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RBNZ's McDermott talks about monetary policy decisions, but is quiet on current conditions; says RBNZ using committees more in OCR decisions; says regularly researching drivers of surprisingly low inflation

RBNZ's McDermott talks about monetary policy decisions, but is quiet on current conditions; says RBNZ using committees more in OCR decisions; says regularly researching drivers of surprisingly low inflation
John McDermott, Assistant Governor, RBNZ

By Bernard Hickey

Reserve Bank Assistant Governor John McDermott has given a speech on how the Reserve Bank makes its Official Cash Rate (OCR) decisions, but has steered clear of giving any guidance on the Reserve Bank's next decision on August 11.

Since the last decision on June 9, further data has emerged showing house price inflation accelerating at the same time as the currency has risen much higher than the Reserve Bank's forecasts, effectively pulling the Reserve Bank in two directions.

Some economists and market observers had hoped the Reserve Bank would give it some guidance in the speech, given the extent of the changes since June 9, when the Reserve Bank held the Official Cash Rate at 2.25% and signaled one more cut.

"I do not intend to send any particular messages about upcoming monetary policy announcements," McDermott said in the first paragraph of the luncheon speech to the Manawatu Chamber of Commerce.

McDermott said the bank had strengthened the role of its committees in making monetary policy decisions since 2013 and now used a similar approach to that used by the Bank of Canada, whereby legislation mandated a single decision maker, but decisions were made within a committee framework.

"These changes mean the Bank now relies less on the single decision maker model," he said.

A Governing Committee, which includes the Governor, Deputy Governors and Assistant Governore was formed and was responsible for reaching appropriate settings for monetary policy.

Although he noted the Governor retained statutory responsibility for policy decisions.

This committee was advised by a Monetary Policy Committee that included several senior staff, including the Governors, and two external advisors. They worked over a nine day period before decisions.

"In the first three days of this process, the Governing Committee has discussed with the staff and MPC: current economic and market developments; an initial set of economic projections; key risks and judgements that make up the projections; and a number of alternative scenarios and policy options," McDermott said.

"This is supplemented by a range of additional information relevant to the policy outlook, including information on trends in household and business credit and unobservable variables like the output gap, inflation expectations and the neutral interest rate. Particular effort has been made over these three days to ensure a diverse range of views and opinions have been hear. The set of meetings conclude with a final set of conditional projections for the economy over the next 2-3 years and a conditional projection for the 90-day bank bill rate," said.

The Governing Committee then met on day five to reach a monetary policy decision and finalised it on day eight, the day before the OCR announcement on a Thursday.

McDermott said the bank always made forecast errors, reflecting uncertainties in the current state of the economy and its outlook.

"For example, the vast majority of forecasters were unlikely to have been able to accurately predict the sharp decline in oil and export commodity prices that occurred over 2014 and 2015 – one factor that has led to current low inflation," he said.

'We were wrong, but less wrong than most'

He said the bank's forecasts had been inaccurate since 2010 because CPI inflation had been weaker than forecast and the New Zealand dollar had been stronger.

Over a period of 8 quarters ahead the mean forecast error had been 1.13% for CPI inflation and 5.86 points on the Trade Weighted Index (TWI) measure of the currency, he said.

The Reserve Bank's forecasts had performed better than benchmarks of other forecasters.

"This suggests that there were no obvious major sources of new information that the Bank could have used from these benchmarks in its decision making," McDermott said.

"Overall, the Bank, other forecasters and the Bank’s statistical models did not foresee the persistent weakness in inflation or the persistent strength in the New Zealand dollar," McDermott said.

"Despite this, the persistent period of weaker-than-expected inflation remains a focus for the Bank. Low inflation has been a common experience in most advanced and many emerging economies. The Bank has shifted its resources in recent years towards more fully understanding this low inflation environment, and this is a strategic priority in the Bank’s 2016 Statement of Intent."

(Updated with more details)

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Why do you think inflation is consistently low rbnz?

Gee I can tell you - you don't include housing costs in your basket of goods when deriving CPI

The private sector is therefore constrained by how high it can set prices.

