ANZ Banking Group chief economist Richard Yetsenga says questions should be asked as to whether central banks' inflation targets remain relevant

His team may be tipping cash rates of just 0.25% on both sides of the Tasman, but ANZ chief economist Richard Yetsenga doesn't expect such low rates would prove a silver bullet and says questions should be asked as to whether central banks' inflation targets remain relevant.

Speaking to interest.co.nz in a Double Shot interview, Yetsenga said ANZ is picking three cuts from both the Reserve Bank of Australia (RBA) and the Reserve Bank of New Zealand (RBNZ) by next May taking both their respective cash rates to 0.25%. Why? Because the current 1% record low both central banks are at isn't working.  

"Both central banks are undershooting their inflation targets. Growth has been slowing in both economies," Yetsenga said.

"In New Zealand the business surveys are suggesting we'll probably get some further slowdown in growth. In Australia growth might be basing out, the housing market looks a little bit better, but New Zealand's coming off a 2.5% growth rate, Australia's potentially stabilising at a 1.5% to 2% growth rate. [It's] difficult to see how either central bank's going to achieve their inflation target under those conditions given interest rates where they are, even though they're so low from a historical perspective."

But asked whether he thinks rates at 0.25% will be a silver bullet, Yetsenga says; "Probably not, no."

"It's very difficult for me to argue that you will get inflation in either Australia or New Zealand sustainably at 2.5% based on what either central bank does with monetary policy."

"It doesn't mean you shouldn't do anything because their mandates are to achieve an inflation target. They need to deliver into those as best as they can. But the reality is we've got a global environment that's not generating much inflation. We've got weak business investment and we've got low wage growth. And they're the things that ultimately are going to get inflation back to the target, if and when they happen to return," said Yetsenga.

The operational objectives of the RBNZ's monetary policy are to keep future annual inflation between 1% and 3% over the medium term with a focus on the 2% mid-point, and to support maximum sustainable employment. In determining monetary policy, the RBA has a duty to contribute to the stability of Australia's currency, full employment, and the economic prosperity and welfare of the Australian people. It has an inflation target, seeking to keep consumer price inflation to 2% to 3% on average over the medium term.

The latest official inflation figure for New Zealand was 1.7%, and for Australia it was 1.6%.

Are the inflation targets still relevant?

Asked whether we should be questioning whether these central bank mandates and targets are relevant, Yetsenga said yes, we should.

"The Reserve Bank of New Zealand, New Zealand, led the way on inflation targeting. It chose a particular form of inflation target...Never in the last 25 years has there ever really been any question about the central bank's ability to achieve its target. The only question was 'what level would you choose, was it hard edged or soft edged,' other administrative issues, But there was no question about achieving the target."

"Now, of course, even with quantitative easing in some economies, interest rates below zero, interest rates in New Zealand at 1%, which even five years ago you would've thought would never happen, we still can't achieve the inflation target," Yetsenga said.

"Yeah, I think we need to have a look at what the targets are, how they intersect with structural issues in the economy, what their successes and failures have been, and a long hard think about whether we've got the right framework."

But asked whether he has any alternative framework in mind he said he didn't.

"The only thing I can think about at the moment is easing a lot when it's not doing a lot might not seem like the right thing. [But] when you have an economy with a reasonable amount of debt the last thing you want is inflation expectations to get un-anchored to the downside. The last thing you want is to get entrenched deflationary expectations, that would be a much worse situation, I think. So what central banks are doing to me is entirely appropriate," Yetsenga said. 

"But probably I'd prefer maybe a 'do no harm' approach to policy. If growth is okay and there's no further deterioration in inflation, even though you're undershooting, why wouldn't you just be patient and be happy with that and see how things transpire. But that's not the way we run policy. We have an active target, we need to do what we can to get it."

'Talking about stimulus is unhelpful'

Asked whether he thinks the New Zealand Government should be taking advantage of its strong credit rating, low debt level and low global interest rates to borrow and provide some economic stimulus through infrastructure investment, Yetsenga wasn't especially enthusiastic.

"There's a famous quote out of the US. If interest rates were at zero we should bulldoze the Rocky Mountains. So I think it's attractive to think about low bond yields and say 'well the government should borrow and spend some money.' Particularly when you are growing your economy [and] one of the primary means you're generating growth is by importing people, which a lot of small open economies are doing. You need infrastructure for quality of life reasons, to move people around and hospitals and school capacity and all those things. So you need that. Is it going to sustainably drive growth, the answer is no it's not." 

"You can ratchet up infrastructure a little bit, but you spend some time in the centre of Auckland [and] it's pretty disruptive when you need to do large scale infrastructure, it's environmentally unfriendly, it's extremely expensive. And if you want to drive growth in the economy you need to do more infrastructure on top of the more infrastructure every year," said Yetsenga.

"I think talking about stimulus in a way is unhelpful, not that it's not important, because it takes us away from the fact that there are some big issues here. And chasing growth for the next year or the next two years, sure we'll ideally have a bit of that, but actually it's the structural picture which needs the work."

So what happens if the RBA and RBNZ do both cut to 0.25%?

"There's a new acronym we're using, ELB - the effective lower bound. I think the experience of Europe is you can still have some easing impact taking interest rates below zero. But a 25 [basis] point cut below zero is much less effective than a 25 [basis] point cut when you're in positive territory. And one of the key reasons is because you impair the ability of the banking system to deliver credit."

"So we're hopeful that central banks in Australia and New Zealand choose other mechanisms if further easing is needed at those low yields rather than taking rates into negative territory."

He said some form of quantitative easing, or QE, was most likely.

"I think it will be something in the QE realm and one of the by-products will be to hopefully get the exchange rate down and keep it down."

Will technology be the circuit breaker, eventually?

So is there a circuit breaker out there?

"At some point the technology disruption we're going through, which for virtually every occupation, every industry, every company, they're being disintermediated or adjusted in some way because of technology. Ultimately we should come out of that with higher average living standards, more income growth, better paying jobs. But we're in the disruptive phase," Yetsenga said.

"Now if you look at the industrial revolution there's evidence that the disruptive phase lasted for 50 years. I have no view on how long or short this disruptive phase right now will be relative to that, but it could go on for quite a period of time." 

"That's about the only really positive circuit breaker I see at this point. That we do get the productivity wave coming out of technology and that drags living standards higher the way every other productivity wave has done," said Yetsenga. 

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