It is widely recognised that inflation can be either cost-push or demand-pull. It is also widely accepted that inflation expectations influence both purchase and pricing decisions, with this feeding back at a macro level to self-fulfilment of the expectations.
These explanations, despite being correct, are superficial.
Simply knowing that the above explanations are true, in itself does very little to help policymakers prevent inflation. If the solutions were simple, we would not be in our present New Zealand situation with inflation at three percent per annum despite a stagnant economy.
Three percent per annum of compounding inflation does not necessarily sound very much. However, it means prices double every 24 years. In 100 years, prices increase 19-fold.
In the last five years since September 2020, our inflation rate, using official CPI data (Reserve Bank series M1), has actually averaged 4.6 percent per annum. This is despite the Reserve Bank mandate to keep inflation between one and three percent in the medium term, with a specific focus on the midpoint of two percent.
During this latest five-year period, non-tradable inflation has averaged 5.2 percent and tradable inflation has averaged 3.8 percent. This difference, particularly given that it has been a period when the exchange rates were overall in decline, tells us very firmly that we cannot blame our problems on the rest of the world. We have been creating most of the inflation problems ourselves through domestic inflation for items in which there is no international trade.
Looking back over the two preceding decades, a similar picture emerges. Non-tradable inflation averaged 3.2 percent while tradable inflation averaged only 0.8 percent.
During those two earlier decades, overall inflation at 2.2 percent was close to the target midpoint but it was only because tradable inflation was exceptionally low. A lot of that low tradable inflation was thanks to what was happening in China, our most important trading partner.
Out of curiosity, I used the RBNZ inflation calculator to tell me the extent of consumer price increases in New Zealand between the start of Year 1900 and the latest price levels in 2025. I found that consumer prices have increased by a factor of 123 over that time. In other words, what could be bought with New Zealand’s one-pound note in 1900, would now, in 2025, cost $246. That works out to a compound rate of inflation of 4.3 percent annum.
Given that our rate for the last five years through to September 2025 averages 4.6 percent per annum (as reported above), compared to this longer 125-year rate of 4.3 percent, we don’t seem to have got any better at inflation control!
We can call it ‘money creation’ or some other term, but the bottom line is that one way or another a lot of money has been and still is being created. Of course, in recent and current times there is no need to print physical money. Instead, it can be done with digital key-strokes.
I have no argument against the need to create money in the presence of a growing population in a growing economy. That would be a silly argument. But have we consistently overdone it as short-term political expediency?
In recent months, I have spent considerable time bringing myself up to date on monetary economics- thinking, searching for a path forward. This journey reflects that although I have at times been using macro-economics in my work, it has been a long time since I studied monetary economics in a formal setting. In the meantime, monetary economics has got a lot more complex.
Currently, conventional economic wisdom says that inflation is best controlled by adjusting interest rates. In New Zealand, we use what is called the Official Cash Rate, better known as the OCR, as the key tool. The OCR was first introduced in 1999.
This current focus on interest rates is in direct contrast to most of the last two decades of the 20th century, when the dominant theory influencing macro-economic policy across the Western World was that the answer lay in directly controlling the supply of money.
My own conclusion is that neither of the above two approaches as applied in the past, nor the preceding mantra of Keynesian thinking, by themselves provide a sufficient pathway to the ever-changing future.
What became very clear during my recent investigations is that what works during one period of history does not necessarily work at other times. There are very few absolutes in relation to monetary theory. Macro-economic theory-building is a pragmatic journey of what seems to work within changing institutional frameworks and changing behaviours. More on that later.
The first question to put to rest is the notion that inflation does not matter very much as long as incomes rise at no less than the rate of inflation. The answer is that inflation, even at rates of around three percent per annum, is distortionary. It leads to bad investment decisions. More too on that later.
Of course, there are both winners and losers from inflation. That is part of the reason why it is so hard to control. Many individual fortunes have been made on the back of inflation, with property ownership and associated financial leverage from borrowing being of fundamental importance.
Conversely, I am confident that there has never been a billionaire who got there by saving money in the bank.
Failure to get on the first step of the property ladder, often linked to an inability to access a Bank of Mum and Dad to get started, lies at the core of the increasing inequality that we have seen in New Zealand.
Some History
If we go right back to the 19th century, there was minimal inflation in those times. The key western countries used a gold standard. The world economy was growing but so was the quantity of gold, and hence the quantity of money was increasing.
It may have been a matter of chance rather than purposeful policy, but in those days, prices did stay relatively stable. At times prices did increase a little, and at other times they decreased a little. This linked to the specifics of what was happening with gold supply relative to innovation-led economic growth.
Then everything started to change with military mobilisation across Europe preceding the First World War. Britain left the gold standard in 1914. This allowed the printing presses to churn and fund the War effort. Similar events happened in many parts of Europe, with Europe at that time the centre of the World economy.
Once the First World War was over, the additional money was available for consumables in what became known as the Roaring Twenties. German hyper-inflation in an environment of war reparations was the ultimate illustration at that time of what could go wrong with money-printing.
Then came the Great Depression starting in 1929. The key insight from those depression days was that full employment does not occur naturally in a capitalist economy. It needs help from the Government to reduce oscillations in the business cycle.
