reserve Bank in danger of being caught between a rock and a hard place in its inflation fight?
I pose this question because of the Reserve Bank's apparent determination to see the life squeezed out of stubbornly high non-tradeable domestic inflation, and its new political masters' reverting the central bank's monetary policy to just inflation targeting.
This government move ramps up pressure and expectation on the Reserve Bank to force inflation back below 3% at a time when key inflation drivers may not be things the Reserve Bank's actions can really influence.
Both the Government and Reserve Bank's determination to win the inflation war are welcome. The high inflation of the past couple of years has been a salutary reminder of the harm it can cause.
The questions now, however, are; at what cost and just how dogmatic should our policymakers be in their inflation fight, and is the Reserve Bank maintaining the Official Cash Rate (OCR) at 5.50%, or increasing it, really the way to rein in that non-tradeable inflation?
The OCR was lifted from just 0.25% in October 2021, with monetary policy having been kept too loose for too long by the Reserve Bank's admission, reaching its current level in May 2023. This has resulted in a startling spike in interest rates for both home loan and business borrowers. The weighted average yield on the total of all business loans with registered banks rose to 7.86% from 3.36% in the two years to November 2023, Reserve Bank figures show. The weighted average for home loans rose to 5.72% from 2.86%.
Over the year to December 2023, households faced a 31% increase in interest costs, according to Statistics NZ, and the annual interest bill for NZ's mortgage holders rose 47.5% to $17.694 billion.
Add on the high prices experienced for the likes of food over the past couple of years, where annual inflation peaked at 12.5% in mid-2023, and times have certainly got quite a bit tougher for many New Zealanders.
Meanwhile, the latest Reserve Bank forecast has unemployment reaching 5.2% by June 2025, up from 3.9% as of the September 2023 quarter.
Tradeable v non-tradeable inflation
The latest Statistics NZ Consumers Price Index (CPI), remember, had annual inflation at 4.7% in the December quarter. Breaking that down, tradeable inflation, featuring imported goods such as petrol, was down to 3%, with domestic non-tradeable inflation at 5.9%.
In a speech last month Reserve Bank Chief Economist Paul Conway noted annual non-tradeable inflation came in higher than the 5.7% expected by the Reserve Bank.
"To sum up, monetary policy is working, with the economy slowing and inflation falling. But we still have a way to go to get inflation back to the target midpoint [2%]. We will have much more to say on this in the February [Monetary Policy] Statement, which will be based on an assessment of all incoming data," Conway said.
That Monetary Policy Statement is due on February 28.
Questions raised
BNZ Head of Research Stephen Toplis raised some serious questions about the Reserve Bank's battle with non-tradeable inflation last week.
Given the drivers of non-tradeables inflation, "it's highly unlikely monetary policy will be able to get it anywhere near 2% in the foreseeable future," Toplis said. Over the past year Toplis noted the major contributions have come from cigarettes and tobacco, property rates and related services, household energy, out-patient services, hospital services, education and insurance.
Whilst the Reserve Bank maintains its modelling shows non-tradeables inflation is interest sensitive, Toplis argues while this may have been so in the past, a significant amount of today’s inflationary pressure is not.
That's because the key drivers of non-tradeable inflation are local and central government charges, New Zealand’s infrastructure deficit, the impact of climate change and, rising insurance premiums following natural disasters. Add to that population growth, with net migration growth at record highs, and its impact on housing and local government costs.
"Monetary policy will not quickly address global warming issues - It won’t improve the weather. It won’t fix Wellington, or anyone else’s, water problems. It won’t curtail population growth," Toplis said.
The central bank can warn government about its policy impacts on inflation, but it can’t direct policy.
"The Reserve Bank’s actions can do little in this space but act as a barrier to second-round effects."
Toplis went as far as saying he hadn't yet heard a good argument proving 2%, the mid-point of the Reserve Bank's 1% to 3% inflation target band, is the optimal number.
A second bank economist, Kiwibank's Chief Economist Jarrod Kerr, also recently queried the ongoing feasibility of the 2% target. Speaking in interest.co.nz's Of Interest Podcast, Kerr said more extreme weather events, moves to decarbonise the economy, improving insufficient infrastructure, wars and geo-political tensions are all inflationary.
