Roger J Kerr questions how the Reserve Bank can keep missing its inflation target with no apparent ramifications

Roger J Kerr questions how the Reserve Bank can keep missing its inflation target with no apparent ramifications

By Roger J Kerr

The conduct of monetary policy management in New Zealand is under increasing scrutiny as the RBNZ do not appear at all concerned that they have been breaching the 1% minimum annual CPI limit for more than two years now.

Inflation has been below the 1% level due the high NZ dollar value (TWI Index) and the collapse in oil prices in late 2104 and again in late 2015.

Whether there should be any censure or consequence for the RBNZ for failing to achieve their sole objective is a moot point.

The Governor of the RBNZ is accountable to the RBNZ Board of Directors for everything including achieving the inflation target band.

The inflation control accountability and performance assessment is under the Policy Targets Agreement (“PTA” - clause 9 of the Reserve Bank of New Zealand Act 1989) the Governor signs with the Minister of Finance.

Bill English may seek the removal of the Governor (through the RBNZ Board under clauses 49 and 53) if the RBNZ is not doing its monetary policy job, the performance of the Governor in ensuring the Bank achieves its policy targets is inadequate and a Monetary Policy Statement is inconsistent with the PTA.

Note that the Act does not allow the Governor to be dismissed simply for failing to meet the policy targets i.e. missing the 1% to 3% inflation band.

The criteria in the Act refer explicitly to the performance of the Bank and the Governor in pursuit of those targets. Therein lies the rub.

It appears that the RBNZ are not censurable for being outside the inflation target band for two years. They only suffer some consequences for poor performance if they were slack in their attempts to achieve the targets.

Looking back on this year and the rise of the TWI to 78.00 that has kept inflation below 1.00%, you have to conclude that the RBNZ did not do enough the stop the Kiwi dollar’s rise in the middle of the year.

They would argue that they could not cut the OCR in May, June and July because the housing market was on fire.

The rebuttal to that argument is they were far too slow in tightening the LVR banking regulations on the residential property market, not acting until the Government gave them a boot up the backside in late July. An earlier LVR change would have allowed an earlier OCR cut.

The other contentious issue with the RBNZ’s performance is when is the allowance for “temporarily” being outside the 1% to 3% inflation target band is no longer temporary.

In most people’s mind “temporary” would be two or three quarters, not eight quarters.

However, it seems the RBNZ themselves are conveniently (and rather suddenly) taking a very liberal interpretation of “temporary” with eight to 12 quarters outside the 1% to 3% limit being acceptable in their eyes against the context of  20 to 30 year business cycles.

I cannot find any reference to 20 to 30 year business cycles in the RBNZ Act and PTA.

Habitual breaching of any financial limit should be a serious matter.

If an interbank FX dealer, or corporate treasurer or fund manager continually break their dealing/hedging/investment limits there are immediate and serious consequences i.e. being fired!

The Minister of Finance has asked for the RBNZ Board to report to him six-monthly on performance of the Governor.

Bill English should also be questioning the RBNZ’s current interpretation “temporary” in respect to their breach of the PTA and requiring a definition that can be communicated to us all.

It would be news to most that the RBNZ can breach their limit continually for three years (the last two years and the next year) and there are absolutely no consequences.

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Roger J Kerr contracts to PwC in the treasury advisory area. He specialises in fixed interest securities and is a commentator on economics and markets. More commentary and useful information on fixed interest investing can be found at rogeradvice.com

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46 Comments

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"Inflation has been below the 1% level due the high NZ dollar value (TWI Index) and the collapse in oil prices in late 2104 [sic] and again in late 2015."

What justice do you suggest we mete out to these traitors?

Burn Wheeler at the stake for not being able to control global oil prices?
Waterboard Grant Spencer for the heinous crime of failing to prevent other central banks from engaging in quantitative easing?

Maybe just fix the broken way that inflation is measured.