Keynesian Thinking
The solution that then took hold across the Western World was underpinned by Keynesian thinking with the English Lord Keynes leading the charge. He enunciated and popularised the importance of fiscal policy together with direct creation of employment by Government.
Keynes argued that job creation, funded by Government borrowing of money, would shift the economy to a higher level. The increased economic activity would provide the necessary income to repay the borrowed money.
Keynes was less forthcoming about where the borrowed money should come from, but he clearly understood that simply printing money was highly inflationary, and that an unconstrained ‘money- printing’ policy did not provide a long-term pathway. At times he was specific that funding should come from increased taxes. At other times he argued for reduced taxes.
So-called Keynesian thinking had fully taken root across the Western World by the time of the Second World War and it lasted as the dominant economic paradigm through until the 1970s.
In New Zealand, Keynesian policies were de facto used as the dominant economic paradigm through until the mid-1980s and the arrival of Roger Douglas as Finance Minister in the Lange Government.
However, I doubt if Keynes himself, who died in 1946 at age 62 from a heart attack, would have agreed with a lot of what subsequently became known as Keynesian economics. Keynes’ focus was on business cycles and how to minimise recessions and avoid depressions. Long-term priming of the pump is another matter.
The term ‘money printing’ had yet to develop as a pejorative term in Keynes’ time. The euphemistic term was ‘deficit funding’. Although some of this deficit funding could come by borrowing from the private sector, a government could also borrow from its own central bank.
The consequent assets and liabilities from governments borrowing from central banks sat on the balance sheets of these governments and central banks, but did not necessarily have to be repaid. Governments could, if they chose, simply wipe off the debt, given that in those days they were the full legal custodians of their central banks and hence operated on both side of the transaction.
To clarify the point, in those times there was no such thing as central bank operational independence. Central banks did whatever the Government told them to do. More too on that later.
Coming back to the years of big deficit funding by politicians in New Zealand, it was the Muldoon years of 1975 to 1984 when inflation really took off. The compound rate of inflation in those years averaged 13 percent per annum. This caused prices to treble over the nine-year period. However, it could well be argued that the pump priming was already well under way in the preceding three years of Norman Kirk and Bill Rowling.
It was a global phenomenon but New Zealand fared worse than many other OECD countries.
1984 and Beyond
Everything changed within the New Zealand economic scene following the election of the Lange Government and the appointment of Roger Douglas as Minister of Finance in 1984. It was a time of tough economic medicine. There were six years of neo-liberalism under Douglas, with policies known colloquially as ‘Rogernomics’, followed by three years with Ruth Richardson as Minister of Finance, with similar policies known colloquially as ‘Ruthanesia’.
Starting in late 1984, the dollar was floated, import restrictions were removed, tariffs were removed, and union power was constrained.
By late 1991, inflation was down to one percent per annum. However, unemployment reached a peak of 11.2 percent in September 1991, which tells something of the cost of bringing inflation under control.
Whereas Keynes had been the international economic standard bearer from the late 1930s through to the 1970s, for much of the next 20 years it was Milton Friedman’s monetarist polices that represented dominant economic thinking.
Fundamental to Friedman’s monetarist thinking was the notion that, if inflation were to be prevented, then creation of money needed to be constrained tightly and in balance with real levels of economic growth.
To achieve long-term economic stability, Friedman was explicit that this growth in money supply should itself be stable and not chasing short-term business cycles. Key mechanisms could include key-stroke money creation, or various credit controls imposed on banks. However, these mechanisms had to be tightly constrained and set in accordance with long-term growth prospects for real economic growth.
One of Friedman’s enduring quotes is that inflation is always a monetary phenomenon. He pointed to the classic quantity of money identity that:
MV = PY,
where M is quantity of money,
V is velocity of circulation,
P is prices (nominal), and
Y is production of goods and services.
This relationship, being an identity relationship that can be considered a truism, had been known for several hundred years. I recall being introduced to it in Stage 1 Economics in the late 1960s.
It follows that if both V and Y are fixed at any point in time, then prices must be directly determined by M, the money supply. Accordingly, Friedman’s focus was on M, the quantity of money, with this being something governments and their central banks could supposedly control through a mix of regulations and direct control of money creation.
In practice, it did not work out quite as simply as what Friedman suggested. As the financial world got more complex, it became harder and harder to decide exactly what was and what was not money. Aligned to this, the velocity at which money circulated, for example whether consumers spent money or saved money, was clearly not constant. International money flows were another complicating factor.
This highlights that an identity relationship that holds by definition does not necessarily lead to simple equations. In the case of money, all four terms in the identity relationship are variables with complex interactions. None is a constant.
Specific Inflation Targets
New Zealand was at the forefront in the late 1980s of setting a specific inflation target, which was initially proclaimed by Finance Minister Roger Douglas as ideally being between zero and one percent, but then set at zero to two percent. Then in 1996 it was reset at zero to three percent, and in 2002 constrained to between one and three percent. That is where it currently sits, although with a specific goal of averaging around two percent over the medium term.