"If we do wake up in a few years time and realise keeping inflation between 1% and 3% in a world where climate events and the transition to different energy sources proves to be quite inflationary and quite persistent, then the argument will move from getting inflation back down to 2% and averaging it there, so maybe we soften that stance a little bit and allow inflation to run slightly higher. From the Reserve Bank's point of view, I could imagine that they could relax it from say 2% to 2.5%, maybe as high as 3%," Kerr said.
Little option but to dig its toes in
This, however, doesn't appear to be on the Reserve Bank's agenda. Governor Adrian Orr is set to make a speech on February 16 when, among other things, he'll discuss; "why - despite these challenging years - we continue to believe that a flexible inflation target centred on 2% still makes sense."
Speaking in Interest.co.nz's Of Interest Podcast in December, Orr said monetary policy was an important part of why inflation was declining, but supported the view of having "some humility around what monetary policy can or can't achieve." He also acknowledged profit-led inflation had played a role in NZ's high inflation.
However, it appears we should expect a strong defence of 2% inflation targeting on February 16.
Orr's new political masters, heavily critical of him and the Reserve Bank's performance over recent years when in opposition, have made much of changing the central bank's monetary policy mandate to remove any questions that inflation targeting is its game.
On December 13 new Finance Minister Nicola Willis trumpeted the removal of the requirement to support maximum sustainable employment from the Reserve Bank's monetary policy remit, which was added by her predecessor Grant Robertson in 2018.
"With no hierarchy of objectives, the introduction of a dual mandate heightened the risk of a future policy error – with monetary policy led in multiple directions, even as inflation embedded itself in the economy," Willis said.
“Risking higher inflation in the pursuit of unsustainably high employment, just creates the conditions for a more severe hike in interest rates later on to bring inflation back under control."
And after the release of the latest CPI data Willis said; "Our government understands that inflation is the thief that erodes the real values of people's incomes and savings. We are focused on removing excessive inflation from our economy and won't be satisfied until we have."
So we have a government that's talking tough about fighting inflation. Whilst that's welcome, putting too many eggs in the Reserve Bank's inflation targeting basket may not be. I'm not calling the removal of support for maximum sustainable employment a mistake. Rather, as Toplis and Kerr have argued, and Orr has acknowledged, monetary policy has its limits.
Who will be monetary policy's mates?
With the Reserve Bank's sole monetary policy focus on price stability, we've now moved back to the regime established under the Labour government in the 1980s when it outsourced monetary policy to the Reserve Bank. This followed the domineering rein of National's dual Prime Minister and Finance Minister, Rob Muldoon.
Is this a case of back to the future, with NZ recommitting to a 1980s-era monetary policy recipe, assuming it's still the best approach in the 2020s?
As Toplis explained, some of the inflationary challenges we're facing - think council rates, insurance premiums, rents and energy costs - are unlikely to be affected much by the Reserve Bank increasing or lowering the OCR.
There's an old saying that monetary policy needs mates. And if we're to tackle the key causes of our current non-tradeable inflation, it seems likely monetary policy will require some long-term mates.
And the key one probably needs to be the Government. Tackling some of our problems, think housing, decarbonisation and infrastructure, requires investment and long-term thinking. This may even require flexible thinking on how we target inflation and the inflation level we're prepared to live with.
Being clear and honest about the sources of inflation, and having an open mind to potential solutions in a world of overlapping emergencies as German economist Isabella Weber puts it, could be useful.
The coalition government is still in its infancy. It remains to be seen to what extent it's prepared to allow the use of government funding tools such as bond issuance to help fund NZ's key long-term challenges, and to what extent it's prepared to assist with the facilitation of workers and resources to tackle those challenges.
Good starts from the Government could be moving NZ away from its ad hoc immigration policy, disconnected from other public policy settings, to a long-term policy on immigration to help with housing and other infrastructure that benefits from long-term planning. And developing long-term funding, alongside local government, to tackle inadequate infrastructure and address climate resilience, might also be useful.
*This article was first published in our email for paying subscribers early on Wednesday morning. See here for more details and how to subscribe.
