Govt policies targeting housing costs, electricity prices and council rates central to non-tradable inflation outlook; Is it finally becoming the Reserve Bank's mate?

Govt policies targeting housing costs, electricity prices and council rates central to non-tradable inflation outlook; Is it finally becoming the Reserve Bank's mate?
Non-tradable inflation (red line) has been consistently higher than tradable inflation (blue line) for almost 20 years.

By Alex Tarrant

Monetary policy needs mates, Ruth Richardson once said, and the government may finally be turning into the Reserve Bank's best friend.

Ministers are making noises that they will deliver on promises to help the Reserve Bank keep interest rates lower by stepping up the fight against the central bank's biggest bugbear -- non-tradable inflation.

This represents the price rises for goods and services where prices are not set on global markets or not facing competition from imports. This type of inflation has been running more twice as fast as tradeable inflation, where prices for goods such as oil, travel, electronic goods and cars have often been kept down by a high currency.

Policy options to make new housing more affordable, a renewed attempt to control local government rate rises, and (if you believe the government's argument) greater pricing competition in the electricity sector, mean the government could really help the Reserve Bank control inflation, dampening the need for Official Cash Rate hikes to levels seen during the previous decade.

Prices in those three non-tradable categories rose in the 5-9% range through the mid-2000s, putting pressure on the Reserve Bank to hike the OCR to its record high 8.25% for a year from the second half of late 2007 through to July 2008 in its attempts to keep inflation in check.

It is the Reserve Bank's task to try and keep inflation, as measured by the Consumers Price Index (CPI), within a target band of 1-3% per annum over the medium term. However this was hindered over the last decade as one of the two components of the headline CPI, non-tradable inflation, outstripped its tradable counterpart.

Non-tradable inflation includes housing construction, electricity prices and local government rates. Non-tradeable and tradable inflation together make up headline CPI inflation.

Reserve Bank governor Alan Bollard's tussle with non-tradable inflation was well publicised during the mid-late 2000s as electricity prices, local council rates, and the cost of building new homes outstipped the headline CPI measure.

As an example of the divergence between non-tradable and tradable inflation, headline annual CPI inflation averaged 2.8% over the decade to the December 2011 quarter. Over that time, annual tradable inflation averaged just 1.6% while non-tradable inflation averaged 3.7%.

A 2010 research paper by Michael Kirker of the Reserve Bank's economics department found that non-tradable inflation made a much larger contribution to core inflation than its tradable counterpart. On top of this, nearly two thirds of the annual variance in core inflation was due to movements in non-tradable prices.

Economists and policy-makers argue that if non-tradable inflation had not put so much pressure on the general level of the CPI, the Reserve Bank may have been able to keep interest rates lower than they otherwise were.

For that to happen, central and local government needed to come to the party by getting fiscal policy under control, and by implementing policies aimed at reducing price pressures in the non-tradable sectors of the economy.

'We'll be your mate'

The National party campaigned the last two elections on policies it said would help the Reserve Bank keep interest rates lower than they were last decade, promising to control its own spending, bring the housing market back in check, and introduce more competition to electricity pricing.

Prime Minister John Key and Finance Minister Bill English have both repeated Bolger-era Finance Minister Ruth Richardson's line that "monetary policy needs mates," meaning the government needed to play its part in the fight against inflation.

Local government

On the rates side, the attention of local government Minister Rodney Hide between 2008-2011 was turned to amalgamating Auckland's councils into the Super City structure, which, it was argued, would mean lower rates rises in the country's biggest city.

The local government mantle has been picked up by Nick Smith, who is fronting a proposed radical reform of the local government sector in an attempt to reduce the scope of local government activities and limit their ability to push up rates, according to Jane Clifton's report in this week's Listener magazine.

Moves may include more council amalgamations, and even abolishing regional councils. Legislation would introduce incentives for rates restraint and penalties for rates increases above a certain level, Clifton writes.

Smith began 2012 in Parliament laying into the rates rises seen over the last decade, saying in Question Time on Febuary 8 that local council rates had increased by an average 6.8% per annum in the decade since the Local Government Act 2002 was passed into law. That compared to average rates rises of 3.9% per annum the previous decade, he said.