These guys are supposed to be economics experts? I'm gobsmacked

And what do you think the largest item of household expenditure is for NZers - yes, it's housing costs

ahhh... Housing costs are most definitely weighted in headline CPI calculations..

you got to wonder how they're calculated given rapid housing inflation and that it is most peoples' biggest cost

mmm, no, not really...What you gotta wonder is:
- if any of these commentators understand basic mathematics
- If anyone actually reads about what the Stats NZ and RBNZ indicies actually measure.

the weightings for housing do not match what is spent from peoples pay packets, it is high time they were reworked, housing only makes up 24%

They were reworked less than 2 years ago. If they are revised upwards, it will be by a percentage point or so, which is likely accurate.

Remember, when we talk about headline CPI, we don't only talk about the inflation of prices in Auckland, Wellington or Christchurch. It is a weighted measure for the whole country.

People are getting poorer and poorer because their biggest cost, housing, keeps rising far more rapidly than their incomes, but wow there's never any inflation. Math needs a very close inspection. May be the weighting, as you say sharetrader

You didn't even realise that housing was included, so your comments on what needs inspecting in CPI doesn't carry any meaning on this topic.

With the crash in the price of oil and other commodities a lot of stuff has got a lot cheaper, largely offsetting the rise in other costs, such as housing.

It's not that complicated.

thing is math club i assumed housing was under represented might want to ask yourself why the price of other things are falling...could some of the reason be people can't afford them, and in NZ that could be in part because of housing? 

You argument assumes no interralationship between spending categories when the reality is we all make tradeoffs depending on how much money we have

very crude calculation on petrol costs alone. We used to spend about $600 a month and now it is about $480. That is $120 a month saving. If I was paying $500 a week in rent, you could put my rent up 5% and I would still be better off. That isn't factoring in the affect to prices that lower fuel prices has. There are a lot of things that are cheaper now than before. A lot of smaller things can add up to make a big difference. Other thing to factor in is that interest rates have dropped so the outgoings per week will not have increased to the same level as the purchase price of a house. A $390k mortage at 6.9% (about what I paid 5 yrs ago) costs about the same as a $525k one now at 4.25%.

daveb1978 i accept there's some validity in what you say, at the same time i know people that can afford very little because their rents or mortgages are so costly now, not by choice, they have to spend less...less demand, then you get lower prices

What does Inflation do if we raise Interest rates, assuming mortgages have increased from 390k to 525k?

Have a look at where the house prices are rising (not by much in most places) and also consider that a lot of people in NZ do not have a mortgage. Ergo the initial purchase price doe not effect a % of NZers CPI.

Also consider what you want to achieve when you measure CPI and the devastating effects you will unleash on SME's, employment and peoples lives (loss of their home) if you try and fight imaginary inflation with OCR rises.

Exactly! should be double that.. 50% is more realistic...

50% of income going on housing costs as an average across the country is not in any way realistic.

For many people it is very real, especially in Auckland.

Yes, about as realistic as Willy Wonka or Alice in Wonderland.

You are saying that the average New Zealander spends 50...yes 50%!...of their income on housing?
I would be very surprised if even in Auckland this was the case.
We are in serious trouble if that is the case for the whole of New Zealand.
Luckily we have skilled economists and statisticians who can identify that this is not the case.
In fact you, too, can by looking at readily available capital stock data and using some basic deductive prowess.

auckland would be very much so around 50% as an average, a lot more renters than the rest of the country also as the population of auckland area makes up around half the population of NZ you would expect the weighting to be higher than 24%. i would have thought in the 30's by now

Okay, I understand what you mean by 50%/"half".
Because 1.5 million is 50% of 4.5 million.
All sorted. I agree with everything you have to say on the topic of statistics now.

I have seen 80% nymad.

..and I have seen 5%.
Does that mean the average in New Zealand is 42.5%?

Alas two examples, a sample does not make.
We are talking averages. Just think about what you are saying.
In order for the rate to be an average of 50%, assuming 33% of households spend 25% of net income on housing (probably a very conservative figure) the remaining 67% have to spend 62.3% of net income on housing.
Sorry, but I just find that hard to believe. Sure it is the case for some, but not the majority.