47 Comments
Did you mean a 2.0% OCR?
That'd imply 4.0% retail mortgage rates (assuming the big banks restrain their margins to 2%)
Certainly not needed at this time.
But back to 5.0% retail (OCR at 3.0%) by year end would get NZ Inc. humming along and investing in much needed additional capacity again.
I've already read the arguments from those two bank economist's, smells of pushing one's own agenda.
Important not to lose sight of this. Despite the well-meaning soundbites and general mastery of the economic narratives, bank economists only talk about the 'greater good' and 'better solutions' through the prism of their paymasters' objectives - to optimize the debt servicing fees from the issuance of greater debt.
It is what it is.
re ... "Those clamoring for a massive lowering ate to many debt pies."
A somewhat strange assertion. Popular. But wrong.
Many of us want rates down so we can get back to investing in NZ Inc.'s future capacity.
Nothing like additional capacity (i.e. supply) to bring prices down.
Really? How so?
If there is capacity in the system (there is now) and I'd not be creating scarcity in any products or services (I wouldn't be) - how would that be inflationary?
You really do need to explain how came that view because it makes very little sense to me.
That's the problem tho isn't it?
Any reduction of rates won't see more capital flowing into productive investment, it'll go into pumping up asset prices. If we could solve that problem I'd be all for lower rates; as it stands, lower rates just pump more capital in the gerontocratic pyramid scheme that is our housing market. Banks don't seem to have any incentive to change this.
Any reduction of rates won't see more capital flowing into productive investment, it'll go into pumping up asset prices. If we could solve that problem I'd be all for lower rates; as it stands, lower rates just pump more capital in the gerontocratic pyramid scheme that is our housing market. Banks don't seem to have any incentive to change this.
The central banks provide the incentives through risk weighting 'guidelines' I believe. So you run into a few problems here: 1. It all goes to seed and the general public starts asking uncomfortable questions about why we have been led down a path of destruction (Greenspan admitted he was wrong but those who followed more or less followed the same playbook); 2. You adjust the balance of how credit creation is allocated and the boomers get all bent out of shape as their golden egg is taken away - politically unpalatable (and no, central bankers are not politically agnostic).
The building of new dwellings is a productive investment. And it will help lower dwelling prices by adding to the supply (and choice).
But yes - if the ponzi scheme re-starts in earnest this could happen (yet again).
But the RBNZ I believe has learnt a valuable lesson in the past few years about moderation. I have every expectation they'll use new tools like the LVRs and DTIs, and the changes to the settings of existing tools which have been under discussion for years, to focus borrowing away from 'houses'.
Of course the NACTF will fight them. But the RBNZ need only mention 'financial stability' and 'big earthquake' in the same sentence to get their way. (The outcome of a big earthquake is truly scary. I'll be poorer, as will just about everyone else!) And as per usual the cost of insurance will play a part.
Inflation still over twice target. Let's get real. Interest rates are still only in a normal band. Those clamoring for a massive lowering ate to many debt pies.
Time for a diet, not more pies.
Too much is being asked from the target debt slaves - the Millennials. I've been harping on about this for quite some time. You don't have to have a PhD in Economics to understand that it's unrealistic. Perhaps time for the Boomers to accept some cold hard truths.
Too much is being asked from the target debt slaves - the Millennials.
Imagine the disparity in Gen Z then, they're all off to Australia the second they realise they have greater opportunities, and they, like many Millenials, have to take a different path to the common housing narrative which is likely more daunting than most realise. The real question is, of those that leave, as a generation that has the most global economy seen before, and largest choice of countries to live and work in, how many will return from each generation.
As much as we bash the boomers, there's plenty of GenX in the same boat too who had the same opportunities and capital gains to be had. Personally it would be lovely to keep super as it is, as there are many who have worked their whole lives in the expectation they'd be ok for retirement and now live only on super, or have their savings stripped form retirement homes or through medical needs, or even family manipulating it out of them. The hard fact however is that someone has to pay for this ever increasing cost, and there isn't the birth rate below them to support it for too long now.
The last section nails it.
