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BNZ's Tony Alexander says the world has changed and central banks are struggling to figure out exactly how & why

BNZ's Tony Alexander says the world has changed and central banks are struggling to figure out exactly how & why

BNZ’s chief economist warns we need to stop relying so heavily on interest rate forecasting when making financial decisions as its accuracy is wavering.

Tony Alexander makes the call in his latest Sporadic, released after the Reserve Bank (RBNZ) cut the Official Cash Rate (OCR) by 25 basis points to 2.75% this morning.

He points out interest rate changes from central banks around the world, haven’t had the intended effects on inflation.  

The RBNZ for example raised the OCR from 2.5% to 3.5% between March and July last year, as it anticipated inflation would rise, as accelerating economic growth lifted the pace of wage rises and boosted business pricing ability.

However, instead of going up, inflation has fallen. It sat at 0.3% in the year to March this year – markedly lower than the RBNZ’s predication of 1.9%.

Alexander says, “It is not just that our growth predictions have been too high, and that on the basis of that our employment forecasts have been too optimistic.

“It is that even with good jobs growth, wages growth has failed to accelerate. And businesses have tended not to use stronger sales growth to boost selling prices.”

He says our central bank isn’t the only one “having to cut interest rates after raising them in anticipation of things happening which ended up not happening”.

“The European Central Bank took their cash rate from 1.75% to 2.25% in 2011. It now sits at 0.3%. The Reserve Bank of Australia took their rate from 3% to 4.75% in 2009-10. It now sits at 2%. The Swedish central bank, the Riksbank, took their repo rate from 0.25% in 2009 to 2% in 2011. It is now -0.35%.

“Interest rate forecasting accuracy has gone out the window. Apart from getting the 1% rise in the RBNZ cash rate correct last year you will struggle to find any other accurate interest rate predictions in New Zealand – or elsewhere – since early-2007.”

Alexander says the world has radically changed since the global financial crisis (GFC), and old relationships between key economic variables are no longer what they were. The problem is no one knows what to look for moving forward.

Fed might follow other central banks in cutting rates sooner than expected after a rise

Alexander suggests people build flexibility into what they do, and focus on constructing resilience to the shocks we can’t predict, like bird flu, El Nino and terrorism.

He says we should be careful forecasting New Zealand interest rates over the next two years, based on the assumption US rates will rise over this time.

The Federal Reserve is expected to put itself in the same position as the RBNZ, RBA, ECB and Riksbank have at various stages since 2010, by raising rates in attempt to curb inflation.

Yet looking at how inflation’s responded and how low these rates have fallen to date, brings into question the commonly held view the Fed will track rates up in a slow stop-start fashion for three years.

“What few in the markets seem to have discussed is the chance that the US monetary authority in a year’s time cuts interest rates”, says Alexander.

Why forecasts are wrong

Digging into the detail, Alexander provides a list of reasons why traditional forecasts have been wrong. Here’s a summary:

  1. Since the GFC, finance has been moving more quickly into various assets, so using asset prices as a gauge for what market participants consider to be the true worth of something is no longer valid in many cases.  
  2. We have become more sensitive to price changes, so businesses don’t have the same pricing power as they did in the past.
  3. We are less willing to ask for pay increases, as we don’t want to risk losing our jobs amid news of high unemployment overseas, economic shocks and turbulence.
  4. We are more conscious of having debt, so are less willing to borrow, even if interest rates are low.
  5. Businesses, particularly in the US and Europe, are less willing to undertake capital expenditure. This is reducing productivity, and consequently economic growth and the prospects of payrolls being boosted.
  6. Businesses are aware that any lift in activity will be dampened to some extent by tightened fiscal policy governments are likely to implement to alleviate their high debt levels.
  7. The GFC has revealed deep structural problems in many economies – ie Greece.
  8. New Zealand is very vulnerable to immigration and emigration flows. Currently we are riding the wave of record net migration. When this reverses, we’ll receive a major shock.
  9. The world is awash with liquidity looking for a home, courtesy of hefty money printing in the US, Eurozone and Japan.
  10. Baby-boomers are retiring, and it’s hard to predict how consumer and asset markets will be affected. We don’t know if retirees will sell investment property to free up cash, or buy more to fund a longer retirement.
  11. Increasing globalisation means shocks in individual economies are more likely to be transmitted with greater impact to other economies.   

