It was the inevitable discussion we were going to have at some point.
And right now the clock seems to be ticking loudly, suggesting that the point has been reached for us to have serious conversations about whether an out and out focus on targeting low inflation is still the right way to steer our economy.
We've been doing this for over 30 years now. Squeeze the life out of inflation and all will be well. It worked, until Covid broke everything. Can we assume that carrying on as before will now work again in the future?
Can we still assume that dogmatically insisting that our inflation level must be 2% is the right way to go? Will inflation globally ever quite 'behave itself' again in the future as it has in the recent past and are we going to visit upon ourselves unnecessary hardship by trying to insist that the future (for inflation) will be the same as the past was?
Enormous issue, potentially, and with our interest rates having been cranked to pain levels (Official Cash Rate hiked from 0.25% from October 2021 to 5.5% now) to fight inflation, people want to know when and where the relief is coming from. What if inflation doesn't just jump obligingly back into its 2% box?
Reserve Bank (RBNZ) Governor Adrian Orr seems set to take the bull by the horns - I suppose in fairly typical fashion - by using his upcoming speech to the high powered 2024 New Zealand Economics Forum at the University of Waikato on Friday, February 16 to outline why the RBNZ "continues to believe that a flexible inflation target centred on 2% still makes sense".
To give some perspective, it may seem odd to say it, but based on the RBNZ's own back-record of official speeches, Orr doesn't publicly speak in this country on nuts and bolts monetary policy very often - not outside of the fairly controlled agenda of the Official Cash Rate (OCR) announcements.
I reckon you can pretty much say the last time Orr gave a public address focusing strictly on monetary policy was at the same Economics Forum two years ago when he talked on the subject of Tackling Inflation During a Pandemic.
This tells me that Orr and the RBNZ folk see questions around the inflation targeting as a hot issue and they are suspecting they may need to play a front-running role in order to maintain the inflation-busting, monetary policy, status quo into the future.
So, Orr is picking up the baton for a discussion/fight that may be about to begin. Seemingly at this stage the RBNZ is looking to defend the current inflation targeting approach and sees no reason to change. But what will the Government think? This may well be why the RBNZ is attempting to pre-empt discussion.
Monetary policy as we know it today started in 1990 with the first Policy Targets Agreement signed between the Finance Minister and RBNZ Governor. That first PTA defined 'price stability' as achieving an inflation rate of between 0% and 2%.
In 1996 the inflation target was broadened to 0% to 3%. Then in 2002 it was narrowed to 1% to 3%.
And finally in 2012 an explicit focus was given to the 2% mid-point of the 1% to 3% target range.
The RBNZ explains the rationale for this change, thus: "This was important to anchor inflation expectations to 2%. Without a mid-point target, inflation expectations may float to either end of the 1% to 3% band, depending on the economic outlook. In practice, we were already point-targeting 2% inflation, but formalising it in the PTA had a stronger effect on anchoring inflation expectations."
That 'explains it' I guess. But it's still just a figure that someone has hit on and decided it's the one to run with.
In the meantime, we've had revamped RBNZ legislation that has included the setting up of the RBNZ's Monetary Policy Committee and with the inflation target included in the committee's 'remit' - replacing the PTA. In 2018 we had the inclusion in the monetary policy target of 'maximum sustainable employment' alongside inflation targeting. The new Government has removed that in favour of a sole target on inflation again.
Annual inflation measured by the Consumers Price Index was 4.7% as of the December 2023 quarter, down from 5.6% in the September 2023 quarter. As of its most recent (November 2023) forecasts, the RBNZ was seeing inflation getting back into the 1% to 3% range by the September 2024 quarter. But rather crucially though, the RBNZ's not forecasting achieving the 2% holy grail till September 2025. Long time.
That is a very long time. And patience may have been well and truly frayed long before then, from the markets, the public and maybe the Government?
In a recent speech, the RBNZ's chief economist Paul Conway made the comment that global supply shocks "could become larger, and more frequent and persistent".
Typically the RBNZ like other central banks around the world has tried to 'look through' such shocks, meaning that they won't start hiking interest rates because the shocks will be short lived. This didn't work too well in the aftermath of the pandemic and the multitude of supply chain shocks.
Conway posed the question of whether ‘looking through’ these shocks is still appropriate.
"In what circumstances should monetary policy respond to bring demand back into balance with supply? And what are the implications of inflation expectations?"
This is significant stuff, as it brings us to the whole (rather arbitrary) split between the so-called 'tradable' (read 'imported') and 'non-tradable' (domestic) inflation. This, as I say, quite arbitrary split, between domestic and imported inflation, is set to take a central role in the debate about whether there's a better way for us to be targeting inflation.
In that last CPI figure for the December quarter the 4.7% annual inflation figure was actually comprised of a 3.0% (and dropping like a brick) 'tradable' figure and a 5.9% (and sticky as hell) 'non-tradable' figure.
The RBNZ is going to get more and more scrutiny for its targeting of the 'non-tradable' figure. Let's face it, this is a debatable figure. How do you truly differentiate a price rise domestically if it has, when push comes to shove, been prompted by higher fuel prices?
The reality is that in the recent past prior to the pandemic our domestic inflation was much higher than imported inflation. Often, as globalisation did its thing, we were actually importing DEFLATION, which masked somewhat higher local costs.
As one instant example, the annual inflation rate for the March quarter 2020 - the last pre-pandemic figure - was 2.5%. But the non-tradable rate was actually 3.4% - so outside of the RBNZ's 1%-3% range and well above the explicit 2% target.
I think there's every reason to believe that we can't rely in future on importing low inflation from overseas. If our domestic inflation therefore settles at levels above 3% like previously, what happens?
By implication, the RBNZ will be forced to keep interest rates up.
Maybe the RBNZ would not mind that.
There's no doubt that the interest rates currently prevailing ARE reining in the normally un-rein-in-able housing market.
Interestingly the RBNZ last year circulated a discussion document raising the prospect of using higher interest rates to specifically control house prices, while earlier RBNZ research highlighted how pre-pandemic, NZ had among the biggest house prices rises in the world - along with one of the highest rates of population growth and one of the biggest falls in mortgage interest rates.
It seems clear the RBNZ wants to keep interest rates up till it has got inflation where it wants it.
Trouble is, you can't say with confidence that magic 2% will be achieved. In the meantime, what's going to happen when our wannabe house buyers and mortgage holders see overseas countries starting to get interest rate relief, when maybe they are not?
As housing-centric a government as this one will surely show itself to be, is not going to tolerate that for too long.
I can see the logic in an arbitrary inflation target, because if you don't have a properly set target level it's too easy to let things slip.
But equally, I think the RBNZ's going to struggle to justify that 2% figure. Why not say give the RBNZ a straight target of keeping inflation under 3% - or even a figure slightly higher than that? The 'old days' with inflation of the recent past are not the 'new days' I fear.
By trying to achieve the unachievable - as arguably we might be now - we could just be inflicting unnecessary pain on ourselves.
Let the conversation/debate/argument begin.
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