Record high immigration = rent inflation. If anyone thinks this is going to change before we pass 5% unemployment I have a bridge up on TradeMe.
Climate change = insurance inflation, a double whammy on top of mortgage interest for anyone who has borrowed to buy a house.
Record rate increases are both a reflection of past inflation and a projection of infrastructure costs going forward
Not to mention everything is falling to bits if you believe the media. Roads, water, power generation, etc. Lots of money needed everywhere all at once.
None of this is going to change one iota whatever the OCR is. So while increasing the cost of money dampens consumer spending, keeping the OCR high because insurance pricing is rapidly changing completely lacks nuance.
What would be more effective?
Can we revisit what goes into the CPI basket or perhaps use a different basket? Rents should stay I feel because that is a link to house prices and for whatever reason house prices don't get included. Some other stuff seems to be decoupled from consumer behaviour.
ComCom to be more aggressive in shooting down duopolies? Who am I kidding, they didn't do it under a Labour government so it falls to the ministers to grow some courage.
Do home insurance costs during an era of climate change need to be linked to CPI and therefore mortgage rates.
Stricter rules for council spending over the next 20 years? It seems every council is simply trying to raise rates by 20-30% a year.
Cheap funding available for core infrastructure? An infrastructure investment kiwisaver fund?
These are all big things, which is why they don't happen. Governments don't do big things now, they complain about the opposition and then avoid taking risks.
The immigration and rent inflation is baffling isn't it. They want to push the GDP per capital stats for the sake of extend and pretend mentality and to save face on the world stage and hold the dollar value up, yet it counteracts the efforts of the RBNZ and siphoning of disposable income via mortgage rate increases that only benefit the banks. Either way the bank wins, and everyone else sees further destruction of their purchasing power due to government incompetence. Absolute rort when we have the highest body in the country exposing their misshapen priorities doing counteractive things that only hurt those that vote them into power.
Regarding rent inflation - When it can cost as much as $500/week for a room in a university hall of residence (i.e. dorm room) there's a whole lot of room for rent rises within a commutable distance of that university. Suddenly $300/week per bedroom in a private rental starts looking like a good deal.
Agreed, couple that with the cost of education as the Universities have been profiteering since 2009-2010 onwards. When I started Uni in 2009 papers were $300 per paper with $500 for the more practical courses involving lab sessions etc weekly. Within 1 year they were $500 each and more for the practical one, by the time I'd finished they were pushing $800-900. All across the space of 4 years. Not sure what the costs are today but it wouldn't surprise me to see $1300-1500 per paper.
There exists a level of demand below which producers & retailers will cease making increases to price in order to maintain the frequency of purchases from their businesses. Put aside the impact a higher OCR has on the cost of these businesses borrowing and focus solely on the impact it has on the cost of a household servicing mortgage debt.
We know that only about a third of kiwi households have a mortgage. That is, around 650,000 out of 1.9M. Of those, about half have debt of less than $260,000. That portion of the mortgage holding group are not going to be materially affected by interest rate rises, nor will those people without a mortgage.
If the financial stress generated by OCR increases only materially affects a sixth of the population, how much pain do we have to inflict on that group to make an appreciable impact on demand? If all 800,000 of them stopped purchasing consumer goods all-together, would companies still be able to trade & increase prices based on the demand from the other group of less affected New Zealanders?
How does the RBNZ, or Government, or anyone, get that larger group to slow down their purchasing? How do we get them to accept their share of the pain, so that the sixth don't get drowned by it? How do we make them care about the people who are going under?
https://www.stats.govt.nz/news/mortgages-and-other-real-estate-loans-dr…
https://www.ceicdata.com/en/new-zealand/annual-household-income/househo…
Try writing that same comment but beginning with ... There exists a level of supply above which producers & retailers will ...
It's a massive con job that 'demand' is always the problem. Or indeed is usually the problem.
And yet we hear just about every pundit start exactly as you have.
(Just as an aside, the opening statement does not hold true for all products. Some products (e.g. toilet paper (lol)) have inelastic demand curves whereas exotic breads have extremely elastic demand curves.)
But a seriously good comment none the less..
The larger group had their share of the pain while the other group were enjoying record tax free capital gains.