Exactly. Time to acknowledge that CPI is calculated incorrectly, and that the OCR has no bearing on Inflation.

Here we go, again..

Proven that it works yet?

No! didn't think so.

I don't need to.
The fact that 90% of the central banks in the world believe that expectations based monetarism is an appropriate regime, is proof enough.

Only 28 Central banks around the world target inflation. Of those, all (yes all 28) have failed to curb the current trend, and most have proven incapable of fixing any other issues identified with the current financial systems in place. So whatever they are doing clearly does not work.

To do it correctly you need to
a) Correctly measure inflation (i.e not just look at simple price rises of consumer goods), and
b) Implement more measures other than Interest Rates

Looking at the root causes of inflation, it would appear almost impossible to control without full blown state intervention in almost every aspect of daily life.

And how much of the share of the world's monetary system is controlled by those 28?
I did make up the 90% statistic, but that was laziness. I didn't think you would try to argue that the Sub-Saharan Africas of this world would have enviable monetary systems.

1 - What more do we need to do measure inflation? I mean we can include anything you want in there. It's just that you suggest illogical things. You talk about endogeneity in interest rates and inflation and then you suggest we include asset classes and capital costs in inflation measures.. I have no issue with changing inflation measure constituents, provided it makes sense to do so.
2 - The RBNZ has more tools than interest rates, alone, which it uses frequently. If you were a monetarist, however, you would understand the need for purity within the system. Increasing the constraints within any system is going to result in decreased efficiency. So no, more tools are not the answer.

"Looking at the root causes of inflation, it would appear almost impossible to control without full blown state intervention in almost every aspect of daily life."
That is just not correct. Read any of the sentiments of key monetarists and you will understand why. As I and other economic commentators have said on here numerous times; the fundamental issues lie with government policy mistakes, not monetary mismanagement.

Lol, ohhh thats a classic statement that one! Given not ONE of the central banks saw or predicted the GFC! Yet many who are not even economists ........DID!
Jezz, just give it a rest. I have watched and read your constant argument with Noncents and you have consistently failed to prove anything factual in the REALTY of real world economics, much like the central banks have. Blind leading the blind.

True, I'll give you that.
Lets face it though...Neither you or noncents prove anything, either.

Says you! Simple question: has ANYTHING the RBNZ done lately (like almost the past five years) actually proven to control inflation? Whether goods & service costs OR for that matter and most importantly ANY form of inflation?
I believe recently someone reiterated to you that the proof of failed central bank policy is in the actual economic results

"Whether goods & service costs OR for that matter and most importantly ANY form of inflation?"
Well, you can look for your self on that and see that we do have price inflation among our non tradables.

"I believe recently someone reiterated to you that the proof of failed central bank policy is in the actual economic results."
True. But all I see are policy targets missed (consistently) in 3 of the past 26 years of inflation targeting. That doesn't prove to me that the regime is as fundamentally flawed, as it does for you. I would call that a transitory thing but definitely not yet a failing in the way you would classify it.
What I also see, which you fail to, is that the issue of the missed targets doesn't fundamentally lie with the central bank, but more so central government policy.
I mean, you can argue what you will and by all means go for it. I only know what I have spent a long time studying and consulting on rather successfully.

Consulting on my a**! Lol. Mate all you know is that your central bank "idols" have failed miserably and are like you it would appear, too damn arrogant to admit it like a bunch of stuck up intellectuals who cant admit their entire education and claimed knowledge has been blown to smitherines! Thats the great thing about economic reality, it makes a mockery of those who claimed to be "economists". The failed experiments have gone global once again. Bring on NIRP & ZIRP all they like. It wont fix the fundamental flaws in their stupid fairytale models.

Wow, excellent rebuttal.
Well structured and definitely no sign of that trademark regression into personal attacks as a substitute for genuine intellect, we have come to know you for.
On a more serious note though, go back to your 99%'er parades and TPPA protests. That is where you belong, with the people who thrive on misinformation and misunderstanding.