Although these targets were and are set by Government, the task of achieving them was delegated in 1990 to the Reserve Bank, which from 1990 has had operational independence from the Government.
By the late 1990s, Western governments were increasingly becoming non-enamoured with trying to directly control money supply as the key tool to control inflation. The Friedman approach was considered to be inadequate. Instead, the new idea was to place increasing weight on interest rates as the tool.
Accordingly, the old idea of managing inflation by a ‘fractional reserve’ system, whereby the trading-bank reserves required by the Reserve Bank relative to trading-bank borrowings were adjusted, became less important.
Interest Rates as the Inflation-Controlling Tool
In New Zealand, the key change to using interest rates occurred in March 1999, and appears to have been led by the Reserve Bank itself rather than directed by politicians. That was when the Official Cash Rate (OCR) was first introduced.
This is still the same system that New Zealand currently uses some 26 years later, with the Reserve Bank’s Monetary Policy Group meeting on seven occasions per year, and at each meeting determining whether there should be a change to the OCR.
This OCR determines the rate of interest which the Reserve Bank pays to the trading banks on the deposits they hold at the Reserve Bank. More important, it provides ‘guidance’ to the banks as to what is appropriate within the broader economy.
Note that I use the word ‘guidance’. The OCR does not actually control what the banks pay citizens for their deposits, nor what borrowers have to pay on their borrowings.
I recall a seminar in the relatively early years of the OCR system, where a very senior official of the Reserve Bank, speaking under Chatham House Rules, acknowledged, to use his own words, that there was an element of ‘con in the system’ such that the Reserve Bank had to be careful that it did not stray too far from where the financial markets were heading of their own accord.
If the Reserve Bank did stray too far from where the markets wanted to go, then the Reserve Bank’s OCR system would lose credibility. Chatham House rules preclude me from saying who that high official might have been.
The idea of low interest rates is that people who have home mortgages will have more money to spend on other things when interest rates are low. As to the proportion of adults who have mortgages, this can be confusing, but it is less than 40 percent. The remaining 60 percent or slightly more either rent or are mortgage-free owners.
Investors might also be more likely to take on new business projects and borrow more if interest rates are low. This means more money is created via credit creation.
The counter effect is that when interest rates are low, then earnings on savings are less. Those who rely on savings have less to spend.
However, the empirical evidence is strong that lower interest rates do increase overall expenditure. There is then an expenditure multiplier affecting both M and V as increased spending works its way through the economy, albeit with delays. Typically, this increased expenditure then leads to inflationary pressures.
Here in New Zealand, the experience over the last 25 years has been that all of the major banks do take close guidance from the Reserve Bank via the OCR.
The Last Five years
Although the OCR is currently the month-to-month tool used by the Reserve Bank to control inflation, it is not the only tool in the toolbox. In 2020, in the early days of the COVID pandemic, the Reserve Bank initiated two schemes of quantitative easing to provide more liquidity into the financial system and to specifically lower interest rates.
The first of these schemes was the Large Scale Asset Programme (LSAP) which in 2020 and 2021 injected $53 billion into the economy through the Reserve Bank purchasing government and local body bonds using created money. These bonds are currently being withdrawn from the market, with the winding down expected to be complete by mid-2027.
The second programme was the Funding for Lending Programme (FLP) which provided the banks with $19 billion of cheap funding at the OCR from the Reserve Bank. These FLP funds will have been repaid to the Reserve Bank by the end of 2025.
A key consequence of the LSAP and FLP was that the markets were flooded with liquidity and cheap money. It was the presence of this money in the market that set off the property boom of 2021 and through into early 2022. The subsequent reversal of this property boom has been painful.
The combined excessive level of the LSAP and FLP also drove the inflationary boom through to 7.3 percent in June 2023. Bringing that under control has also been painful.
Both the property boom and the inflation take-off should have been predictable to the Reserve Bank but apparently that was not the case. I was a lonely voice when I first wrote about the forthcoming monetary flooding back in June 2020, and followed that up with further articles throughout 2021.
Whereas the Reserve Bank was working from models built on historical behaviour, I based my assessments on expected behaviours, recognising that we were in a ‘new world’.
Despite the current quantitative tightening associated with the current withdrawal of the LSAP and FLP funds, New Zealand’s ‘broad money supply’ as calculated by the Reserve Bank’s C50 series, continues to increase rapidly. This ‘broad money’ is essentially what is known internationally as ‘M3’ money although the Reserve Bank no longer uses that term.
In the year to October 2025, both broad money supply and domestic credit increased by just over five percent. In the six years from October 2019 the supply of broad money has increased 37 percent. Where is this money coming from?
The answer is that apart from the excessive use of the LSAP and FLP, the remainder has been coming from credit created by the trading banks to willing borrowers, within rules set by the Reserve Bank. However, the Reserve Bank takes what is essentially a ‘hands-off approach’ within a framework of relying on the OCR to influence behaviours, plus a focus on ensuring that there is sufficient liquidity in the system to avoid instability.
This means that the combination of citizen savings, spending and investment behaviours, combined with banks willingness to lend, is currently the fundamental determinant of growth in the money supply, with a consequent effect on inflation. I emphasise that monetary economics is very much a study of human behaviour.