Rates in the decade since the Local Government Act was passed had risen more than any other component in the Consumers Price Index over that time, Smith said. (Ironically, in the video below of Smith making these comments, sitting next to him in Parliament was former Auckland mayor John Banks.)

Housing costs

A housing boom during the 2000s meant New Zealand house prices shot up to some of the most unaffordable in Western world.

Cheap credit, tax incentives for housing investment, and growing housing and skills shortages have all been blamed for the rise in prices which prompted the Reserve Bank to hike the Official Cash Rate towards 8.25% in attempts to try and cool the housing market, and dampen the wealth effects that came from the rising values of New Zealand property.

And while the CPI does not factor in changes in the prices of existing houses, it does measure housing costs, including the cost of building a new home. Over the last decade the cost of the purchase of new housing rose on average by about 5% per annum.

The government claims tax changes in the 2010 Budget to disincentivise housing investment, by not allowing for depreciation to be claimed on buildings with an expected life span over 50 years, have gone some way to reduce Kiwis' love affair with property investment.

But housing shortages, particularly in Auckland, have seen prices begin to rise again after they came off their peaks through 2008 and 2009. Shortages of skilled labour for housing construction, reduced access to development finance, and tight city limits, mean not enough new homes are being built to keep up with demand, putting upward pressure on house prices and rents. 

The government last term set up the Productivity Commission, ordering as its first task a look into ways to improve housing affordability in New Zealand. The Commission released its draft report late last year, which argued the release of more land on city fringes (and, most importantly, Auckland's fringes) would be the most effective way to ease upward pressure on housing costs.

Auckland housing costs

Finance Minister Bill English last week told interest.co.nz that the government was welcoming the discussion on Auckland housing costs.

“There is, for the first time, a bit of discussion in Auckland about some of the ideas that have dominated their planning processes for the last 20 years,” English told interest.co.nz following the release of Treasury's Budget Policy Statement last week.

“They’ve got to think through the economic and equity impacts [of opening up the fringes], and when it’s your largest city, this is a significant economic decision. We’re not trying to say that’s a magic answer, but in terms of improving the external balances, we’ve got to break it down into those things where we can actually make decisions," English said.

Meanwhile, the Department of Building and Housing is pushing Building and Construction Minister Maurice Williamson to consider policies making it easier to build medium density housing to deal with Auckland's shortage and affordability problems. See more here.

Energy costs

The third big contributor to non-tradable inflation, household energy costs, is in the government's sights as part of its partial sell-down of four state-owned energy companies over the coming five years. This CPI subgroup had price rises averaging just over 6% per annum over the last decade.

The government's argument is that easier access to capital, private sector disciplines, and new forms of electricity generation will enable greater price competition among electricity providers, which will take pressure off prices.

Will the noise turn into action?

While the government is making the right noises about controlling non-tradable inflation, it remains to be seen whether actions taken will bring this component of the CPI closer in line with its tradable counterpart.

While the headline annual CPI rate fell to 1.8% in the December quarter, and the Reserve Bank says that core inflation sits around 2%, non-tradable inflation still remains higher than tradable inflation at 2.5% vs 1.1%.

Government policies are likely to be the deciding factor as to whether non-tradable inflation takes off again back towards the 4% mark it hovered around through the previous 10 years.

Pressures stemming from the rebuilding of Christchurch through the latter parts of 2012 and into 2013 are forecast to weigh on inflation, particularly construction costs. Government actions relating to other non-tradable prices are likely to be central to how high the Reserve Bank hikes interest rates as the economy, and pricing pressures, get going again.

Here is the Reserve Bank's December quarter Monetary Policy Statement forecasts for the two types of inflation (red line for non-tradable inflation and blue line  for tradable) and for overall inflation (grey bars).

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What hogwash....I have seen no effort whatsoever by govt (read English Key and Cabinet mates) to extend any control at all over councils demanding more money so they can splurge on make work schemes and.....bloated salaries for bosses.

