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Opinion: Bollard has gone soft on inflation
June 6th, 2008
Deep breath. The Reserve Bank of New Zealand Governor Alan Bollard has gone soft on inflation.
This is a tough opinion piece to write. I personally like the Governor and admire much of what he has done, particularly his warnings about house prices and finance companies, and his moves to keep New Zealand’s banking system stable and New Zealand-run. His criticisms of government spending growth in the last year were also brave and timely, although he seems to have backed off that criticism this week.
But I think it’s time to question Dr Bollard’s inflation-fighting credibility. That’s because consumer price inflation has either been above, or is projected to be above, the upper limit of the bank’s 1-3% target band for periods totalling almost four years between 2002 and 2011. I hope it starts a debate.
Firstly, can the central bank chief credibly say he may cut the Official Cash Rate (OCR) just as consumer price inflation is hitting an 18 year high?
I ask the question because that’s what Dr Bollard did in Thursday’s June Monetary Policy Statement when he forecast a sharp slowing of the economy, with little GDP growth over 2008, but with a spike in consumer price inflation to 4.7% in the September quarter. He is forecasting that annual consumer price inflation won’t return to the target band of 1-3% until the June quarter of 2010.
Dr Bollard is using consensus forecasts that oil prices will drop back below US$100 a barrel and the bank’s own forecasts that slowing consumption spending and a weak labour market will drag non-tradeables inflation (ie domestic inflation not directly influenced by overseas prices) down from almost 4% to under 3% by September next year. The chart below shows non-tradeables inflation has been above 3% for six years and all through Dr Bollard’s term as governor.
Dr Bollard said the sharp slowdown and the likely depressing effects on inflation had given him enough confidence to start talking about a rate cut later this year. The New Zealand dollar duly fell more than 1 US cent and both wholesale and retail interest rates were cut by around 20 to 30 basis points. The “dovish” tone of his comments surprised the markets.
His decision to flag a rate cut later in 2008 is a big call. To decide to signal a rate cut before any tangible signs of a slowing of inflationary pressures takes some confidence in your forecasting ability.
It’s worth examining the governor’s record. The chart above shows when consumer price inflation was outside the target band, or forecast to be outside the target band, during his period at the helm.
Alan Bollard began his term as Reserve Bank Governor in September 2002. It’s not fair to give him the credit (or blame) for inflation results in his first two years, given any monetary policy decisions will only show through into actual inflation 18 months to 2 years after they were taken. His first actions were to cut the OCR from the 5.75% he inherited from Don Brash in September 2002 to 5% by December 2003.
Starting from the September quarter of 2004, inflation started rising from 2.5% as the housing market surged along, fuelled by a potent mixture of aggressive lending, property market speculation by 39% tax rate avoiders and strong migration. Nothing symbolised this period better than BNZ’s ‘Unbeatable’ mortgage campaign in the spring of 2004, which used cheap foreign borrowing to fund a price war that drove 2 year mortgage rates down to 7%, just 50 basis points above the OCR at the time.
This powered ’second wind’ in the housing market. It also fuelled a domestic consumption boom that drove non-tradeables inflation up over 4% through 2005, 2006 and much of 2007. This was where the real damage was done.
By September 2005 annual CPI inflation rose above the target band to 3.4%. Dr Bollard started lifting the OCR in January 2004 and kept pushing it up to a plateau of 6.75% by March 2005. It was held there until it was lifted in October and December that year to 7.25%.
The OCR was then held at 7.25% for 15 months between December 2005 and March 2007. This was during 2006 when the housing market slowed briefly before taking off again as the banks again competed hard for market share as the ‘Unbeatable’ era mortgages were rolled over.
In Thursday’s MPS the Reserve Bank looked at its previous decisions and decided:
Taking a longer term perspective, higher interest rates earlier in this cycle might have resulted in lower underlying inflation pressures currently, thus enabling some additional flexibility in response to costs shocks currently facing the economy.
However, in keeping with clause 4b of the Policy Targets Agreement, substantial consideration was given to the potential implications of higher interest rates for the already excessively high exchange rate.
I think it’s fair to say the Reserve Bank is acknowledging here it should have been tougher through 2006 and hiked interest rates earlier and higher. Bollard was eventually forced to hike the OCR to 8.25% in the second half of 2007 as it became clear inflation was running hot.