Yes, there are fancy econometric models but they are all built on historical human behaviour patterns. Historical behaviour patterns change as time goes by and this makes prediction difficult. There is a famous quote from economic modeller George Box from some decades ago that ‘all models are wrong but some are useful’.
The Reserve Bank influences human behaviours by interest rates, but there are lags in the system. For example, most house loans are fixed for between one and three years by decisions of the borrowers. Hence, changes in the OCR can take well over a year to have their full effect.
My own opinion is that the Reserve Bank in the last six years has consistently adjusted interest rates with too great a range and been too slow to find the turning points. Ever since COVID they have taken us on a crazy ride. This crazy ride continues.
The Future
I am writing this just days after the arrival of Anna Breman from Sweden as the new Governor of the Reserve Bank. However, Breman has already made it clear in her initial meeting with the parliamentary Finance and Expenditure Committee (FEC) on December 2 that she will be strictly following, “with a laser focus”, the single mandate given by the Government to the Reserve Bank, which is to manage and control inflation.
This idea of a single mandate was traditional in New Zealand from the start of the Reserve Bank’s operational dependence in 1990. However, in 2018 the Labour/NZ First coalition brought in a dual mandate whereby the RBNZ was also responsible for maximising sustainable employment. This second mandate was then removed by the current Government in late 2023.
My reading between the lines is that the new Governor of the Reserve Bank, in explaining her ideas to the parliamentary Finance and Expenditure Committee on December 2, has implied rather strongly that the RBNZ has been distracted from its current single mandate and that this ‘won't happen on her watch’. I happen to agree with her stance.
This laser focus on inflation does not mean that maximising sustainable employment is not critically important. But it does mean that maximising sustainable employment is the role of the Government, using fiscal policies, and not the role of the Reserve Bank, which has a sole focus on monetary policy.
I hope Breman will use the OCR with more skill than her last two predecessors, using both less brake and less accelerator, and identifying turning points at an earlier stage. We need a much smoother OCR journey.
I note that Breman has also indicated that she will be encouraging diversity of thinking in relation to monetary decisions. That is encouraging. There seem to have been elements of groupthink within the present system.
As well as damping down the overuse of the interest rate tool, we have to ask again as to whether there are other tools that can contribute to controlling inflation.
There also needs to be a new discussion as to whether New Zealand should revert to a lower target than the current one to three percent. Why not a range of zero to two percent and a mid-point of one percent, as laid out in the Reserve Bank Act of 1990?
One way or another we need a society where property plus financial leverage is not the main avenue to wealth and where money in the bank does not get destroyed by inflation.
*Keith Woodford was Professor of Farm Management and Agribusiness at Lincoln University for 15 years through to 2015. He is now Principal Consultant at AgriFood Systems Ltd. You can contact him directly here.
48 Comments
I have no argument against the need to create money in the presence of a growing population in a growing economy. Why? Money is just a medium of exchange. Do you skip Mises and Hayek? Printing is an elite enriching rort paid for by the rest of us.
"That's because this new borrowing is new money "injected into the economic system at a specific point" that advantages those consuming the counterfeit capital while disadvantaging those trying to save.
If the money or credit were evenly distributed among all economic agents, no “expansionary” effect would appear, except the decrease in the purchasing power of the monetary unit in proportion to the rise in the quantity of money.
However if the new money enters the market at certain specific points, as always occurs, then in reality a relatively small number of economic agents initially receive the new loans. Thus these economic agents temporarily enjoy greater purchasing power, given that they possess a larger number of monetary units with which to buy goods and services at market prices that still have not felt the full impact of the inflation and therefore have not yet risen.
The purchasing power of these home-owners is paid for by the losses of savers.
Hence the process gives rise to a redistribution of income in favour of those who first receive the new injections or doses of monetary units, to the detriment of the rest of society, who find that with the same monetary income, the prices of goods and services begin to go up. “Forced saving” affects this second group of economic agents (the majority), since their monetary income grows at a slower rate than prices, and they are therefore obliged to reduce their consumption, other things being equal."
https://pc.blogspot.com/2025/08/john-key-is-still-fucking-moron.html
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Profile, I included Keynes and Friedman because I could see how their thinking had been of major importance to economics at the policy level in Western countries. I did not consider including reference to either von Mises or Hayek because I did not consider they had the same influence on policy. However, I acknowledge that Margaret Thatcher revered Hayek and was definitely influenced by him. Also, if Keynes and Friedman were still with us today, I have some ideas as to what they might be saying, and each shaking their head in some frustration. I think there would actually be some agreement between them. In contrast, I find it challenging to decide what Hayek would be saying in the modern world. Perhaps he would be saying that booms inevitably head to busts and that inappropriate monetary policy starts the boom that then leads to the bust. I am open to that idea.
KeithW
I included Keynes and Friedman because I could see how their thinking had been of major importance to economics at the policy level in Western countries. I did not consider including reference to either von Mises or Hayek because I did not consider they had the same influence on policy.
Which is important because it's reality. Mises and Hayek are fringe in terms of what influences political decisions and central bankers.