Maybe if that smaller group hadn't been enjoying tax free capital gains at the expense of the larger group, there would be more empathy. If the larger group hadn't been excluded from even participating in the game due to those same capital gains the other group has enjoyed, maybe the system would work closer to as intended.
If there were no capital gains then you'd see a much more productive system in so many ways and a population who have to think, innovate and contribute a lot more for their money. Sadly you get many with the old rhetoric of giving up avo on toast and spending frivolously talking down to you from the heights of their 4 properties and tripled values in capital gains just waiting to be cashed in while living on rental income very comfortably and moaning about how the pothole on their street hasn't been fixed so they are going to write to the council. Go figure
Great piece Gareth.
I won't bore people with my usual rant on the medieval design and mythical impact of monetary policy, but I do think it is worth emphasising a few home truths that are hinted at by Topliss in this article and the reference to the excellent work of Weber.
My main point is that goods and services are getting more expensive - often because more energy, materials, credit and labour are required to make them available. For example:
- If a ship comes the long way round to deliver goods, that's more fuel, credit, and paid work.
- If a house has to be built further up the hill, to higher standards, construction takes more energy, time, materials (and credit!)
- If roads need to be constructed differently to cope with flash flooding and ground movement, more time, energy, and different / more materials are required to get it done.
- If maintenance schedules have been ignored (a stitch in time), then getting back to satisfactory quality is going to take... more energy, time, materials etc (you get the gist)
Sitting on our tiny island and thinking that we can wrestle these inevitable costs down by reducing the disposable income of 600,000 households with mortgages, adding billions of dollars to business costs, and hoping we can make workers desperate enough to work crap jobs for less money is next level stupid. We need an honest debate with the public about why things are getting more expensive and an open discussion about what we can actually do about it.
The most obvious starting point is productivity. We need to rediscover industrial policy and start focusing investment in the infrastructure and technology that reduce the energy, labour and materials needed to produce goods and services (with a strong focus on balancing trade and regaining energy and food security). Mass electrified transit vs thousands of Teslas. Warm, dry apartments in urban centres vs McMansions in the sprawling 'burbs. Vertical / automated horticulture vs 19th century farming techniques (and RSE workers sleeping in sheds). Some of these things are politically unpopular, but if we were discussing how we reduce our improve our quality of life by reducing resource use as a country, and reducing our exposure to volatile world markets, would that change the conversation?
We also need to reduce consumption. It is simply not OK that so much of our imported energy goes into people driving fossil-fuel hungry boats around our shores, or dropping kids at schools on the other side of town in Ford Rangers. We eat hundreds of kg of meat a year per capita - the most disastrously wasteful food source at scale. We are also in a total mess with inequality - with the top few per cent of households consuming a completely disproportionate share of our resources. Ironically the same people tend to complain most about the size of Govt, yet Govt taxation / spending is ramping up because more and more cash needs to be redisibuted back to people on low incomes who can not earn enough to secure the goods and services they need to survive.
Covid might have taught you that but wiser heads will write the history. They will start with ...
Covid resulted in broken supply chains and constrained supply below previous market equilibriums for many products.
Insufficient supply will lead to higher prices if suppliers are free to sell only to the highest bidders. This varies, or should vary, depending on the elasticity of demand. However, this didn't hold true in NZ with many products that were not subject to supply shortages also increasing in price.
And as no governments worldwide were either prepared or willing to introduce any form of rationing or price stabilization mechanisms, the entire supply chain up to, but not including, consumers simply raised prices and sold to the highest bidders.
The same was observed following covid when oil shocks and storm shocks likewise created supply shortages that were often perceived rather than actual.
Much of the domestic supply shortages were manufactured.
Most of our agriculture went up in price, yet according to all and sundry we produce enough to feed 10x our population. i.e. we should have seen excess supply and lower prices as the domestic market was flooded with food, and this is what should have happened if the government had managed the economic situation better. Cost of living would have remained stable (and they would likely have got the traditional third term)
It is this level of mismanagement (and acceptance of it) that makes me strongly believe that in a real crisis, we would literally destroy crops while the populace starved.