In hindsight (very easy for me), it’s clear Bollard should not have cut rates in 2003 and should have hiked faster and higher through 2006.
We are living with the consequences of those decisions now with inflation outside of the target band. The oil and food spikes are a factor, but non-tradeables inflation is a major factor and has been elevated above 3% for nearly six years. Non-tradeables inflation has never been below 3% during the governor’s term, yet he is forecasting a fall from 3.9% to 2.5% between December of this year and September of next year. This is worthy of scepticism.
It’s worth looking at the policy targets agreement (PTA) signed by Bollard and Finance Minister Michael Cullen in September 2002, which was referred to above by the Reserve Bank and re-signed last year without changes when Bollard was reappointed for a second 5 year term. It helps explain a few things.
The agreement was changed significantly in 2002 so that Bollard has to keep “future CPI inflation outcomes between 1 per cent and 3 per cent on average over the medium term.”
This was a significant weakening from the previous agreement in 1999 (between Dr Cullen and previous Governor Don Brash). The 1999 agreement was for a target of actual CPI inflation between 0 and 3%. Not only was the bottom of the range (and therefore the middle) lifted, but Dr Bollard’s role became targeting forecast inflation rather than actual inflation and on average over the medium term. This created an enormous amount of wiggle room, which the governor is using.
By the 2002 policy targets measure, he has acheived his target of always forecasting inflation will fall back into the target zone. But how long is this credible when inflation has been outside the target band for so much of Dr Bollard’s term?
Inflation went above in September 2005 and stayed there until the December quarter of 2006. Within a year it was back above 3% again and has stayed there ever since. It is not forecast to fall back below 3% until the June quarter of 2010.
Inflation has therefore either been above 3% or is forecast to be above 3% for 15 quarters or almost 4 years of the almost 7 years between September 2004 and March 2011.
The real answer to the inflation credibility question is inflationary expectations. If people don’t believe the bank is serious about keeping inflation within it’s target band they will vote with their expectations. By the current measures, the bank is hanging on by its fingernails.
The Reserve Bank’s own survey of business manager expectations shows the average expectation is for an inflation rate in 1 year’s time of 3.3% and the median expectation for two years ahead is for 3%. The average expectation is at a equal record 17 year high of 2.9%. That’s no margin of error.
The series shows a significant uptick in inflationary expectations since mid-2004, which is when Dr Bollard’s actions (or inactions) started having monetary policy effect on actual inflation (as opposed to forecast inflation). Business manager expectations of inflation two years out have averaged 2.7% during Dr Bollard’s effective term, up from 2.3% in the previous 4 years.
Inflationary expectations in the broader public are also rising. The Reserve Bank’s Marketscope survey shows expectations ticking up to 5% in the March quarter. This is only second time over 5% since the series began in 1995. Both spikes have been during Dr Bollard’s term.
Yet in Thursday’s MPS the Reserve Bank repeatedly used the phrase “anchored inflationary expectations” in describing the outlook. They are anything but anchored. To expect them to fall back or even to be stable after years of rising invites scepticism.
Dr Bollard pointed out on Thursday that the world is experiencing an unprecedented spike in oil and food prices. He cited the clauses in the policy targets agreement that allow him to look through these temporary spikes in order not to cause undue volatility in output, interest rates and the exchange rate.
He cited the global consensus on oil prices that they would fall and pointed out the significant speculative pressures underpinning oil prices.
Asked if there was a danger the spike in headline inflation would lift inflationary expectations, Bollard said the bank’s inflation fighting credibility would stop that happening.
I now have my doubts.
Dr Bollard may well be hitting his policy targets, but the way the targets have been relaxed and the way he is using them is endangering that hard won inflation-fighting credibility.
It has to be said my view is not widely held. Most economists welcomed Thursday’s MPS and the governor’s “dovish” shift to a clear easing bias, agreeing that the sharp slowdown in the economy required it.
But there is one dissenting economist. Read Westpac chief economist Brendan O’Donovan’s view on the MPS, which is similarly sceptical.
I’m glad I’m not totally alone.
