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Roger J Kerr says New Zealand may have to lead the way again in abandoning arbitrary inflation rate targets, as that regime is no longer fit for purpose

Roger J Kerr says New Zealand may have to lead the way again in abandoning arbitrary inflation rate targets, as that regime is no longer fit for purpose

In a sharp turnaround from the direction and sentiment of just a week ago, the Kiwi dollar has commenced a fledgling recovery against the US dollar in currency markets. From a low point of 0.6275 on 3 September the NZD/USD rate has appreciated to above 0.6400.

The observation is that there are three prime reasons why the direction has reversed:-

  • The Kiwi was belted down to below 0.6400 on short-term speculative selling following a weaker NZ business confidence August survey result last week The NZD selling was never going to be sustainable, as behind the media headlines, it is well understood that the low business confidence index over the last 18 months bears no relation to actual activity levels in the economy (2.5% GDP growth, despite the trade wars). A good number of business folk are just frustrated and grumpy at largely Government sourced uncertainties around carbon emissions, immigration, foreign investment, employment law and regulatory b.s. The trade wars also create unknown uncertainties. Manufacturing and construction industry sectors currently have their challenges; however, the rest of the economy is performing very well in a very uncertain world. Just think what could potentially happen if the Chinese and Americans were to agree a trade deal? The Kiwi dollar would spiral three cents higher in my view.
  • The Aussie dollar has been heavily oversold against Australia’s improving economic fundamentals for some time now according to the writer. The FX markets have taken a while to recognise the change, however Aussie many economic forecasters remain in denial. As expected, the recording of a Balance of Payments Current A/c surplus for the first time since 1975 pulled the AUD out of its downtrend and has lifted the AUD/USD rate off lows of 0.6680 to trade up to 0.6850 currently. Australian GDP growth of +0.50% for the June quarter was bang on consensus forecasts and prevented any disruption to the AUD rebound. The external Current A/c surplus as at 30 June 2109 was forecast to be A$1.5 billion, it was nearly A$6 billion, emphasising the boom in AUD export prices and volumes in their mining/resources sector. The renewed Aussie mining boom will not fizzle out anytime soon as China provides further monetary and fiscal economic stimulus for infrastructure spending to offset trade tariffs on their manufacturing export industries. From being an “out of favour” currency only a few short months ago, global forex markets will progressively change their tune towards the AUD as they see the superior economic performance compared to other currencies. The Kiwi will continue to follow the AUD higher. A move above 0.7000 in the AUD/USD exchange rate would break out of the downtrend line the AUD has been under since 0.8100 in January 2018.
  • Scheduled face-to-face US/China trade negotiations being confirmed as back on again and a weaker than expected August US jobs increase of 130,000 have both weakened the US dollar on global FX markets. Further USD losses can be expected over coming weeks as the Fed cut interest rates on 18 September. Fed Governor Jerome Powell in a speech has reiterated that they need to “sustain the economic expansion”.

Local USD exporters have had another golden opportunity to increase long-term currency hedging percentages at very profitable levels. Doing nothing and hoping the Kiwi dollar will always go lower would border on speculating with the shareholder’s profits!

Is inflation targeting now counter-productive?

New Zealand led the world with its innovative inflation targeting regime by our Reserve Bank in the late 1980’s.

We needed to get persistently high inflation down in our economy as it eroded the value of our savings and our spending power.

Having a clear inflation target of 1% to 3%, and then pulling the interest rate lever that in turn influenced the NZ dollar exchange rate up and down worked successfully in changing economic conditions and behaviour to drive inflation down and to keep it down.

Well, it worked successfully up until 10 years ago, when the technology innovation revolution started.

The technology revolution has driven all sort of prices down for goods and services across the globe.

Instead of managing monetary policy to keep inflation low and steady, we now have central banks moving to negative interest rates and printing money by buying securities to push inflation upwards (to achieve their official, but arbitrary inflation targets).

Unfortunately, the technology revolution just counteracts any price inflation caused by increased demand from the monetary stimulus.