Incidentally. Liz Truss is widely associated with the economic philosophy of Hayek, having been a member of the Oxford University Hayek Society during her student years and drawing influence from Hayek's ideas of free markets, limited government, and supply-side economics.
There is a reason politicians prefer Keynes - oh what fun to print money and bestow it upon your favoured few. Spend today and worry about the consequences later - after all, in the long run we are all dead. Why just this week the Luxinda government showered borrowed cash on multimillionaires Linkin Park. As a politician what is not to like?
Inflations engine is ever greater rent and mortgages. Banks electronically increase money supply with every mortgage they approve. Everyone needs shelter so everyone is effected. We pay ever greater amounts as specland chase retirement income...I mean tax avoiding gains. Those that want to own their own home have to keep up with that.
Banks are laughing all the way to the bank.billions of laughs annually.
Suggest the reference to the occasion of the “Chatham House” dialogue tends to confirm that the OCR operates more in hindsight than foresight.
It is important to recognise that what banks actually do is create credit, and in the process a liability is also created. The money creation then occurs within the wider economic system. The conditions under which credit is created are under the control of the Reserve Bank. So it is actually the Reserve Bank that has to take responsibility for the creation of money.
KeithW
Banks electronically increase money supply with every mortgage they approve.
97% of it. When banks lend money, which creates deposits. The Bank of England's Quarterly Bulletin article "Money creation in the modern economy" clearly states that most money in the modern UK economy - this applies across the Anglosphere - is created by commercial banks when they make loans. This view overturns the common textbook assumption that banks simply lend out pre-existing deposits or that money is multiplied mechanically from central bank reserves. Instead, the bank’s act of lending itself creates new deposits - meaning new money is injected into the economy at the moment a loan is made.
https://www.bankofengland.co.uk/quarterly-bulletin/2014/q1/money-creati…
100%
They only put about 2.5% into the mortgage , the rest is borrowed on international markets with Net interest margin of about 230 points
Thats why the collapse of the ponzi is hurting nz so much
They only put about 2.5% into the mortgage , the rest is borrowed on international markets with Net interest margin of about 230 points
Be careful here. Some people could interpret that incorrectly.
Anyway, many people will understand the idea of fractional reserve banking. Which may not be entirely correct either. According to Richard Werner, the standard fractional reserve banking story is not correct as a description of how modern banks actually operate. He argues that only the “credit creation” theory fits the empirical evidence, while both the financial intermediation and fractional reserve theories should be rejected.
they are on the hook for the lot.... but yeah nothing is replacing that Ponzi that I can see or foresee
so much crap property on to high right now... maybe the quailtiy property has stopped falling but to much denial to allow averages to rise
One day people will realise that the mortgages are the bank's asset. Their liabilities (and what they have to back with equity etc) are customer deposits.
I could not agree more with the closing argument in this article, but the route to the close has some real clangers. A quick run through...
It is also widely accepted that inflation expectations influence both purchase and pricing decisions.
It's what the textbooks say, and it is built into the toy models that economists use, but it is nonsense - particularly if you think that expectations, through purchase and pricing decisions, flow through to actual real world inflation. As so often happens with economics, the empirical evidence doesn't support the theory. A great summary here.
[1975 - 1984 inflation] was a global phenomenon but New Zealand fared worse than many other OECD countries
NZ did not fare worse than OECD countries on average. Here's the data. Inflation spikes are basically always a global phenomenon - caused typically by oil / gas price spikes. Note that UK had their own inflation spike in 1975 thanks to their currency crisis, and so did we in 1985 when the UK left the EC and the NZD lost its Sterling anchor (and was terribly managed).
By late 1991, inflation was down to one percent per annum. However, unemployment reached a peak of 11.2 percent in September 1991, which tells something of the cost of bringing inflation under control.
Look at that graph again. Did we destroy our economy and the lives of tens of thousands of kiwis to get inflation 1 percentage point below our peers for a year? Absolutely ridiculous.
However, the empirical evidence is strong that lower interest rates do increase overall expenditure. There is then an expenditure multiplier affecting both M and V as increased spending works its way through the economy, albeit with delays. Typically, this increased expenditure then leads to inflationary pressures.
Yes, low interest rates give mortgagors more disposable income and they have a high propensity to spend than savers (who lose out when rates are low). BUT, the elephant in the room here is that low interest rates enable people to borrow more to bid up the price of houses, and that sends new money flowing into the economy. People borrow $1m to buy a house, the banks create that new money from thin air, and the house seller receives that money. If that seller spends any of it into the economy (and they do - on aged care for example), then you are increasing aggregate demand.
It was the presence of this (LSAP and FLP) money in the market that set off the property boom of 2021 and through into early 2022.
No, it was the low interest rates that RBNZ enforced across the yield curve thanks to LSAP - combined with long-standing stupid tax and policy settings. The extra liquidity was irrelevant. Banks will always lend to a credible lender - their parent banks are happy to get a 13% return on any additional equity required.