Tags: Alan Bollard, Brendan O'Donovan, Inflation, Michael Cullen, OCR, Policy Targets Agreement
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June 6th, 2008 at 12:08 pm
No Bernard you are most certainly not alone. I was flabbergasted by the content, assumptions and tone of the announcement. As far as I can see they have given up on inflation targeting (political pressure from Labour in an election year writ large), whereas elsewhere in the world central banks are putting rates up to deal with the inflationary surge (the ECB said overnight that there was now a chance they would move upwards next month). Who an earth is advising them that oil will go back and stay below $100? Against a background that the largest producer in the world (Russia) has said that their production has peaked? Perhaps we should not have been surprised; as you point out he has chickened out twice before, and we have all had to deal with the consequences. I forsee two possible outcomes: 1) Continued surge in the oil price above $150 (off the back of hurricane season in GoM for example) stops him dead in his tracks forcing him to stay his hand (actually the BETTER outcome). Talk of cuts is put on hold.
2) Oil stays in the $110-130 area, he goes ahead with some cuts (mad I know) but then is rapidly forced to backtrack on them (sometime in 2009) and base rates are forced up close to 10% as he struggles to get the inflation genie back in the bottle (by which time inflation is pushing past 6%).
As for the view that he has got the housing market licked? Well volume wise yes, but where is this 13% fall going to come from (particularly if he cuts rates). Y-o-Y falls so far don’t amount to much than 1.5% (REINZ) and have not even started according to QV. Don’t be surprised to see REINZ figures next week claim that May prices rose from April and that the Y-o-Y fall has vanished.
June 6th, 2008 at 12:14 pm
You’re not alone on this one, Bernard. Inflation expectations are not anchored. Bollard is destroying the RBNZ’s credibility on inflation and it will be extremely costly for credibility to be restored.
June 6th, 2008 at 12:35 pm
Hello Bernard
I agree with you.
The situation looks very strange and a very naughty idea just crossed my mind: might this be only an attempt to avoid, or postpone, a housing market crash?
After all, lower mortgage rates will benefit, even temporarily, all those who have to refinance now. A few potential buyers might also decide to buy now?
And if inflation ends up hitting the ceiling in a few months, Dr Bollard will raise the rate…
All countries are in a “wait and see” mode at the moment and keep their rates unchanged. Nobody knows what the consequences of the credit crunch will be, or is it that nobody wants to be the first to tell the hard truth?
The situation is quite interesting…..
June 6th, 2008 at 12:45 pm
Awesome post – I completely agree with your concerns.
The Bank is effectively accepting a policy failure and they don’t really seem to care. I wouldn’t be surprised if we get stuck in a wage-price spiral over the coming years.
June 6th, 2008 at 12:49 pm
[...] 2: Bernard Hickey goes into detail about why this early cutting is a bad idea. The money quote is non-tradeables [...]
June 6th, 2008 at 1:43 pm
Spot on and I agree with all the other comments, absolutely stunned at the change in tone and what other central banker in the (real) world would actually state in advance when they see rate changes happening, surely thats for the likes of the public and the economists to debate.
I had a lot of time for him prior to this week, now it looks as though he’s had someone stood behind him with a gun telling him what to say in a last desperate attempt to seek re-election.
Totally correct in the assessment as well, raising earlier/quicker/higher in a smaller economy would have calmed things before they got out of control. No-one can expect house prices to double every 4 years forever and ever and what may now happen is a good old fashioned boom and bust cycle for the next several years that is to all intents and purposes uncontrollable.
What he needs to do is pull back from this but that won’t happen unfortunately so we now need changes in policy across the board.
June 6th, 2008 at 1:49 pm
It is interesting that you mention the Policy Targets Agreements, I believe that it seems Bollard is keeping in line with the changed PTA. So I guess if anything we would have to question the finance minister on why the wording of the PTA was changed.
June 6th, 2008 at 2:09 pm
Hamish
Very interesting. I think the PTA is a double act. Both Drs Bollard and Cullen signed up to it. They are both responsible for the inflation outcomes, particularly given that Cullen controls fiscal policy too.
Bollard was Cullen’s Secretary to the Treasury and was Cullen’s choice when Brash left. By necessity, they will have worked together closely since 2002. No one is questioning Bollard’s independence. But the 2002 policy targets agreement, along with the 1999 watering down of the agreement with Brash, have Cullen’s fingerprints all over them.