It is well past the time that someone said “stop the stupidity” with the outdated inflation targeting and we all accept the fact that 0% inflation is great (what is magical about 2% inflation anyway?) as long as you have positive GDP growth.

Standards of living decline when you have negative growth and deflation, but that is not the current situation.

The industrial revolution in Europe in the 19th Century caused deflation, economic growth and increased standards of living. The technology revolution today is doing the same, we should embrace it as we are all better off.  

Slashing interest rates to zero may have been justified for a period immediately after the GFC to get the world economy going again, however that it not the case now.

Today a zero price for money is having unintended negative consequences:-

  • Savings and pension funds previously reliant on fixed interest yields for low-risk income/cash returns will now have the zero investment yields causing hardship and failure.
  • Speculative asset bubbles (property and shares) are likely as borrowing costs to punt on asset prices increasing are negligible. Risk/reward investment equations are completely distorted.
  • As debt costs are so much lower than the cost of equity, marginal manufacturing capacity has been added around the world and that in turn drives end-product prices down (the opposite of what the central bankers intended).

New Zealand may have to lead the way again in abandoning arbitrary inflation rate targets, as that regime is no longer fit for purpose.

The technology revolution is a game changer for traditional monetary policy management, we just need to recognise it and stop holding on to outmoded conventions.


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*Roger J Kerr is Executive Chairman of Barrington Treasury Services NZ Limited. He has written commentaries on the NZ dollar since 1981. 

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.. what is magical about 2 % inflation Roger , is that it gives the government a nifty way to deflate their debt in a sneaky manner over a long time frame ... inflation being the hidden tax that ultimately undermines savers hoards of term deposits...

Another reason is to prevent hoarding of cash if the inflation rate is too low or negative, an economy is spending remember. Depressions are caused by deflationary spirals when it becomes a good investment to hoard cash and it's all in too few hands.


So much better to steal the savings from pensioners by stealth? Recessions are caused by asset bubbles deflating. Borrowing and spending to soften the downturn is fine, but emergency response tends to become long term policy, turning recessions into depressions or stagnant, long term decline. Why else do you think the West is declining? Inflation causes our best minds to work on gaming the system, rather than increasing productivity.

If you want to hoard, buy gold if you don't like inflation. Fiat currency is the lubricant in the economy and old people hoarding it stalling the economy is pretty negative. I'm shocked at the economic illiteracy of all the upvoters of your comment. What good is hoards of cash if you run your society into the ground.

Oh no technology makes goods cheaper! Sounds terrible! I'm yet to meet a household with no TV as they're waiting and waiting for some amazing new model that'll be half the price. Goods these days are disposable or have planned obsolescence - again technology being a great example. Maybe just maybe ideas around inflation targeting are outdated eh.

1. There are in now in excess of 15 trillion bonds with negative yielding debt. This did not happen just last night.
2. The ANZ business survey occurred on August 29, that is the previous week to which is stated. The NZD/USD barely moved.
3. The NZD was at the thick end of multi year lows against multiple currencies following Mr Paddles ( I mean the committee ) cutting of the OCR by a third. It was due a bounce, it will retest .
4. ANZ , the much loved institution, has slated three OCR cuts for both Australia and New Zealand by mid 2020, not reflective of strong economies.
5. New Zealand's economy could not sustain a meaningful increase in the OCR . See point 4.

Interest rate cuts do not increase bank credit creation, because they do not increase, and presently even reduce, the bank credit supply capacity. Credit demand is irrelevant, as the restricting factor in the bank credit market is always credit supply. Link


Our empirical study found that interest rates lag and follow economic growth, being Granger-caused by it. Which is probably why the Department of Commerce in the US has been using rates as a Lagging Indicator. Link

“Interest rate cuts do not increase bank credit creation, because they do not increase, and presently even reduce, the bank credit supply capacity. Credit demand is irrelevant, as the restricting factor in the bank credit market is always credit supply.”
So if our interest rates wouldn’t have dropped since the 80’s would house prices be what they are now? We know the answer is no and key here is that when a bank makes a loan, they create “credit” this increasing the money supply. Lower interest rates = higher house prices = higher loans = higher bank credit creation = higher credit/money supply. It’s one lovely self reinforcing circle (or spiral rather).