Thanks. We? Really, Well perhaps you would like to elaborate on my and others 'misinformation and misunderstanding' of the current domestic & world economic issues? Cause most of us only see desperation from central banks trying to save some face and even failing at that.

I am starting get you now though. The very definition of intellectual narcissism we also see at the RBNZ.

Or maybe we be a bit pragmatic and acknowledge that, sometimes, greater forces are at play therefore
- i) any action we take is akin to pissing into the wind;
- ii) tinkering with definitions is delusional; and
- iii) models aren't always perfect predictors of global macro-economic events.

Exactly. Why is housing excluded, when the actual house itself is a depreciating asset, as are improvements. They need to include housing, and that should bump up inflation a lot.

The fact that housing is excluded is very convenient isn't it

I agree. Inflation is being under-reported. All the major asset groups are highly inflated and M3 is running around 5-10%. Plus there's already been 2 boom-bust cycles since the 90's and we're a long way up the 3rd.

http://www.interest.co.nz/charts/credit/money-supply

If the real inflation rate was reported, workers would demand pay increases to match, then even the CPI basket would start inflating, and interest rates would have to be increased.

The bias is always strong with Kerr.
He criticises the RBNZ for factors he willingly (or inadvertently) points out as uncontrollable.

EiIther interest rates work in controlling inflation, or the factors that govern inflation are uncontrollable.

What is it?

The issues we have are not with Central Bank policy, they are with Central Govt. policies.

So what you are saying is that the RBNZ can't control inflation, which means you are now contradicting your own comments the other day.

Regardless, the issue is with the fundamental logic and theory.

RBNZ has a mandate to control inflation,
They are meant to undertake this via interest rate changes.
The current economic theory being that interest rates control inflation.

If inflation targeting by central banks worked/works. Then only one conclusion can be drawn from the current global situation, and that is that it was deliberately managed to be this way.

As I commented in another article. Interest rates are nothing more than a financial theory that uses inflation as an input. Changing the interest rate has no bearing on inflation. If it did, we would be seeing changes to the inflation rate every time the interest rate changes. We do not.

What we do see is changes to the interest rate every time inflation changes. For something that is meant to be controlled, it seems a bit backwards to me.

No, what I am saying is that at every point we hear about the unfortunate case of the RBNZ and its inability to control inflation.
What we don't hear about is the mismanagement of central government.

In the case of this article we hear about the impact of low oil prices. Not how this is an artificial gaming of the system by OPEC.
We hear about record low interest rates, but don't hear about the huge incentive for arbitrage in property markets.
These are the factors that are killing numerous Central Bank's abilities to stimulate inflation, not the inflation targeting regimes.

"As I commented in another article. Interest rates are nothing more than a financial theory that uses inflation as an input."
Sure, I agree with that. But the theory has been put into practice quite successfully, you must admit. It's only in the last few years doubt has been cast..
To say that forward expectations of interest rates has no bearing on forward inflation however is a long shot.
"Changing the interest rate has no bearing on inflation. If it did, we would be seeing changes to the inflation rate every time the interest rate changes. We do not."
Nor would we expect them to in the short term - the one key factor you seem to miss. The idea of inflation targeting is for it to be a regime of smoothing the forward volatility in prices. This is something that we have categorically documented as a success over the past 25 years..
Sure, it could be coincidence or correlation. But, lets face it if it was coincidence, it has been a pretty monumental coincidence that a regime designed in the 30s and refined over 50 years before implementation was successful.

"Sure, I agree with that. But the theory has been put into practice quite successfully, you must admit. It's only in the last few years doubt has been cast.."

So it has taken a few years for the economists that developed the theory to realise they were wrong. Doubt has been cast since the beginning. Sadly the doubters weren't listened to then, maybe they will now.