On average, over the medium to long term term, it seems the Reserve Bank of New Zealand cannot be considered truly independent while the Finance Minister appoints the Governor and writes the PTA.
That’s a long way from the original aims of the 1989 Reserve Bank and the original 1990 Policy Targets Agreement.
cheers
Bernard
June 6th, 2008 at 2:09 pm
Yes, if judged against inflation targetting only – the record is questionable. But, doesn’t everyone agree the Reserve Bank Act needs amending? Surely export, growth, and employment objectives need to be part of the policy targets agreement – as is the case for most countries central banking policy?
For some time, NZ has needed to curb the carry trade interest in our currency. He held rates, but sent out a warning shot across the bows of those enthusiasts.
The dollar dropped (not near as much as it needs to), mortgage interests rates dropped (not near as much as they need to) and he told the RE speculators still with their head in the clouds about the value of their real estate assets to “get real” (I also note an article about the cost of new home building coming down as well). He also told the folks thinking of entering the RE market to hold off and wait until year’s end when both house prices and interest rates might be down on the present.
Sure, there will be inflation well beyond 3% – but that’s going to happen regardless – and households and government (both local and central) need to learn to adjust spending accordingly. It ain’t gonna be easy, inflation is going to skyrocket the world over – and being in the high OCR position we are in means we can ’stay the course’ better than others.
I see it as the Governor had two choices, raise interest rates or put them on hold. He held – and added a whole lot of comments with intentions well beyond his mandate – but they are only comments, and I doubt he’ll follow through on any rate cut before years end. Hopefully the comments will serve the purpose (to give exporters and mortgage holders some relief) in the meantime.
June 6th, 2008 at 2:38 pm
cant believe yesterdays announcement,this talk by the governor has just pushed up petrol and food and all imported goods,he opened his mouth and added to inflation.what is going on
June 6th, 2008 at 2:49 pm
interest.co.nz readers are an astute lot
It’s not suprising the RBNZ has gone soft given their political masters.
Q: What drives inflation?
A: Spending rising faster than output.
Q: What drives spending?
A: Credit and confidence (particularly low unemployment)
And who’s the biggest spender in the land – Government
Labour believe they spend money better than anyone else. Being bare-faced politicians they claim increased private spending from tax cuts will drive inflation and imply increased government spending magically will not.
Check out the growth in “G” in the national accounts, number of employees in the public service etc. and you’ll know why Bollard doesn’t want to bite the hand.
Other posters are right – there’s another round of cost to come getting inflation back in the bottle when and if Labour’s socialist spend up comes to an end.
Overall this is a classic example of Government spending “crowding out” private spending – because they spend so much our spending is reduced by high interest rates and exporters are badly hurt by high exchange rates driven by international interest rate trading.
Personally I think there’s something in choosing another device (like petrol prices) where a surcharge could be added to petrol to reduce overall household budgets available for other spending so exporters don’t bear the brunt of interest/exchange rate adjustments.
Regarding Kate, the poster above, No – everybody does not agree on amending the RBA to explicitly target “real” outcomes. That’s exactly what Labour have been trying over the last decade hence the relaxed PTA and the mess we’re in. We tried it with Muldoon as well and got interest rates of 20%.
Anyone like another round of that?
June 6th, 2008 at 3:53 pm
Yep. bought my first house in 1979 when rates were that high, but I paid $37K at a time when my income was $10K and rising and there were a wealth of good jobs too.
The situation now is rates are not that high, but unmanagable for many, as we lost pace with the developed world on wage growth – and at the same time had this massive spiralling of house prices, as per the world over due to cheap/loose credit.
If the Governor yesterday had been acting in accordance with the unamended target (0-3%) in the pure sense that the RBA was enacted in 1989 – then he’d have raised interest rates based on both existing and forecast inflation trends. And then more currency speculators would have invested in Kiwi, further eroding our export sector.
I don’t know – I’m not an expert in any of this – just a casual observer – but I feel the ‘pureist’ approach (a single ‘blunt’ instrument) to economic/monetary policy just doesn’t serve us best anymore (if it ever did). Globalization has changed the playing field forever. More flexibility is needed.