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This is a long winded diatribe to reach a simple, but starkly obvious, conclusion.

In the innocent days of 1958, wages accounted for half of America’s gross domestic product. Today, thanks to the onward march of globalisation and technology, labour’s share of the pie has fallen inexorably to 42 per cent, a trend that has been repeated in many other countries. Read more

Milton Friedman certainly has a lot to answer for.

"The success of the article was not because the arguments were sound or powerful, but rather because people desperately wanted to believe. At the time, private sector firms were starting to feel the first pressures of global competition and executives were looking around for ways to increase their returns. The idea of focusing totally on making money, and forgetting about any concerns for employees, customers or society seemed like a promising avenue worth exploring, regardless of the argumentation...Even better for executives, the article proposed that, to ensure that the firms would focus solely on making money for the shareholders, firms should turn the executives into major shareholders, by affording them generous compensation in the form of stock. In this way, the alleged tendency of executives to feather their own nests would be mobilized in the interests of the shareholders."

These clowns never cease to amaze me. Over the past three decades the economics profession has been unrelenting in its espousal of the doctrine of squeezing unit labour costs and fiscal austerity and are apparently mystified by the only logical outcomes of the policies they advocate. What do they expect from the restraint of the two economic sectors with the highest marginal propensity to consume (labour and the government) would be?

Agree, but only some of the economics profession....

The current fractional reserve banking system needs exponential debt creation in order to function. I would suggest that we are now getting close to the limits of this Ponzi scheme.

The current fractional reserve banking system needs exponential debt creation in order to function.

Doesn't exist and the atrophied remnants in the US are overwhelmed by the BoE create it 'as and when' policy claim.

"Rather than banks receiving deposits when households save and then lending them out, bank lending creates deposits" … "In normal times, the central bank does not fix the amount of money in circulation, nor is central bank money 'multiplied up' into more loans and deposits." Read more

So, if there is not enough credit outstanding, it is a function of the banks believing the punters are not up to servicing and liquidating it or it's not a profitable proposition due to regulatory imposition.

Equally, central bank printing acting as a crowding out effect cannot be dismissed either.

why a central bank has to control the price of money? It's one of the only things that should be left alone for market to decide.

The global crisis (NZ didn't get hit before but it will be now..) is lasting more than any other crisis in history because of the intervention of central banks.

The solution was easy. Do nothing

But now we all see the result: zombie businesses, banks bailed out at taxpayers' expenses, bubbles everywhere, encouraging debt and distortions in markets due to artificially low interest rates.

Does any economist really know how a system designed for infinite growth and debt-based is going to work from now on? We're all becoming Japan..

The world economy is in a lot of trouble, we are moving from moments of panic to "everythings under conrtrol". For example the chinese have announced they will restart stimiulus and most of the sharemarkets have bounced back. Really? that was the good news everyone was looking for to give them confidence to buy shares?

"The story of our money starts as a simple fraud. It is a fraud that has infiltrated every facet of our lives. When one benefits from this fraud, the draw to perpetuate it is in most cases overwhelming."

We have inflation & lots of it.
Asset prices (e.g. house prices) are through the roof. We just quietly ignore them and only include rent in the CPI.
Asset allocation is completely distorted when labour is taxed but many capital gains are not.

The financial system is eating its tail. Unfortunately that means we are next.

"Alexander says the world has radically changed since the global financial crisis (GFC), and old relationships between key economic variables are no longer what they were. The problem is no one knows what to look for moving forward." Tony, plenty of people understand whats going on, but they are not being listened to. Research the lead-up to the 2008 GFC; there were plenty of people warning about the path we were on. Perhaps because they weren't from inside the accepted narrative, or approved academia, they were ignored.

"The financial crisis of 2008, just a few years before his death, largely redeemed Mandelbrot in financial circles. The risk models of the financial engineers failed us all. Unforeseen defaults in mortgage markets cascaded through system and reverberated throughout the entire economy. Risk wasn’t being managed. In fact, it was being stepped up.