The combined excessive level of the LSAP and FLP also drove the inflationary boom through to 7.3 percent in June 2023. Bringing that under control has also been painful
I'm losing it, Keith! We import about a third of our consumption by value, the cost of those imports (across the world) went up by about 23% in a year. Now, if one-third of your input costs go up by about 23%, and you pass that through to prices, how much do your prices go up? Yep, a bit over 7%. This happened across the world!!! How hot inflation ran by country through this period was almost entirely a function of how much they relied on imported oil and gas. We are not in control of our prices at all during a global price shock and we need to accept that and do better!
I've never been able to understand why there's such an importance placed in inflation expectations when forecasts vs actual correlate poorly. Inflation expectations are rarely the precursor to spikes in inflation in either direction.
It's up there with the Ricardian Equivalence.
Expectations come into play when inflation expectations change. It is the change in expectations that changes financial behaviours, with these behaviours then flowing through to influence inflation. The lags are complex and of course expectations are not the only factor in the system. Right now consumer expectations of inflation are higher than most economists expectations. Time will tell who is right. My own judgement is that the new Governor will likely be encouraging the Monetary Policy Committee to raise the OCR before the end of 2026. Moving early but gently is my hope.
KeithW
JFoe, it'd be great if you were able to contribute a few articles on this topic also. Really enjoy reading your posts as well as Keiths articles. Maybe a multi part contribution on a bit of history as you allude to in this post plus the current situation.
Excellent article. Covering the breadth of economic forces - including fiscal policy. Where have you been hiding? And thankyou for this gold - finally someone in NZ says it out loud:
"But it does mean that maximising sustainable employment is the role of the Government, using fiscal policies, and not the role of the Reserve Bank, which has a sole focus on monetary policy."
"However, I doubt if Keynes himself, who died in 1946 at age 62 from a heart attack, would have agreed with a lot of what subsequently became known as Keynesian economics. Keynes’ focus was on business cycles and how to minimise recessions and avoid depressions. Long-term priming of the pump is another matter."
He probably would have argued that we should have been incresing taxes and interest rates in the 2012-2019 period as the rockstar economy boomed (something I was arguing at the time) - ie to minimize the boom and providing 'insurance' for when the recession arrives. But it seems to have become political suicide to ever argue for incresaed taxation - even when the economy is booming and house prices were rising faster than peoples incomes!!
The majority of people (that I've talked to, including many extended family members) always want lower taxes and forever government intervention in markets to keep the boom going forever (and the weak political leadership of recent has been completely willing to oblige) - it is delusional thinking because it is completely unsustainable in the long term. The focus of what is right for me right now - not what is going to bring long term stability for everyone.
One example is people thinking house prices can always rise at 7% while the RBNZ targets general inflation (ie wages) to rise at 2% - mathematically if you under the financial principle of Price = Cash flow / discount rate, then you know this is impossible to sustain forever. The last 30 years have been living in lala land - house prices consistantly going up at 7% (doubling every 10 years) while you point out that generation inflation is only going up circa 4% (nearly half house price appreciation) - this means we have a substantial housing bubble in real/inflation adjusted terms - which has been brewing for about 3 decades. We have never had the cash flows (productivity) to justify such prices being paid for our houses - its completely bonkers what has just happened.
My two cents on the matter of inflation (at least recently) for New Zealand:
1) World-wide inflation and increased shipping costs (the pandemic supply-chain disruption upped this quite a lot) are big contributing factors and quite out of our control
2) On the local side, NZ is incredibly bad at investing in long term productivity which limits our ability to control inflation (reliance on energy costs etc):
- We have short government cycles encouraging short-term thinking
- We have a low-wage economy that favours cheap labour over investment in plant/technology
- For a first-world country we have horrible R&D investment
- We all know our tax system is geared for low-value investment in residential property over productive investment yet we do nothing about it (or in this government's case, undo changes that the last government did to try and change the behaviour a bit)
- We insist on picking the short-term individualistic options instead of the long-term positive options for society (e.g. RONS vs public transport investment, sprawl vs density, public health initiatives vs ambulances at the bottom of cliffs)
Sorry, I was only going to write a couple of short things and now I will stop instead of writing a whole thesis on this.
A substantive and lengthy article with lots to chew on thanks Keith.
'Simply knowing that the above explanations are true, in itself does very little to help policymakers prevent inflation.' IMO policymakers are part of a group in society that benefits from the financialization of our economy who are educated, in privileged positions and wily so gain wealth through inflation and therefore don't prevent it- it's built in at a target between 1 and 3%. So the certainty of inflation encourages greed for many at the detriment to the common good of people, especially the poor.
In my own situation for many years past the increase in government valuation per annum of my lifestyle block has far exceeded a low income full time wage earners yearly gross income - a symptom IMO of an out of control economy and financial system. I don't intend selling so a disproportionately increasing rates burden compared to retirement income.
It isn't just the policy makers and MPs who benefit from higher inflation at the expense of other proportions of society. 'In the year to October 2025, both broad money supply and domestic credit increased by just over five percent. In the six years from October 2019 the supply of broad money has increased 37 percent', and 'The OCR does not actually control what the banks pay citizens for their deposits, nor what borrowers have to pay on their borrowings.' Part of the former is IMO a necessary response to Covid 19 with financial rescue measures for our economy, but the latter also that huge bank profits made from persons in need of shelter leave NZ every year to overseas shareholders...