June 6th, 2008 at 5:15 pm
Id look twice crossing the road and then look again!
June 6th, 2008 at 8:57 pm
Andy Hamilton, re median house price – if less sales happen at the very bottom end of the market ie with investors and first home buyers but still reasonably active in the high price bracket then it is not surprising to see that the median increases slightly. (Actually quite a good climate to change house when prices aren’t getting away on you.) However there is no question that anyone who purchased a home in the late 2006 to early/mid 2007 period would now have lost equity. I suspect that median price falls will lag the volume fallls by about 6 months. Keiran Trass will most probably have his predictions proved correct.
June 6th, 2008 at 10:59 pm
Your comments and the Governors words do not inspire those of us exporting. Enduring the pain of the high currency for such a result is very disappointing. We may as well pack up our bags and turn our heads away from hitting them on the brick wall.
Why is it our m3 cannot remain equal value to an agreed basket of international commodities like gold silver steel meat milk oil etc ? The fiat monetery system has seen primary producers relativity erode from 22 bushels of wheat to buy an ounce of gold in 1897 to 80 odd bushels required to buy the same ounce today. That is a huge loss!
Given the importance of land based exporting in NZ this legalised theft of purchasing power not only holds back increased wages but also overloads our environment as producers are forced to increase productivity to remain competitive due to the compounding effects of inflation.
To condone this theft of peoples’ savings just to allow politicians to give away something to get re-elected is dispictable to all who take financial risks and sets a bad example to the children who follow.
Surely there are better tools in the toolbox that maybe not as popular but more effective for us to remain competitive as a nation?
June 7th, 2008 at 8:15 am
Inflation fighting! All central banks ever do is manufacture inflation. It astounds me that anyone actually thinks that this Reserve Bank has ever done anything other than ensure a steady rate of inflation… that’s what they do and were created for.
The purchasing power of our money has done nothing but buy less year over year for decades. The Hickey piece is lame at best.
June 7th, 2008 at 8:38 am
The RBNZ’s oil price expectations look even lamer in light of the overnight action. Having had 24 hours to think about it I have come to the conclusion that the oil price in September ($130 plus) simply wont let him cut by then.
June 7th, 2008 at 9:25 am
RB should lower interest rates immediately. It was the influx of carrytrade money that caused the housing boom – the banks were desperate to loan out the excess money. This country is dependent on exports and they should be the first priority. The higher cost of imports when the dollar falls will more than offset any inflation caused by lower interest rates. In the mean time we may be able to save some of our beaten up exporters and stop the last few manufacturers from leaving our shores.The blinkered approach to the economy in this country is staggering, what did they think all the people who work in the manufacturing sector were going to do when all the manufacturing moved to China and Asia? If necessary, in the short term, the cost of petrol could be lowered to keep the country moving.
June 7th, 2008 at 9:48 am
Be interesting to see what the NZ sharemarket does on Monday!
June 7th, 2008 at 10:12 am
Dorothy don’t want to be picky but are you sure about this comment?
‘The higher cost of imports when the dollar falls will more than offset any inflation caused by lower interest rates’
As the $ falls we will IMPORT inflation. Westpac reckon 1% rise in inflation for every 10% fall. So if the $ was at 0.60 we would have an inflation rate of 6% or so and rising.
I think folk are far too dismissive of the dangers of inflation – it hurts everyone in the economy, destroys savings and ultimately destroys economies. If the exporters want to point their finger anywhere then point it at the house market bubble and the tax incentives that have helped it grow (and the easy lending). It is this that has unbalanced our economy more than anything. The government and the RBNZ could and should have pricked this bubble years ago (thus avoiding the rates we have now). But like the UK government Labour here realized that the middle classes could be lulled into passivity (and then taxed by stealth without complaining too much) if all they could see was ever appreciating house prices, with the mirage that somehow everyone was getting richer off the back of house price equity.
June 7th, 2008 at 10:35 am
RBNZ seems to have taken a view that they are not too concerned about the “imported” inflation. It does not matter whether inflation is imported or not. Control of inflation by interest rates has only a limited effect. The supply of money must be controlled in order to avoid impending risks of huge overseas debts on the economy. Inflation & higher interest rates will only increase poverty because of these are disincentives for increasing productivity. It is a pity there is no long term fiscal displine to which we could all agree upon. Focus on short term gains, both political and financial, is to blame. Debts will take further revenge- just a matter of time.
