Treasury sees 'high hurdle' to changing inflation targeting

Bonds

Treasury is reviewing the PTA ahead of the end of RBNZ Governor Graeme Wheeler's term in September next year but says 'no case' has been made to change the current framework

2nd Aug 16, 5:02am by David Hargreaves

By David Hargreaves

Finance Minister Bill English's department The Treasury is already reviewing the Policy Targets Agreement between the Finance Minister and the Reserve Bank Governor, but at this stage looks unlikely to recommend a move away from the increasingly contentious policy of inflation targeting.

The existing PTA signed by English and current RBNZ Governor Graeme Wheeler makes 'price stability' the objective of monetary policy - with the policy target to keep future CPI inflation outcomes between 1% and 3% on average over the medium term, with a focus on keeping future average inflation near the 2% target midpoint.

The RBNZ hasn't come close to achieving this target in recent times and inflation has been below the 1% bottom of the target range for nearly two years now.

There's been an increasing level of debate about whether targeting inflation in this manner is now either realistic or desirable, and whether other economic measures should be targeted instead.

The PTA is revisited whenever a new RBNZ Governor is either appointed or re-appointed. Appointments run for five-year terms.

Wheeler was appointed in 2012 and his current five-year term expires on September 25 next year. He hasn't given any indication yet whether he's seeking a second term but, regardless, a new PTA would be signed next year.

Asked about what if any preparatory work was going on, Treasury said it regularly reviewed NZ’s monetary policy framework in advance of the signing of a new PTA "which either stays the same or gets amended".

"You’ll be aware that previous reviews have led to some changes being made to the PTA over the years. Needless to say, reviewing monetary policy has been challenging in the wake of the GFC (for NZ and other countries around the world); we will be looking closely at domestic and international developments to ensure our framework remains fit for purpose."

Treasury said there had been "a few countries" that have recently undertaken monetary framework policy reviews - and it cited the Bank of England, Bank of Canada, and Sweden’s Riksbank.

"None of these reviews have led to a movement away from inflation targeting," Treasury said.

"Our view is that no case has yet been made to change our current framework and there would be a high hurdle before going down that path.”

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13 Comments

by scarfie | 2nd Aug 16, 8:35am 1470083703

The RBNZ has never been in control of inflation, they only control the peaks and troughs within the trend. Really the measure of inflation is measingless without measuring asset price inflation. Right now there is a glaring disparity between M3 money supply growth, and official measure of inflation or GDP. I have asked the question before, where is the excess money going?

by nymad | 2nd Aug 16, 8:43am 1470084202

"The RBNZ has never been in control of inflation" - That's a bold statement..
The measure of core inflation would be even more meaningless if it incorporated asset classes.

by scarfie | 2nd Aug 16, 1:30pm 1470101448

Prove that they have been. The M1 chart is a good one to look at, the YoY change going back 30 years. Doesn't look to me like a trend they are in control of.

by dictator | 2nd Aug 16, 11:25am 1470093945

The money, for the most part, doesn't circulate into the general economy and generate any income or consequential spending. It will be going into other investment assets. You can see the pattern in the US where billionaires are accumulating substantial cash reserves. That money is idle and functionally useless.

by Stephen Hulme | 2nd Aug 16, 8:55am 1470084941

Treasury said there had been "a few countries" that have recently undertaken monetary framework policy reviews - and it cited the Bank of England, Bank of Canada, and Sweden’s Riksbank.

"None of these reviews have led to a movement away from inflation targeting," Treasury said.

Their collective delusional behaviour has been noted by none other than the central banks' banker, BIS.

A monetary policy regime narrowly focused on controlling near-term inflation removes the need to tighten policy when financial booms take hold against the backdrop of low and stable inflation. And major positive supply side developments, such as those associated with the globalisation of the real side of the economy, provide plenty of fuel for financial booms: they raise growth potential and hence the scope for credit and asset price booms while at the same time putting downward pressure on inflation, thereby constraining the room for monetary policy tightening. Borio page 12 of 38

More importantly, the banking system does not simply transfer real resources, more or less efficiently, from one sector to another; it generates (nominal) purchasing power. Deposits are not endowments that precede loan formation; it is loans that create deposits. Money is not a “friction” but a necessary ingredient that improves over barter. And while the generation of purchasing power acts as oil for the economic machine, it can, in the process, open the door to instability, when combined with some of the previous elements. Working with better representations of monetary economies should help cast further light on the aggregate and sectoral distortions that arise in the real economy when credit creation becomes unanchored, poorly pinned down by loose perceptions of value and risks. Borio Page 17 of 38

And, billionaire, Bill Gross who was more direct in respect of the Fed's failings.

Low yields reflect and enforce deflationary economy. 1.2% growth for past 12 months. Fed is clueless. Read more?

by dictator | 2nd Aug 16, 11:38am 1470094714

The inflation statistics that are reported are not statistics. If subjected to intense external scrutiny serious flaws in their method would be revealed. The CPI itself is no more than a manipulation of statistics to provide the desired answer that there is inflation. Of course when the input to your model shows inflation when there's actually deflation you will make the wrong decision. Simply Garbage In Garbage Out (GIGO).