Yes, its almost like make work....."we have nothing to do, lets vote on a new stadium"....
I pity OAPs and others on low incomes when we see rate rises of 5% anually, I notice the increases, my tiny pay increase was wiped by such increases many I think are not taht lucky......you cant keep doubling the rates every 15 years....
regards

I might be old, but not that old, and bob the builder has explained the council consent fees, and huge.one has beaten the 3x affordability to death .. but .. when I built my first house .. the only council cost was a $75 refundable crossing deposit, which we got back, and the house and land still cost me 6x my annual income.

Did you pay an extremely high price at the time?
The house my ex wife and I purchased in 2000 was approx. 2.4 times our combined income.
The same house now is 5.6 times my single income (my income is 1.45 times what it was in 2000).
Maybe the 3x affordability should relate to the size of the mortgage and not the house price?

The only way ratepayers will ever be able to get their rates bills reduced is to have a rates strike, as was proposed by the recent protests in ChCh regarding the CEO's salary increase.  It makes no difference who the mayor or councillors are, they all just rubber stamp the increased spending proposals submitted by the council bureaucracy.  The main problem is that the largest portion of LA rates are staff wages and salaries, which is on average 70% of the budget.   

Won't work AR...short term media hype soon swept under carpet...best approach is to target individual National MPs like Smith...not until the weight of losing his job dawns on him will you see any real effort to smash the council greed.

Maybe you should include a rent strike also and take on the unholly aliance between the property investors, councils, banks, government and the building material industry.

Well, the LG Act 2002 did unleash, upon an unsuspecting populace, the Four Well-beings, courtesy of one Sandra Lee, long since scarpered.
 
But as every legal human activity can be contemplated under one of said four:  economic, environmental, social, cultural, what this dopey piece of twaddle actually did was to take the brakes off LG spend.  And as LG revenue is non-contestable (try not paying yer rates and watch the caveats pile up in yer land title...), getting the dosh is assured.
 
This was all meant to be controlled by the 'consultations' around the Long Term Plan (used to be the LTCCP) but in practice, most submitters to this intimidating document, come with their hands out for more lovely Other Peoples' Money, not to argue for restraint.
 
And most Social and Cultural spend is on events and staff - the public love the former (a lot of events are Free!!!  ) and it's bloody hard to wind down the latter.  So there is a baleful 'coalition of the entitled' to misquote Mancur Olson, which acts as a ratchet behind such spend - always up, never down.
 
It will take legislative change (perhaps, hint, by prioritising ABC - anything but Cultural (and Social)) to turn this tanker around.
 
I'm not optimistic....

Me neither because the humbug from govt amounts to just that...utter twaddle. Greece here we come with LG bosses on two million pa each, for 4 hours 'work' a day and the debt levels beyond 200% making the piigs look prudent. Every town a high rise parking building and a sport complex plus a theatre and whatever else the 'busy' LG staff can dream up.
And we have to read garbage about govt being mates with the RBNZ....enough to make you spew.

Bernard, here you are somewhat naive. Judge by deeds not words; the NZ economy generally is riven with monopolies, oligopolies and statutory barriers to entry  stifling competition (even in retail, the freest sector, encumbents regularly use the RMA to fend challengers off). Utilities and all government costs are and have been for years right out of control. That's a big cause of how we have ended up with the worst of both worlds - high cost of living and low wages. One would expect this from weirdo Fabians/Labour but National's hands are and continue to be just as dirty.
Ergophbia     

The problem with this sort of sensationalist prophesying is the assumption that CPI, tradable or otherwise, is the metric of concern when setting the state determined O/N interest rate.
The success of this policy determinant is based on what assumptions and outcomes that are consistent with avoiding price gouging, we forever endure?   

"Finance Minister Bill English today further pushed the case for some of the Government's controversial moves ahead - part sales of state assets, welfare reform, and tightening spending in the public sector.
And he used an argument about fear of debt to advocate for the unpopular SOE sales.
In a speech to an Auckland Chamber of Commerce and Massey University lunch he challenged opponents of the SOE floats that will begin this year to say how they would fund their capital programmes."   herald.
 
http://www.nzherald.co.nz/nz/news/article.cfm?c_id=1&objectid=10787494
Did he indeed. Just don't hold your breath expecting any reduction in govt waste...or indeed local govt waste. "Fear of debt"...are we to believe that English and Key et al have only recently woken up to the financial chaos that has many many years to run. Or have they played the role of telling lies to the public for too long about recovery and growth and job creation!