You have to admire Roger really - Hedge now he says and probably not without reason as the Kiwi is at the bottom end of it's recent trading range and heaviliy oversold.

Not to sure if I would be comfortable or happy to receive heding advice from him as he appears to only be a Kiwi Bull - which is interesting in itself given ANZ's recent call that we could well be at a cash rate of 50bp in the not to distant future - will our currency be very attractive at that level of return for foreign investors given the small scale of NZ?

Who knows - given the current world, we could finish the year with the Kiwi at sub 60 or over 70 given the crazy world we are living in.

Who knows - given the current world, we could finish the year with the Kiwi at sub 60 or over 70 given the crazy world we are living in.

Yes, Who knows. Anyway, the carry trade was the key driver of NZD, not the "greatness" of the NZ economy.. As long as the differential remains attractive, NZD could be higher than some would expect.

"0% inflation is great as long as you have positive GDP growth"

What does our GDP per capita growth look like once adjusted for inflation? Its flat, not positive and lags behind the OECD average.

GDP growth by anyone measure is a poor measure of the performance of an economy, particularly for a country in love with immigration like NZ.

couldn't agree more. now that most of the western world seem to have adopted a similar monetary policy, and are grappling with the same issues, it appears that there are structural factors at play. to me it seems pretty obvious that to entice high paying jobs, and industry NZ needs to adopt much low tax rates to be competitive. If we don't we will just continue to sell high price houses to one and other and pretend we are getting rich. And for all those naysayers that point out the bleeding obvious immigration pressure, and infrastructure well that is something that we need to grapple with. If we don't adapt then we run the real risk of becoming a banana republic. This is becoming more evident with the continued attacks on our primary industry (agri) by the current government who are bashing the farmer at every opportunity

At what point do we question the story of "getting rich", of what being rich is?

For once I agree with Roger re inflation targeting. However... 0% inflation is massively inflationary. Because of course the story of humanity is consistently advancing and being able to trade more for your hour of work than ever before. So naturally we should always have deflation. A dollar today should buy far less than a dollar could in 20 years, or to take money out of equation, an hours work today traded for goods today vs an hours work in 20 years traded for goods in 20 years. Any deviation to this law is someones snout in the trough.

Regarding the technology revolution of the last ten years depressing prices... often hear this but is this then not the definition of productivity gains? And have we had an acceleration in productivity, as I never hear that said. I think we should have had given the internet, however any productivity increase from the internet has been stolen from us via socialism by stealth, huge increases in public service in local and central government when it should be less. Think about this. Subdividing a 100 acre farm in 1994 compared to now. In '94 it was all brown manila folders getting transported round town for the paperwork, manual surveying using sticks with wheels and trig instruments, phone calls, letters... Now every single part of that subdivision process is perhaps an order of magnitude easier and faster. But... to do that subdivision today would require far more hours of work to be traded for those services (i.e. cost far more). How is this possible? Too many snouts in the trough. It's the same pre 1984 b.s but by stealth.

At what point do we question that story of humanity? Consistently advancing and trading to what ends? Productivity to what purpose and whose benefit?

After the monetisation of human relationships and needs, inflation is also the addition of a multitude of products and services plus price increases. Measuring tools have simply not captured this to give a true measure of inflation over time.

Well said

"we all accept the fact that 0% inflation is great"
Roger, inflation is need to erode the gargantuan debt which has no chance of being repaid, it can only be deflated over time by inflation

Wrong. Private debt has been extinguished in Japan without inflation. Debt has been transferred to the public sector. Asset prices have deflated over time.

How has private debt been transferred to the public sector in Japan JC ?

At what point do we question this as a false truth? As a lie we have been conditioned to, to continue accepting more debt?

It doesn't work if debt continues to increase over and above "inflation". The problem is the inflation of debt. There is no money supply, there is only the supply of debt.