"Nor would we expect them to in the short term - the one key factor you seem to miss. The idea of inflation targeting is for it to be a regime of smoothing the forward volatility in prices. This is something that we have categorically documented as a success over the past 25 years.."
So you are saying they targeted this period of long term (what is it now - 5 years) of decreasing inflation?
Or could it be that they have no control whatsoever and the theory is flawed?

"Sure, it could be coincidence or correlation."
Of course there is correlation, they use inflation rates to calculate the interest rates.
The theory implies it is meant to work the other way, it doesn't.

Growth, inflation, sharemarkets, in fact the whole financial system is ultimately based on Human psychology. Economic theory tries to remove the human from the system. Hence why throughout history, most (if not all) economic theories have failed when applied to reality.

But the whole Inflation targeting theory is that Interest rates control inflation.

Can we now agree that the theory does not work and that further measures need to be taken?

No need to be dramatic, just sack them.

If I was paid $500k a year and didn't do jack all my boss would sack me after a few months (if not earlier)... Wheeler has got away with it for over two years now. Where's the accountability?

Great, fire Wheeler - he must be useless if you say so.

I'd love to know who you'd replace him with - presumably you'd expect his replacement to:
- Demand the Saudis to turn the taps off and the US to stop shale exploration; and
- Call for central bankers to convene on Waiheke, then tell the Fed, BoE, ECB and BoJ they have their monetary policy settings all wrong and demand they cease QE.

Then we would have inflation and everyone would be singing kumbaya....

How about looking at it in terms of 'what use is a RBG who is not empowered to do what needs to be done'?
If you have a 500k a year employee, let him do his job, If he fails, replace him. IF however, you have not set him the 'A' in SMART goals then ask yourself why do you even have that employee? Disestablish the position.

A simple program written by a 9 year old could do a better job i.e. "if CPI < 2% cut OCR by 0.25%".

It's not rocket science.

Its not like it is massively outside the target. If inflation was running at 3.5% would you be so critical?
In fact he has probably run closer to target than any governor that I remember!

Is the RBNZ Governor responsible for the large number of deep pocketed immigrants and speculators that keep bringing in dodgy cash that keeps the NZD too high?
Step up ShonKey and Double Dipton for their help.

It would be news to most that the RBNZ can breach their limit continually for three years (the last two years and the next year) and there are absolutely no consequences.

Who officially censured Bernanke for this nonsense?

As then-former Chairman Ben Bernanke wrote in November 2010 explaining why QE2 was in his view necessary:

This approach eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action. Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.

You should notice the weasel word in his phrasing: “can” also spur spending. The reality is that economists don’t really understand how this might actually work. As with all statistically-based models, there wasn’t a whole lot of data to fill out all possible ranges of scenarios in order to produce truly robust models of correlations between asset prices and consumer spending under all conditions. Most of the econometric work was taken from the 1980’s and 1990’s where asset prices were rising and so was spending. Rather than view that as perhaps an accident of mere circumstances unique to those times, this “wealth effect” was instead, as usual, given status as a core economic “truth.” Read more

Like comparing apples and oranges.

Bernake had different targets (not just a fixed CPI target) and also pulled finger ASAP after GFC cutting fed rate to 0% and instituting QE. All this while the RBNZ procrastenated and even increased the OCR several times (while still missing its CPI target).

Incompetent apples and oranges, nonetheless.

Totally agree with the comments - the whole concept of a direct link between interest rates and inflation as measured has proven to be wrong.
We have inflation of the money supply running at over 10% of GDP/annum plus highly dangerous asset bubbles in property, shares and bonds. We have a global surplus of everything including labour and a government hell bent on exposing us to a race to the bottom through free trade and low quality immigration.
Inflation is not going to happen - nothing to do with Wheeler.
This is crazy stuff and even stranger that this same Roger was saying we need to raise interest rates a few months ago.

The question I ask if we see another drop in OCR and banks dont pass this on then what measures do they have then?

I think that banks are not willing to lower their rates anymore. We have only seen sub 4% rates for a short time and apart from HKSB no other players have offered rates below 4% even with the last cut to 2%.