Unfortunately, the lessons remain surprisingly unlearned. Today’s managers, driven by data and focused on ROI, continually believe that, with just a little bit more effort and precision, that they can keep Mandelbrots “Noah effects” at bay and consistently engineer results."

"The contemporary monetary system has become progressively more detached from the underlying “real” economy of labour, resources, goods and services. Just as the pre-2008 credit bubble detached debt from any real prospect of repayment at value, subsequent monetary activism has tended to undermine the concept of money as a “store of value”.

Another one for Tony to read

Question; I think I see a link that was raised in the "Why Europe Failed" series. Is this another symptom of the "elites" trying to take over? Economists and big bankers have a model that they work to, and it fundamentally is about control. But they got to clever and caused a world wide crisis that continues to bite. Now the world is not hearing or dancing to their tune and they haven't another one to play! Perhaps there is a chance for the common people after all?

Murray... to is spelt too not to - yes

You cannot tax (includes - fees, licenses, registrations etc) the shit out of the economy, you cannot grow the public services beyond what small and medium sized enterprise can afford......why economists cannot get their heads around this is astounding!!!

Government debts and spending is simply to high.

The public servants do not work enough hours to what they get paid!
The pubic servants are overpaid for the work they do undertake.
The public servants use too much of business's time in unproductive unpaid compliance!
The public servants are completely unaccountable to the rest of the population.
The public servants have saturated what SME's can physically and financially attend too!
The public servants want to ensure SME's do not exist in the current form and are trying to transform all business into large corporate ownership...they keep finding ways to add on costs to SME's who has to stay lean and mean to afford to stay in business.

The bureaucrats obtain by compulsion every piece of information they desire in order to measure some facet of the it is not a free economy it is a controlled don't expect historical economic patterns and cycles etc....simply because the bureaucracy and public services don't know how to run and implement normal SME style business practices......

We have school teachers, police, Doctors etc only working part of a year but being paid for a full years work.
The costs of the public services and bureaucracy is not exempt from the law of diminishing returns!!

You cannot keep taking out large chunks of SME money and place it in the hands of Government to spend....the circle might look large to start off with at the first cycle stage but it slowly gets smaller and smaller until it strangles itself! There will be deflation before there is inflation unless there is some bureaucratic cost relief to the SME's. Over-regulation has always strangled an economy!!!

Without those civil servants, teachers, police, nurses etc, you would not have a civil society in which to do business and prosper in peace. Police & teachers may disagree with you on their workload.

10. Baby-boomers are retiring, and it’s hard to predict how consumer and asset markets will be affected. We don’t know if retirees will sell investment property to free up cash, or buy more to fund a longer retirement.
As a person in this category I would like to offer these comments. In our situation and I suspect this applies to others, that the second option looks the better option... "buy more to fund..." With the prospect of falling interest rates, OCR and mortgage rates, the returns on term deposits and fixed interest options to supplement the national pension and private superannuation will become lower and lower over the next few years (1-3y ??). Rental property or a property to live with an attached flat, rented to provide a supplementary income, plus acting as a retirement small business looks attractive.
The comments of Notanecomomist on teachers, police and doctors receiving a full years salary, but only working part of the year is erroneous. As a teacher, one spends a large amount of non-contact time preparing material and lessons, as well as marking work, extra-curricular sport, cultural events and so on. At least a portion of "holidays" is also spent in these tasks or on PD development work. These things are expected, largely unpaid. This commentator should try doing the job of any one of these professions. They would find the demands of the job results in burn out in many cases, and good practitioners need respect and understanding for completing their tasks competently day after day. Do not begrudge well earned time off. Its essential!

I well understand the dilemia Tony, one we all have when we're rid of debt, but the problem with that approach in "buying more to fund" is the bit that Tony has dead right in that you can no longer have any degree of confidence in the true value of any asset, especially those that have had a rocket under them for a number of years - maybe it drags on for alot longer, or maybe an eventual dump in values doesn't matter (its the kids lesser inheritance), but then maybe that dumping also involves rents and your income ? The one thing we do know is we're going to get plenty more shocks over the next decade or two as the inevitable consequence of QE and 5,000 yr low interest rates, and whatever we choose to invest in is never going to be comforable

anyone slightly alarmed by this warning? is the titanic starting to sink while the band keeps playing?

Days to the General Election: 23
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