Bill, how about admitting that the country couldn't afford the tax cuts, it was a dumb move.
If I was PM for the day I would:
- reinstate income tax to the levels it was, and go further and increase at higher income levels
- Reduce WFF entitlements by circa 20-30% 
- Cut back the govt bureaucracy (Bill's at least got that one right)
- Get rid of interest-free student loans
- Reform superannuation entitlement (off the Nats' agenda because of Key's silly pre-election promise)
All income earners would feel some pain from this, but really the sacrifice is minor in the scheme of things. But the fact that all income earners would feel some pain is a good political reason why none of this would ever happen, hence the fantasy
So we'll just kick the can further down the road, sweet!  

Bernard - are you saying you disagree that energy is needed to do work? Perhaps you could come lecture to the Physics Dept, write a book or something.
 
Locak Govt uses energy. Housing uses energy. All services are pretty much oil-based these days - plastic pipes, digger-laid. Houses are just masses of enbedded energy.
 
Up the 'price' of energy, faster than you up incomes, and you get rates and housing rising faster too. Lengthen the supply-lines (think army campaigns, Rommel vs Auchinleck etc) and you up the embedded cost per house, street, or front-line soldier.
 
Seriously, you can't keep being blind forever.

Oh - and energy will have to fund a private dividend commensurate with keeping the few ahead of inflation at the expense of the many. It - electricity - will also be asked to displace increasingly-harder-to-get oil in particular, and it's cheapest/easiest generation options are the sites already developed.
 
Electricity prices will run ahead of inflation from here on. It's what we've been saying for a while now.....   

The elephant in the room is the cost of building materials caused by monopoly or duoploiy supliers.  Australia has a lower cost of building despite wages being over 30% higher (some tradies get 100% more in Australia).  Go figure.  The cost of building has now risen so high that people can no longer afford to build.
The government is either too gutless or corrupt to address this one, but it is still doing it's best to increase demand with new immigrants..

ChrisM - conventional materials are never going to be cheaper, they're embedded energy too. You can, of course, build smaller. We seem to forget that, just calling a house a house and forgetting the cottage to McMansion trend.
 
Equally, it is still possible to build an entirely satisfactory house for sod-all using currently-produced materials.

Andy,
Being on a LA as a Councillor, I can assure you that nowhere near 70% of our budget is on staff salaries and wages.
The biggest issue facing all TAs are the requirements being imposed on them by the regional councils which have mostly in turn come from legislation in Central Government.
The most cumbersome of this ironically imposed by Nick Smith in his former portfolio.
The new drinking water standards which need to be met in the next few years,the tougher wastewater treatment discharges etc have resulted in tens of millions in extra work in our district with no option but to be done.
Some of these plants had been operating for years with no issue.
The capital cost,borrowing,depreciation and increased operating costs are driving yours and mine rates up.
Rodney Hide came onto the scene three years ago with the same bluster and once he got his head around the whole story of what local government does he most certainly become more understanding and receptive to our cause.
I think most people in some form of recent weather or natural disasters now have a better idea of just what the local council does these days and is more appreciative than our politicians using us as whipping boys. 

giddyup, I think generally there is widespread support/acceptance for cost increases associated with initiatives that improve the natural environment - and I believe the standards being brought in are based on WHO and other such recommendations - so it's not like NZ has adopted guilt-edged standards for discharges to water and water quality.  Poor wastewater treatment, for example, is I believe one of the main culprits in the Lake Taupo water quality problem.. so these things must be improved.
 
The expenditure that is largely questioned relates more to (as waymad points out) the social and cultural aspects of LG expenditure.  This may not equate to a large percentage of overall costs - but then most rates rises are in the order of 5-7% per annum and trimming that back down to the rate of inflation isn't a big ask either.  It's a matter of priorities.
 

Yes Kate,
That may be true for some Councils,but overall for all New Zealand non core spending has declined from the heady days of 2008 as a % and in real money terms down now to around 15% of total spent.
Also,in comparison to the CPI the Council costs are more concerned with these non tradeables which are generally higher,unfortunately the lower vegetable prices have little value for a Council.