This is where the theory of thinking that houses are fairly priced becomes unstuck.

This is a very simplistic analysis of a deeply complex topic. Few central banks target inflation exclusively today, even the RBNZ has updated the PTA to include employment now. In an open economy, the term structure of NZ's interest rates is heavily influenced by our trading partners and G10 counties. To maintain high rates = over valued currency and an imbalanced economy/recession. Yes technology has enabled significant deflation in tradeable goods and this has been offset by inflation in non-tradeable goods. I don't see an alternative that isn't a massive societal experiment so it will continue.

I don't see an alternative that isn't a massive societal experiment so it will continue.

Hmmmm... In a recent comment I noted the following in response to the authors claim:
Falling expectations of inflation pointing to a need for further stimulus from the Reserve Bank?

Repeating the need for further "stimulus" wont resolve the fact that cutting interest rates and engaging in QE type assets swaps with banks doesn't make the latter's shareholders authorise their employees to extend copious credit beyond those with pristine credit scores and unencumbered collateral. In fact:

The reason the bond market isn’t pricing in a resulting burst of inflation is because the banks buying the balance sheet tools in the bond market (and maybe gold, too) know from experience and practice central banks are incapable of creating inflation. That much has been fully established by the last twelve years. The fact that central bankers don’t know it yet further strengthens the case; they’ll try and simply repeat the same failures even if they go full BoJ QQE shock and awe. Link

Your point eludes me entirely. Why don't you research the economic performance of non-inflation targeting central banks and let me know what you find.

My experience is limited to time spent at a G-SIB US Primary Dealer bank and I stand by what I say without recourse to other regimes and their practices.

Surely all that matters is inflation in food, housing and public transportation. Time to change the 'basket' to simple essentials.

Kate - for my understanding, how do they currently measure housing costs? Is it the capital value or the mortgage/rental cost? If its the latter, the number/strategy doesn't make any sense as its the tale wagging the dog (or vice versa) and inflation targetting becomes meaningless.

Doesn't inflation from a historical perspective relate to money supply? So in theory, during the period that we've been flooding the markets with QE money, we should have been pushing interest rates up? And when we see the largest cost for any consumer (housing) has been skyrocketing, shouldn't we have been putting up interst rates to limit money supply to reduce inflation in that asset/consumer cost? Is everything back to front since GFC?

Here's their explanation of housing costs calculation methodology;

The coverage of owner-occupied housing in the HLPIs includes mortgage interest payments and a link to market-value property prices. This treatment aligns better with the inflation experiences of owner-occupier households. Excluding these in the CPI – which instead tracks the cost of purchasing new dwellings (excluding land) – is a design choice that aligns with the CPI’s principal use for monetary policy purposes. Given that the CPI helps the Reserve Bank set the Official Cash Rate, including interest payments in the CPI would introduce a circularity to this measure.

Clear as mud, eh?

Two months ago Mr. Kerr was confidently predicting "further gains above 0.68 seem likely". What followed... well, six consecutive weeks of NZD losses averaging over 1.25% per week. If you were a business that had hedged at 0.68 based on Mr Kerrs advice, you would looking at quite the loss. His NZD perma-bull status remains despite data to the contrary. At some point, one should expect a bounce from an extremely over-sold condition. The question is whether it is dead-cat, or a change in trend. Back when the exchange rate was bouncing around 0.68, my wife suggested we transfer some USD to NZD before NZD appreciated further. My comment to her was that NZD would see 0.60 before it sees 0.70. I've still yet to be proven correct, although at this point 0.60 appears to be much more likely than 0.70 based on the mid-term trend (as well as the underlying fundamentals at play currently).

That said, I agree that the inflation (and growth) targeting is something that should be changed in the very near future. At some point one needs to start working towards a sustainable economy instead of continuing to push the endless growth economy. One cannot have endless growth in a finite world. Either the targets will get changed, or there will be some serious crises will happen while the knobs get turned to 11 without any positive effects.