'If the solutions were simple, we would not be in our present New Zealand situation with inflation at three percent per annum despite a stagnant economy.' I agree - human competitiveness for fractions of a shrinking pie is going to become increasingly intense with increased population, resource depletion, global warming, and pollution that do not have simple solutions. More likely an increasingly desperate fight for economic survival and social order breakdown.
In my own situation for many years past the increase in government valuation per annum of my lifestyle block has far exceeded a low income full time wage earners yearly gross income - a symptom IMO of an out of control economy and financial system. I don't intend selling so a disproportionately increasing rates burden compared to retirement income.
And this is an unintended consequence of Ponzinomics. Great example of this is the NSW government, which is so structurally highly reliant on property values and transaction volumes for a large share of its own-source revenue. The NSW govt is more reliant on the Ponzi than ever before. For its own survival.
As is the nature of Ponzinomics driven by credit-driven credit creation for pumping up the prices of housing, this flows through to land values for everything, meaning that the costs of goods and services have to be higher based on the higher price of inputs. So you're essentially creating a cost of living crisis for a large segment of the population.
High inflation can be really good for some. Do you think investors and shareholders in NZ electricity sector are complaining? They have received a minimum of $1 billion in dividend payments every year for over 10 years.
Through droughts, earthquakes, hurricanes and flooding the consistent rise in electricity prices and dividend payments is an example of the free market at it's most profitable - a monopolized magic money tree.
Much of NZ's domestic inflation is engineered through artificial scarcity - there is no physical or technical constraint on electricity generation in NZ. The constrained has been deliberately engineered by under investment in generation capacity.
It has been interesting to observe the governments silence on the RBNZ panicking about spare capacity in the economy as inflation breaches the top of 3% band. The RBNZ mandate was explicitly stripped back to just inflation by the coalition.
If the assumptions about the new governor are correct then we should expect interest rates to start rising next year to bring inflation back towards 2% a little faster then currently predicted i.e. with more 'laser focus' and less concern about consumer and business sentiment or spare capacity.
Exactly - which is why i'm completely lost by the last OCR cut. In my view it wasnt justifiable.
I really respect the F Off we only do MP attitude...
Willis what you gonna do?
My take is that there's too much herd mentality in the MPC and they have too much undue influence. They aren't thinking about the broader picture of human behaviour and the delay in the impact of the OCR change in the economy. Hopefully they will start ticking things up slowly again next year one or two times to get the population used to the fact that we will not have another big boom again, and need to temper our borrowing habits accordingly. .
Great article KW.
question though; why no reference to external causes to inflation?
As a nation predominantly dependent on imports, those external influences cannot be ignored - or controlled surely, unless we look at how the value of the currency is managed?
If externals were the major source of inflation then it would show up as such in the tradable inflation.
External sources are important but most of the inflation is internally generated and this is evident from the consistently big non-tradable inflation rate.
It is a common myth that most of our inflation is imported.
KeithW
This is evidently wrong, Keith. Some points to consider:
- The tradable / nontradable method was developed in 2003 in different times. RBNZ have complained about it to Stats NZ multiple times, saying it is barely usable any more.
- The simplistic method does some crazy stuff like decide that international flights are tradable and domestic flights are non tradable. Yet both intnl and domestic flight prices move with oil prices (fuel can be 30% of costs) and companies can move planes to more profitable routes!
- Most businesses that compete use cost plus margin pricing, yet economists still believe their textbooks (don't get me started on that) - so when our $100bn+ of imports go up by 20%, we see a rapid pass through.
- Talking of which, private sector wages were only $125bn in 2023 but imports were $110bn. If wages went up 25% would we say prices wouldn't increase?
- During a global price shock, there is implicit coordination between firms, everyone knows that a major input price has gone up, so they all increase prices. In NZ, you can see those import prices directly flow through to retail prices in the PPI data, it's irrefutable and extends well beyond the tradable / nontradable split. Also note that fuel and energy costs hit at every stage of the supply chain.
- All of this means that NZ prices have to move with shifts in the global price level unless our currency changes relative to our partners. A tiny speck of a country can't opt out somehow. We are along for the ride. The sooner we realise this, the better. Our small island, wiggle interest rates up for unemployment and down for jobs, housing ponzi and primary goods economy, needs a real strategy.
Jonny Foe, Taking airlines as an example, it is correct and appropriate that international flights are classed as tradable. The correct treatment for internal flights would be for approximately 30% relating to fuel costs (landed at port) to be assessed as tradable. Do you have a breakdown from Stats Dept which lists the split for each item between tradable and non tradable in relation to the CPI?
KeithW
Of course Keith, it's the first spreadsheet on the page here, table 6: https://www.stats.govt.nz/methods/consumers-price-index-review-2024/
Marvel at how domestic flights and insurance are 100% non-tradable!
I agree that those two items are indeed worthy of a debate. Fuels are considered separately but unless aviation fuel is included in 'other vehicle fuels' then this is an anomaly. The placement of insurance in the non-tradable category raises the question of how overseas companies should be treated. Either way, I need convincing that these anomalies are sufficient to affect the overall indices except at the margin.