June 7th, 2008 at 10:35 am
I have to dissagree with this and most of the posters
Inflation is being driven by high commodity prices which in tern is being driven by global demand (mainly emerging markets). Do we really think high NZ interest will do anything to slow the price increases in oil or any of these commodities? Why then should the RBZN ruin the NZ economy with very high interest rates?
The only influence the RBNZ has is on the domestic economy and it has correctly been guarding against asset bubbles like the housing market and an overheating domestic economy. I think we can all agree this has worked with a rapid slowing of consumer spending and house prices. I see no need to now force a hard landing and push NZ into a recession.
I believe Dr Bollard has once again made the right call and don’t see the problem with using the flexibility in the inflation agreement to do the right thing for NZ
June 7th, 2008 at 10:45 am
Julian – the BoE and the Fed both recently made the call that you think the RBNZ should make; result – a surge in inflationary pressure as the pound and the US$ sank. Now the governors of both institution have had to come out and say – ‘heck we have a real inflation problem now, and we may have to RAISE rates against a backdrop of declining economies’. That is what will happen eventually to the RBNZ if it cuts now. The situation is bad now, but cutting will only make things far far worse down the road as inflation soars.
June 7th, 2008 at 11:05 am
Andy,
In the case of the Fed I agree with you, however this is an unfortunate result of having commodities priced in USD’s as commodities rally every time the Fed cuts because of the falling USD and because funding commodities futures gets cheaper.
NZD rates and currency moves have no such impact on the market, there will of course be a short term bump in inflation with rising import costs when the NZD falls. This will be a “one off” event however and not a systematic problem with the economy that needs addressing with rate hikes.
June 7th, 2008 at 11:24 am
But there is every chance that the initial inflationary surge will then get embedded in the economy via a ‘wage push’ cycle. Workers will have seen that Bollard has gone soft on inflation; faced with an inflationary surge next year why an earth would wage demands remain static? Unemployment anywhere below 5% isn’t going to put anyone off in the short term from demanding more for their selves.This is exactly the choice faced by economies in the 1970s when the last oil price surge began – to eventually put the inflation genie back in the bottle required eye watering rates following a wage-price spiral.
June 7th, 2008 at 12:03 pm
If the rapid slowdown the economic data is pointing to eventuates I don’t see a ‘wage push’ cycle being a concern. Workers will always want wage increases the real issue is do they have the leverage to force it out of their employers. If there are pleanty of jobs and demand for their skills the answer is yes. If however businesses are struggling and making workers redundant this wont happen.
I’m currently working in the UK banking sector and no body is able to demand wage increases right now despite high inflation, people are just happy to have a secure job (a stark contrast to a year ago).
June 7th, 2008 at 12:12 pm
Sure, but here in NZ we are only just off all time lows for unemployment (at around 3.5%), enough room IMO for the development of a wage push cycle.
June 7th, 2008 at 12:13 pm
Bernard
If oil is so important (and it is critical) why do we have such a lazes faire policy to it? Bollard like a lot of others has been taking to much advice from CERA/Yergin. If these prices (and food which is linked) inflate then his only option is to drive down consumption of other services, which will drive the economy backwards. He could not do this whilst Cullen had the chequebook out, hence the change in the PTA. Did anyone else wince when Cullen stated manufacturers had to increase their productivity (evidently this doesn’t apply to the public service whose numbers have burgeoned in this period)
I would like him to make a policy statement to the effect that we should target reducing our reliance on imported oil and produce more renewable electricity, Energy is THE issue of this century
Neven
June 7th, 2008 at 12:26 pm
You are of course spot on Neven. But I don’t expect anyone in the government to acknowledge peakoil until it is far too late.
June 8th, 2008 at 12:17 pm
Rick you are spot on about M3 being the problem and the solution you mention has been floated before through mechanisms like the EBCU (energy backed currency unit) from Richard Douthwaite and the Terra from Bernard Lietaer.
The money supply numbers in NZ are already showing a fall in the rate of increase since June 2007 which has led the decline in house prices.