He has what's known in the industry as "non-trivial negative predictive ability".

Agreed, although I think I’d bet on 0.55 before .70 in the next couple of years. Time will tell.
As for inflation targeting and setting interest rates, don’t hold any hope for getting back to market driven rates, which would bring things back into a far greater balance. Why? Governments everywhere are the world’s biggest debtors and growing at a rapid rate. What chance is there of them allowing central banks to raise rates? Zero is the correct answer. People can harp on about CB independence, but the reality is something else altogether. When confidence in govt collapses then the system will crash.

Inflation targets are just a fig leaf for looser and looser monetary policy central banks are reaping what they have sown. It will ultimately be used to justify putting cash directly into individuals and businesses bank accounts to buy stocks and Government debt etc.

There is nothing wrong with inflation targeting. It doesn't need to be removed.

In NZ's case its the very high immigration % rate driving real interest rates higher (need for capital to build infrastructure) & the high real rates pushing up the exchange rate.

In the case of the US, Europe, China, & Japan they have very high debt levels meaning the world is awash in money & its value is low & thus so are worldwide interest rates

All very interesting chaps. thank you. A couple of points from my car in the corner:
I've already lost confidence in our government - this happened in the year 2000. Everything since has been b.s. The cost of money has been devalued so much that in asset (read house) terms - I can still (just) remember buying one at $20 something thousand dollars, now I can get one for $2 million. Sure, it's a nicer house but hey, I've earned it. Point being that in my working lifetime what I can buy with my single dollar today is 100 times the less (albeit nicer) than 50 years ago. To me that's a simple 100% inflation (or dollar deflation if the dollar buying power is your start point) which is a flat 2% pa. Simple math I know, but one I can understand.

100% inflation doesn't mean the prices increases 100 times LJM

To get a 10x gain in 50 years, you need an average annual gain of 4.7%. To get a 100x gain in 50 years, you need an annual gain of 9.7%. a 2% gain gets one a 2.69 gain (169% gain).

This is an interesting illustration of the magic of compounding gains, as well as the huge benefit of getting a higher return over a long period. Doubling the interest over a 50 year time period results in a 10x increase in return.

Back to the basics of the LJM post. There was huge inflation in the '70s and '80s, which seriously eroded the value of the currency here in NZ. Look at the average wage back then vs now. Fifty years ago, "The average wage for full-time employees (including overtime and bonuses) at the end of 1969 was just under $50 per week (equivalent to just over $800 in 2018)". It is a bit more difficult to discern the shift in average purchasing power. Look here for a real home price comparison: This shows that the real house price fifty years ago was about half of what it is in NZ currently. Due to the change in interest rates from then to now, a house 50 years ago had similar if not higher mortgage cost than the modern equivalent has. This is in opposition to many of the comments made on this site. I'd suggest that the value of the average house now is far higher than the house of 50 years ago, and for good reason. The modern standard has more sq meters, higher insulation and higher quality fittings, etc.

Couldn't agree more Roger. But if the 2% goes, what other "tools" do you think will be employed to chip-away at the world debt mountain? Because the sole purpose of the 2%, as small as it may sound, is to inflate away a little of the debt created by our banking system - a losing battle anyway!

How about an interest rate increase? That will result in loan defaults for the borrowers that cannot find an appropriate level of return along with a reduction in return to the less prudent lenders. There have been too many borrowers in the last few decades that should not have received loans (and lenders that were entirely irresponsible in lending). There were many tens of millions of inappropriate borrowers in the US a dozen years ago for example. The lenders should have gotten flushed out of the system due to their folly of lending to anyone that was capable of breathing. Those borrowers ended up mostly losing everything (which is appropriate). The lenders on the other hand got bailed out, which is entirely inappropriate. At some point the system needs a reset. Typically, a recession clears out the low performing entities. The last couple decades, the low performing entities have mostly gotten a hall pass instead of a red card.

The argument is academic ...........there is no inflation ( to speak of ).

I firmly believe we are in a deflationary cycle , and the Stats are being fudged to hide the truth