When co-workers would come to be asking why their model did to match scale testing. I would point out that the model needs to be adjusted to match the physical results. The model is invalid if it does not approximate physical reality. The same goes for RBNZ's modelling, why have they not adjusted the model, or its inputs, to find the cause of the departure. It's pretty safe to say that it is operating outside of the valid range of inputs given that the CPI departs from reality. RBNZ have fallen into the same trap as other Government Departments where they hire advisors to produce the requested results, rather than receiving competent independent professional advice that is needed.

When the Reserve Bank Governor is unable to distinguish fantasy from reality that is cause for concern for the Nation. Within the BIS that gets you a promotion.

by Roelof | 2nd Aug 16, 9:39am 1470087588

The "high hurdle" is probably a metaphor for having a train crash first and then changing things ..??

I do recall reading some RBNZ writings, post GFC, suggesting that keeping more than an eye on the credit aggregates and how they are growing relative to GDP etc.... might be important..???

Is our PTA policy framework fit for purpose...??? That would be a fine debate.... I'm not sure if it should be just treasury making this call..??

That fact that the RBNZ is reactionary in coming up with those patchwork ideas like LVR and income to loan ratios...etc.. suggests that the efficacy of the PTA is something worthy of debate..??

In terms of Monetary policy and an economy, a Central Banks primary role is to maintain price stability... Is the CPI too narrow a measure of that...??

Question for debate..: Why doesn't excessive credit growth ( money supply growth ) show up in higher CPI..?? If the effects of high money supply growth don't manifest in consumer prices.. then where does it manifest and is that an issue..??
( Double the money supply in 10 yrs and it sure as hell affects the economy in some big way )
(With the current PTA ... this is simply not considered to be an issue, if the CPI is within target)

by Stephen L | 2nd Aug 16, 11:41am 1470094910

Most of the increase in money has gone into asset prices, only a small percentage of which is actually spend on consumption, being a prime demand economic activity that would drive inflation measured by the CPI. Meanwhile on the supply side, excess very cheap money has driven investment in surplus capacity around the world, driving down prices.
Which all begs the question as to whether in a new PTA any alternative tools would be available to the RBNZ, even if they do, head in the sand, keep only one target. The current PTA gives them only one tool to target inflation- that tool being the OCR. They have some other measures to support financial stability. It seems clear to me that very low to negative interest rates are not driving inflation up anywhere, for the reasons noted above. There are other tools, which other countries are more than toying with. In the currency wars that have been going on for some time, and that will persist for many years, to not give our RBNZ some other tools would be to tie their hands behind their back, at NZ's cost.

by nymad | 2nd Aug 16, 12:10pm 1470096654

Agreed, very little of the increased money supply has gone into productive investment. Give any rational person the opportunity for arbitrage, and they will take it.

I don't agree with your views on multiple targets and tool, though. It shows you to be just as 'head in the sand'. There are very good reasons as to why a central bank focuses on one key target. The dynamic just becomes exponentially more complex with each additional tool or target introduced.
The answer is more in using less monetary tools, with one singular target.

by Stephen Hulme | 2nd Aug 16, 12:46pm 1470098817

There are very good reasons as to why a central bank focuses on one key target.

Well, the RBNZ needs to react better to it's repeated OCR cuts failing to realise a material lift in the reported CPI index, at great ongoing expense to largely innocent others. I highlighted these issues yesterday.

by dictator | 2nd Aug 16, 12:48pm 1470098881

There also another article on this site discussing how banks won't be passing on all of the cut. In this OCR range the RBNZ has rapidly become irrelevant.

by Roelof | 2nd Aug 16, 5:35pm 1470116118

nymad.... really ..You think there are good reasons why Central Banks focus on one key target..???

Even the Central Banks' rationale in allowing Money Supply growth to be endogenous is based on a fallacious premise.. ie. The idea that People always make rational decisions...
( Minsky was closer to the the mark with his views ).
The GFC showed this... like Balls on a bull...

Endogenus money supply growth in the hands of irrational Man...and you think one single key target is all a Central Bank needs..???/

The Management of a Monetary system by Central Bank is an evolutionary thing.... as is an economy..

Is the CPI really the best proxy for measuring the effects of increasing money supply, as it manifests and flows thru an economy..???.. ( In a Global world we can simply import greater quantities of consumer goods )
Maybe the CPI is a little bit redundant as a policy tool target....
RBNZ focuses on one single key target that might be somewhat redundant in todays Global environment...??? Now that would be head in the sand stuff...

Don't you think the GFC gave us cause to revisit first principles in regards to both Monetary and Fiscal policies... ??

by dictator | 2nd Aug 16, 11:51am 1470095467

For money supply growth to create inflation that money would need to go to those people with a latent need to spend. This is another way of saying if you give money to poor people they will spend it. They need things like food, clothing or to pay overdue bills or debts. If you give money to the rich they will tend not to spend it and are likely to invest it.

So what am I going on about? Look at how the new money is introduced into circulation. Due to the "printing" of money being privatised banks print the new money in the form of debts. Primarily these are mortgages. So if someone sells their home, they are presumably moving to another home. In fact one person I know received a substantial sum for selling their home and they will have a lot of money left over after completing construction of their house. What will they do with the excess money? They will invest it. So some of the new money will get into circulation but a large portion will go into purchasing investment assets, or will sit in term investments.

If you look at the construction industry the prices to get contractors to do work are inflating rapidly, the stock market is doing quite well, and there's a lot of money accumulating in banks. Where the money isn't going is to poor consumers, and it's not going to productive businesses in the form of loans.