This is what needed to happen and slowly it will feed through the economy. The external situation is causing problems with energy and food prices rising. There is nothing the RBNZ can do about this (as Julian notes).
In fact I would argue that now the housing market has been routed, rates can now be cut to help the domestic economy cope with the downturn. It may be slightly counter-intuitive but, in the absence of speculative froth in the real estate market, interest rate cuts actually remove pressure for wage increases as workers have more cash to cope with higher prices.
High interest rates have crippled the domestic economy leading to low rates of innovation as business has gone overseas or shut down. It has diverted huge amounts of disposable income towards the servicing of mortgages and general debt enriching overseas owned banks and investors.
I was very surprised by Bollard’s statement given his previous position. However, I think finally he’s seen the light. The housing market is buried, retail is dead and people are being sacked. Now he can loosen the stranglehold.
June 8th, 2008 at 12:39 pm
[...] Bernard Hickey believes Alan Bollard has gone soft on inflation, as does the Westpac Chief Economist. Tags: Alan Bollard, Bernard Hickey, Blog Bits, Citizens’ Juries, Colin Espiner, Craig Foss, inflation, Matt McCarten, Michael Cullen, No Right Turn, NZBR, Paul Walker, Reserve Bank, Russel Norman, tax cuts, Whale Oil [...]
June 8th, 2008 at 1:30 pm
My personal view is that Bernard in his analysis is right. The Economist has a leading article on the fact that average global inflation is now some 5.5% and for two thirds of the world population is about to hit double digits.
The Economist noted:-
RONALD REAGAN once described inflation as being “as violent as a mugger, as frightening as an armed robber and as deadly as a hit-man”. Until recently, central bankers thought that this thug had been locked up for life. Thanks to sound monetary policies, inflation worldwide had stayed low in recent years. But the mugger is back on the prowl.
The article is here:-
http://www.economist.com/opinion/displayStory.cfm?Story_ID=11409414
I blogged about this yesterday, seeking some thoughts as to what this might mean for NZ here:-
http://adamsmith.wordpress.com/2008/06/07/802/
It is perhaps pertinent to note that the International Energy Agency has just published a new report which states that carbon pricing needs to be at US$200 per tonne for the world to stand a chance of hitting IPCC targets of 50% reduction in CO2 emissions by 2050 and may need to go to US$500 per tonne.
SO what will that do to inflation forecasts and the world economy.
June 8th, 2008 at 1:49 pm
[...] yet am not sure that I have got the answers, but came across this opinion piece by Bernard Hickey at interest.co.nz. [Hat Tip:kiwiblog], which together with the comments, by [...]
June 8th, 2008 at 5:22 pm
Raf, thank you for the interlectual leads to increase my understanding and develop a better question to ask. With such esteem people arguing the case, one could conclude poltical and bank self interests are a greater need than eliminating inflation.
June 9th, 2008 at 2:08 pm
Whilst I don’t disagree with Bernard from a technical standpoint, I must challenge the notion of trying to fight imported inflation with domestic toolWe run the risk of squeezing the life out of the domestic economy to control the uncontrollable…overseas prices.
June 9th, 2008 at 3:33 pm
Chris.
Good question. How do you fight international stagflation with domestic monetary policy. Policymakers spent almost a decade in the 1970s trying to do everything but put up interest rates.
Eventually, then Federal Reserve Chairman Paul Volcker chose to focus on restricting money supply growth with brutally high interest rates. It worked. We may have to do the same again.
It doesn’t seem fair, although if you look at our inflation history over the past 6 years, it is a story of domestic inflation mostly. Non tradeables inflation has been over 3% for 6 years. We have borrowed nearly NZ$100 bln from foreign investors in less than a decade and spent it on these shores. That is inflationary. If we have to put up interest rates domestically it will be because we have a domestic inflation problem. International prices have not helped, but they are not the reason for our real inflation problem.
cheers
Bernard
June 9th, 2008 at 3:59 pm
Sam: “It is a pity there is no long term fiscal displine to which we could all agree upon.”