If this happens the RB is out of bullets.

The growth in debt is also another factor in the inflation equation. As this grows there is less money to be spent elsewhere and on things that count to measured inflation.

While house prices have climbed we have seen debt grow and even with interest rates at extreme lows we dont see inflation growing.

The difference between this housing boom and the last in the mid 2000s is we are not getting massive real growth outside pop. increase and the government books are not getting substantially better.

Cant see where inflation pressure is going to come from?

From Bloomberg today....

http://www.bloomberg.com/news/articles/2016-09-25/a-weaker-currency-is-n...

"A weaker currency, once the cure-all for ailing economies around the world, isn’t the panacea it once was.

Just look at Japan, where the yen plunged 28 percent in the two years through 2014, yet net exports to America still fell by 10 percent in the span. Or at the U.K., where the pound’s 19 percent tumble in the two years through 2009 couldn’t stave off a 26 percent decline in shipments to the U.S. In fact, since the turn of the century, the ability of exchange-rate movements to affect trade and growth in major economies has fallen by more than half, according to Goldman Sachs Group Inc."

The author is pemanent supporter of low interest rate. Uses all arguments to support low interedtvrate specially before RBNZ is about to announce.

nzaki,

Wrong. Dear Roger used to be an ardent supporter of higher rates. He used to tell us that they would inevitably cause the $ to fall,thus leading to a veritable tsunami of inflation from higher priced imports.
I am not sure just when he had his 'road to Damascus' moment,but as is common with converts,he argues the case more vehemently than those of us who never believed him.
I am no great fan of Wheeler and I certainly don't think we need another rate cut. Right now,6 month deposit rates are the same as 5 year rates,so there is no yield curve. Rightly or wrongly,the market believes that there will be no hike in inflation and I think that's right. Deflation is the bigger worry. Watch China;if it has a hard landing as people like Rogoff fear, then even NZ's 'rockstar economy will not save the world from recession!!

china are heading down the age old trick of making a military event to take the focus away from domestic issues, same trick the USA as pulled for years.

they can never find inflation... because if they do they are supposed to raise rates... and they don't want to do that because they know that will be economic suicide. This is what the naysayers have said all along.. if the world economy is not a debt ponzi.. then global reserve banks should raise rates, what could be the worst thing that can happen? We are all rich countries aren't we, with strong financial systems?

Exactly. They are measuring inflation on consumables that actually drop in price due to companies doing thing more efficiently. If they measured it on everything, including housing, then they would likely have to raise the rates, which would increase the NZ dollar, and bring even more money into the country. Really the reserve bank has no control, as it is being controlled outside NZ by the debt mountain. At some stage it will burst, but until then, people will keep on buying houses and feeling rich.

Spot on Tim and Rob ... measuring inflation on consumables only and ignoring/ putting a very low weighting on housing (The biggest cost by far) may have made sense in the past however now days it does seem ridiculous.

Quoting inflation rate of close to zero when house prices are rising 15% a year...... if you were to design it from scratch I am sure you wouldn't get a figure of zero in today's market

Nice one Tim. You nailed it perfectly man

Kerr is a bond salesman, he needs declining interest rates to keep increasing the value of existing bonds. What is more amusing is that the "rock star economy" requires lower and lower interest rates, to remain a rock star.

The reality, IMHO, is that the NZ economy is driven by ever increasing amounts of debt, not productive investment creating well paying jobs. No bureaucrat can create an environment that increases productivity unless they reduce the number of bureaucrats and the cost of government. Governments consume wealth not create it. NZ has too many people that consume more than they put in. NZ is not alone with this problem, its the same across all western counties. I doubt we will see change without it being forced on us. No politician will carry off the change we need without loosing his job first, unless they can convince the greater population that we need a deflationary period and a write down of debts. I really cant see that happening. So we go on, debt increases, interest rates will decline. Who knows how it will end, but it will end badly.