Reserve Bank (RBNZ) chief economist Paul Conway says while near-term inflation pressures have eased as oil prices have fallen, reflecting some progress towards resolution in the Middle East, the conflict has still “delivered another significant inflation shock”.
And the challenge for monetary policy, Conway told the audience at a BusinessNZ event on Tuesday, was to ensure that this doesn’t lead to persistent inflation.
The RBNZ’s six-member Monetary Policy Committee (MPC) raised the Official Cash Rate (OCR) to 2.50% from 2.25% last week. When it came to its decision to increase the OCR, the RBNZ noted that although oil prices have fallen, the effects of the oil shock would linger for some time.
“Future OCR decisions will depend on how incoming data, price-setting behaviour, and the strength of economic activity affect medium-term inflation pressures," the RBNZ noted.
The RBNZ is projecting inflation, as measured by Statistics New Zealand's Consumers Price Index (CPI) to be 3.9% in the June quarter and 3.3% in the September quarter. As of the March quarter, annual inflation was at 3.1%.
The RBNZ is tasked with maintaining inflation between 1% and 3% and it specifically targets 2%.
Conway told the audience understanding how workers and businesses respond to inflation and economic shocks is important in assessing whether “cost shocks fade or become embedded in persistent inflation pressure”.
“When inflation is high, people pay closer attention to it. Research suggests that New Zealand businesses pass on cost increases more readily now than in the past and are less likely to reduce prices when costs ease. All else equal, this raises the risk that temporary shocks becoming persistent inflation.”
Asked why this was the case with businesses, Conway said this was an area where they needed to dig deeper as it was not well explored.
He said competition in New Zealand could have something to do with it but there was more work to be done in this area.
‘We cannot take anchored inflation expectations for granted’
Conway said monetary policy was about separating signal from noise.
“The signals that matter most can change as the inflation environment changes, so our assessment toolkit must evolve too. When above-target inflation changes expectations and price-setting behaviour, monetary policy may need to respond more firmly to re-anchor inflation expectations.”
Conway said: “There’s nothing monetary policy can do to soften the hit to our national income from higher oil prices. We are collectively worse off but what we can and what we will do is prevent a temporary increase in costs from becoming more generalised inflation."
He said inflation expectations and price-setting behaviour were key to that and critical for determining the appropriate stance of monetary policy.
“The more businesses can pass on higher costs, the more businesses expect inflation to be higher in future, the more persistent inflation becomes, and the harder monetary policy must work to bring it back to target.
“Encouragingly, medium-term inflation expectations remain well anchored, and spare capacity in the economy should help limit pass through, but after several years of above-target inflation, we cannot take anchored inflation expectations for granted.”
RBNZ will respond if inflation pressures are ‘more persistent’
With last week’s OCR decision, the MPC noted that some further reduction in monetary policy stimulus was likely, Conway said.
“We’re not talking about moving to a restrictive stance. We're talking about a calibrated reduction in monetary policy stimulus. Think of it as drifting back to neutral, figuring out where neutral is on the way.”
“But in saying that, we will respond if inflation pressures stemming from the Middle East conflict prove to be relatively more persistent,” he said.
“Because when high inflation expectations become embedded in price-setting behaviour, getting inflation back to target becomes much more difficult and costly.”
7 Comments
So... Persians and the Orange wonder continue to butt heads, expect higher rates to try to keep a lid on inflation.
But what if increased rates kill the patient-the economy?
Increased rates make perfect sense when the economy is overheating, but nothing could be further from where NZ is today. Unemployment is too high and much too high for younger people, higher mortgage rates will almost certainly put further downwards pressure on most sectors of the service sector-construction work will tank even further and we are now seeing the first signs of a weaker milk price. Furthermore, it looks as though we will see fuel prices rising again, so surely the RB could wait before pressing the OCR button.
Wholesale markets will do the job for them (raising or lowering lending rates based upon inflation expectations) even if they choose not to move the OCR dial.
The older I get, the more I think we waste a lot of money paying these people in RBNZ big $$ to pretend they are in control of the economy.
An RBNZ statement that they were backing investment in the real economy and holding rates at 2.5% would change longterm rates. Hell, RBNZ could even make a few billion taking the gamblers down.
The older I get, the more I think we waste a lot of money paying these people in RBNZ big $$ to pretend they are in control of the economy.
The older I get, the more I realise that we keep tweaking rules and regulations to suit whatever narrative we wish and explain away our behaviours. We had a good run post WWII building large scale infrastructure for the country, then deregulated it leading to an increasing wealth gap which is now entrenched, with no sign of reverting for the betterment of the majority, not the minority.
Take the USA for example, they wage war anytime anyone threatens the petrodollar, and are printing their way to their doom currently while simultaneously ruining their water table with fracking.
Then consider Norway, with high taxation, sensible use of their resources, and most of all a public that understands and supports supporting those most vulnerable vs throwing them to the dogs and milking them for what they're worth like in the anglosphere.
We really are a silly species ruled by our emotions.
88-95 was way worse. For the same reason. Too much debt unsupported by income, aka speculative gambling. Are we better to drag it out for ten years, or force a clean out of the blockage in short order...
When theres a blockage, what do you want your plumber to do...?
Is stating the bleeding obvious a wink and a nod to the fact kiwis are not that smart when it comes to understanding the relationship between inflation and interests rates.?
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