News flash, Tesla's are not going to save the world. People only bought these cars to save money and to stick their middle finger to the petroleum companies. The second that road user charges got implemented and they found out that they would end up paying as much as ICE cars they started screaming, I mean it was ALL about saving the planet right ? Its now a consumerism society with way too many people on the planet, nobody can fix that until it fixes itself when it hits a wall.
Believe it or not, we can act by ourselves. I note many on this very site do more than required by policy/legislation/political ideology.
As an aside, all of the parties policies (Left and right) hasten the destruction, as all of them seem to be of the same ideology. More people = better.
The problem isn't how many teslas are sold, the problem is how many people are able to buy them.
People only bought these cars to save money and to stick their middle finger to the petroleum companies.
Yep, it was for me. I never claimed I bought to save the planet, and I knew that RUCs were coming in 2024. Still far nicer to drive than a similar priced ICE, higher performance, and cheaper to run than anything fun and ICE. A boring ass prius was never under consideration.
But yes, quite disgusted with the whinging from EV owners that are bitching that they will be paying slightly more per km than a Prius driver until the Govt figures out how to switch all the petrol cars to RUCs. Lets see if this govt can actually execute something as challenging as switching all petrol cars to RUCs in a timely manner.
We need to rediscover industrial policy and start focusing investment in the infrastructure and technology that reduce the energy, labour and materials needed to produce goods and services (with a strong focus on balancing trade and regaining energy and food security)
The greens are celebrating the contraction of the industrial sector as a whole(CO2)
Warm, dry apartments in urban centres vs McMansions in the sprawling 'burbs.
See Joel Mcmanus, possible but needs some strong intervention by outsiders.
Vertical / automated horticulture
The Market is figuring this out, there is much more automation in fruit these days in the sorting and quality control.
dropping kids at schools on the other side of town in Ford Rangers
Red herring, almost no one does this.What if its a Toyota Vitz? What if its your kids and you cant live next door to the school? I took the bus to primary school
We eat hundreds of kg of meat a year per capita - the most disastrously wasteful food source at scale.
I wouldnt call essential diatery aminos wasteful
We are also in a total mess with inequality - with the top few per cent of households consuming a completely disproportionate share of our resources.
Thats normal, and 90% of folks would do the same despite what they type about. This occurs in Cuba, Venezuela, Zimbabwe and Maos cultural revolution.
Ironically the same people tend to complain most about the size of Govt, yet Govt taxation / spending is ramping up because more and more cash needs to be redisibuted back to people on low incomes who can not earn enough to secure the goods and services they need to survive.
50-52% of households are net tax positive. WFF tops up the property market,deal with the property market(without destroying credit creation) and the rest follows
could one of you guys explain to me in layman`s terms, why the inflation band is 1-3 and not for example 0 to 5? who came up with that narrow band..
and why is it not averaged over let say a 2 year period/?
and why could they not bring in a tax-free treshold like in Oz, and make it variable, so the IRD on instruction from the RB could raise or lower it, rather than the banks cashing in,,and everybody would be hit relatively evenly
..surely all the accounting software would be able to handle that ...
if they are stupid questions then forgive me,,..just trying to learn...
https://www.rbnz.govt.nz/-/media/e3db75051ec349209deabc075fd40731.ashx?…
or TLDR “It’s the vibe of it. It’s the Constitution. It’s Mabo. It’s justice. It’s law. It’s the vibe and ah, no that’s it. It’s the vibe. I rest my case.”
[Note: I'm pretty sure I got this as part of 2022's consultancy process]
The specific performance metric is averaged out over a 5-year term (this is the 'medium' term). That means it can swing higher and lower than the target amounts - as long as it remains there. So we could easily have one year at 5%, as long as the others are close to 2%. A wide band over the medium term would largely be meaningless, as it would allow far too much variance, which is at odds with the RBNZ's stability mandate.
But the headline metric is over much shorter time-frames, as these are used to predict what will happen in the near-term future, and thus are part of the input variables considered for setting rates.
Not that it really matters - as there doesn't seem to be any accountability written into the law for failing to meet the medium-term target, and the metric used is heavily manipulated for favourable reporting.
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