Ain’t that the truth. If only, if only if only we could somehow foster a collective understanding and will to deal with inflation as one bloody great team. Absolute pipe dream I know. (Reaches for the pipe)
June 9th, 2008 at 4:12 pm
Does non-tradeables inflation include house-price inflation? If so, that is likely to account for a large part of inflation exceeding 3% over the last 6 years – and as is evidenced recently – that will not be the case going forward as prices are rapidly tumbling.
June 9th, 2008 at 4:43 pm
Kate,
Very interesting question.
Here’s Stats NZ’s paper on weights for tradeables and non tradeables and house price inflation. Paper Here
It shows the purchase and construction of new dwellings group is accountable for 8.48% points of the CPI, all of which is counted as non-tradeables inflation. Financial services and credit costs, again all of which is non-tradeables, makes up 0.58%.
Going from that I don’t think a fall in the house prices directly is going to save us. It’s the flow on effects on consumer spending that are a factor as people stop using the equity in their houses like an ATM.
cheers
Bernard
June 9th, 2008 at 7:02 pm
Great spreadsheet – but have a look at the cover sheet – it says 2002, not sure whether that’s just Stats not amending the cover sheet or what.
But it is of interest regardless. Domestic inflation makes up 55.58% of our overall (say) 3% inflation whereas imported inflation accounts for the balance (44.42%).
The two items mentioned by you above make up 9.06% of the 55.58% – or 16% of domestic inflation. If you add local authority rates accounting for 2.04% – then those three items combined equate to 19.9% of domestic inflation.
Add to that the domestic energy sub-group (read: government owned businesses) accounting for 2.93% – then those four items combined equate to 25% of domestic inflation.
June 9th, 2008 at 9:26 pm
We can blame all current inflation on Wall Streets brilliant ‘collateralised debt obligations’ and ’structured investment vehicles’ for creating “easy” credit. The easy credit which has over inflated housing “investment” around the world and made people feel able to spend…. alot.
Don’t blame Bollard, or Governments, or ill-informed consumers. Blame the creators of inflation – the original impetus for inflation.
Bollard is the ambulance at the bottom of a globalised cliff.
June 10th, 2008 at 2:04 am
Bernard,
Regarding this
“Policymakers spent almost a decade in the 1970s trying to do everything but put up interest rates.
Eventually, then Federal Reserve Chairman Paul Volcker chose to focus on restricting money supply growth with brutally high interest rates. It worked. We may have to do the same again.”
I don’t dissagree, but surly it worked because the big global players were playing ball with high rates. I don’t see how higher rates in NZ will have any impact, we seem to already be doing our bit with rates higher than everyone else and don’t see things changing unless the US, Asia and Europe also get on board with high rates?
June 10th, 2008 at 1:31 pm
Bernard: the RBNZ is not alone in running out of options, as Yves’ note here implies.
If the Fed is seen as ‘painted into a corner’, our minnow counterpart is busily surfing the 30m waves of the Great Southern Ocean. Thrilling if correctly pointed, but loose concentration on the rudder, or get crosswise in the trough, and… Well, so I’m told, anyway (being an Estuary sailor at best, heh).
And it doesn’t franlkly help that the boat named ‘Our Funky Little Kiwi Economy’ has some fairly heavy deadweight, to perhaps bend this here metaphor to its breaking point. Or should that be sinking point? Whatever.
June 10th, 2008 at 8:26 pm
I disagree with adriannixon’s argument that easy credit is a global thing and RBNZ cannot be blamed. Our interest rates consistently remained very high because of inflation. RBNZ failed to control it adequately when the problem started many years ago. If the desired inflation band is 0 to 3%, then the target must be the median 1.5% rather than the upper limit of 3%. The previous RBNZ Governer insisted on a median target of 1.5%. This target inflation rate was re-interpreted as 3% later on and the inflation mess started in New zealand.
June 16th, 2008 at 2:02 pm
Julian
You are right to wonder about how much influence the RBNZ has on global forces. But I think the RBNZ’s monetary policy tool is one of the most powerful we have and the RBNZ can control inflationary expectations over the longer term. Again, most of the inflationary pressures are domestically generated over recent years, not internationally generated.
The oil price and food prices are grabbing the headlines now, but it is non-tradeables inflation that has been the culprit for years. It’s only now as the tide of the New Zealand dollar goes out that we are exposed with our pants down.
cheers
Bernard