KeithW
It's worth going back to the kiwi-authored paper that the economists relied on heavily for their inflation theory. Check out what Bill had to say about import price shocks. He perfectly predicted what would happen if systemically important imports leapt up in price.
Bill Phillips was indeed a remarkable man and in multiple ways. However, the Phillips Curve is often used in ways which Phillips himself did not intend. I remain comfortable with the Phillips Curve as a short-term relationship but I doubt whether it is long-term. I recall in discussions with Reserve Bank economists a decade or so ago where they were rather keen on NAIRU as a vertical curve for the long run. My own perspective is that the NAIRU itself changes over time as technical change occurs. I also go back to George Box's perspective that all models are wrong but some can be useful.
KeithW
Bill was dismayed that his work was twisted into a set of economic models that seemed primarily designed to smash organised labour and increase the capital share. His descriptive and obviously accurate model of the impact of an import price shock was regretttably not incorporated into the monetarist framework.
Could it be argued then that the omission of this into the monetarist framework would benefit the oil overlords, as if it were taken more seriously, perhaps the world may have looked to shift away reliance (or a portion of) on such a resource? Perhaps even build society, policy, and national strategy to better prevent import price shocks?
Thanks Keith, but I would have to say you are clearly wrong. Taking just one example, the cost of fuel, which filters through to every single nook and cranny of the economy, I would suggest is a significant driver of inflation. Add in a complexity that when fuel costs go down, are all costs that were previous pushed up because of rises in fuel costs, then pulled back? I doubt it, but this creep should also be accounted for.
With such a significant reliance on imports I don't believe you can claim that imported inflation is a myth. Those imports, at the port of entry, will be subject to all the causes of inflation at their origin resulting in a cumulative impact with the costs incurred here.
Murray86, I did not say that imported inflation is a myth. But I did say that it is a common myth that most of our inflation is imported. Unless the tradable and non-tradable data is totally wrong, then the evidence is solidly on my side.
KeithW
There is a key factor missing in the theorems being presented (comments included)....if you submit that quantity and velocity in relation to availability of 'money' and goods/services are determinants of inflation then you must also include those factors which destroy 'money'....namely tax and debt reduction.
It may therefore be said that inflation is controlled not by interest rates but rather inflation may be managed by taxation.
Taxation can affect inflation, but it depends on how the tax is then used by Government. Tax policy is fiscal policy. Keynes argued for fiscal policy to manage business cycles and to get people employed and hence create growth. I cannot identify any mainstream Western country that in this century uses fiscal policy as its primary method for controlling inflation.
Yes, net reduction in debt will reduce money supply. The Reserve Bank credit series (C50) is net debt so reductions are factored in.
KeithW
The RBNZ may monitor net debt but they do not (and can not) control it....certainly not since all capital controls were removed with deregulated (largely global) banking...therein lies the problem.
The RBNZ has a number of tools they can use. These include loan to value, and loan to income. They could also make some use of fractional reserve. Part of the debate we as a country need to have is the extent to which these tools are underused. The lags in relation to OCR are likely to increase as borrowers increase the fixed term on their loans.
KeithW
Curious that the (under-utilised) tools you mention are relate to housing credit creation....where we have ended up as an economy due to the deregulated international banking system.
I would suggest that those tools are underused for a reason , the main one being that the international finance tail has been wagging the dog of CBs since that deregulation.
Democracy anyone?
"I recall a seminar in the relatively early years of the OCR system, where a very senior official of the Reserve Bank, speaking under Chatham House Rules, acknowledged, to use his own words, that there was an element of ‘con in the system’ such that the Reserve Bank had to be careful that it did not stray too far from where the financial markets were heading of their own accord."
"I emphasise that monetary economics is very much a study of human behaviour."
These two statement lead me to a question I regularly ask; what is the role of government in this matter? Should the private, trading banks be regulated to better manage the credit they create and it's direction? And is the tax system we apply fit for purpose?
I don't believe anyone considers the level of profits made by the trading banks in NZ acceptable, so what should be being done to manage that?
The issue of the profits made by the overseas banks is indeed a big one. But it is not really about inflation. See my comment currently sitting just above your comment re tools the Reserve Bank can and could use for inflation management . Trading banks simply issue credit within the rules set by the Reserve Bank plus their own risk management decisions. As for the NZ banking system, there was a time when the NZ banking system was indeed NZ-owned but that was about 35 years ago. We live our lives shaped by past decisions!
KeithW
I agree it is not really about inflation, however the two are intrinsically connected. I still believe the trading banks should be more rigorously regulated.
And yes the curse of previous politicians decisions haunting us today is very real. having said that for all the arguable 'independence' of the RBNZ can be stated, the reality is it still works for the government of the day to help and support delivering the economic outcomes that government is seeking. Anything else would be unacceptable, surely?
Should the private, trading banks be regulated to better manage the credit they create and it's direction? And is the tax system we apply fit for purpose?
I'd have to say yes to more regulation for banks, as they are in an enviable position that no other form of business is in, being they are a profit driven business with the ability to create money and derive profit from doing so - and have arguably the best information available to be able to leverage this position to harvest profit at a greater margin than other business types.
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