The statement you made was

"You are saying that the average New Zealander spends 50...yes 50%!...of their income on housing?
I would be very surprised if even in Auckland this was the case"

merely pointing out fact nymad that i have seen 80%. Not averages, not medians.

No, they are not. Rents are, Not housing costs as average at all. They were removed in the early 90's by Jenny Shipley's government. So... stop with the assumption and bs.

The original statement:
"Gee I can tell you - you don't include housing costs in your basket of goods when deriving CPI"

Nothing about 'second hand housing costs' in that statement. All other housing costs are included in the CPI; new builds, rental, R&M, etc.
It was just a blanket statement that 'housing costs' are not factored in CPI, which is incorrect.

Since you know so much (little) about the inclusion of housing costs (and 90's politics) you would also understand that it would be completely counter-intuitive to include an asset class (or in this case also already consumed goods), which is what a second hand house is, in a CPI measure. I originally wanted to point this out, but thought it would be completely lost on the target audience.
It turns out I was correct..

The RBNZ is completely out of touch with middle NZ and SME's and that is why they cannot get it right.....
Too big to get out of their offices and see what is happening in the real economy and being reliant upon measuring after the transactions have taken place......if you don't have your nose and ear to the ground then of course you will get it wrong time and time again!

bang on notaneconomist.

I have serious concerns about this outfit - they seem to have absolutely no grasp on how the real economy ticks.

Suspect JK and Co. are worried too but what the hell do they do at this stage of the cycle?

Vote of no confidence?

Override them?

Legislate further?

All a bit late now

Yes... Because what we definitely need is more John Key-esque "well, I was just talking to notanaeconomist the other day and he said "the economy; ohh, not good. The Reserve Bank; oh not good.""

I can't believe you people are actually ridiculing the RBNZ for being responsibly prudent by basing their policy signals and decisions on robust hypothesis testing, using reliable data.

Sure the results aren't perfect at the moment, but their approach is far superior to your suggestions of policy analysis founded on anecdotal evidence.

I find this (i.e. policy suggestions founded on anecdotal evidence) a trend around here...maybe such a trend is anecdotal too.

The test based on hypothetical models, the models are only as good as the person that writes them. Clearly their models are lacking, which means the person that wrote them is lacking.

Agreed. There is always room for improvement.
But, to put your concerns to rest - having seen the main DSGE model and forecasting tools myself, I can assure you that they aren't the kind of thing one person writes.

By all means though if you have any ideas as to what else the RBNZ can do to improve its models, let them know. One proviso though; they kinda like a bit of robust theory to underpin any changes (crazy, I know), so don't forget to provide that.

It is rather obvious you have no skin in the game nymad.........there is no cherry picking data in my office I live in the real world of production and that means it is my arse on the line if I get it wrong........and I don't see why my arse should be on the line for mistakes/errors/acts/omissions that the bureaucracy make continually!!! When they are given a PTA and then further told to get on with it by the PM then business expects them to do exactly that......businesses that cannot adapt quickly to the bureaucracy don't get too far in this world.

I am gobsmacked. Clearly inflation is low because there are strong deflationary forces pushing down the price of tradeable goods particularly manufacturers. As developing countries enter various markets the competition pushes down prices. It has been happening for years and years. Examples stretch back 30 years (cars). Whats to be surprised about here. If any forecasters methodology results in error distributions that are biased (over forecasting inflation for 5 years for example!) then the forecasting methods need adjustment Are these guys incompetent or what? As for the argument that others are worse what a load of s...t. The RB has the money to build the largest forecasting models in NZ and as a result the banks and others tend to coat tail on RB forecasts. Do better guys - this is embarassing.

Actually the problem is a new phenomenon IMHO. Just consider one thing first, most people I believe are seeing no wage increases for years so they have no more money to spend. So from that meanwhile the non-tradeables like rates, power, fares etc are going up at 4~5%. If people have no more money in their wallets and are tapped out on credit that means they spend less in the tradeables sector which causes them to contract and we see 2% deflation there.

"The RB has the money " it also has the blinkers of economists not understanding how the price of oil (ie Peak oil) has changed everything. So what we are going to see is the non-inflation carry on like this for a few years until such time as oil output per day drops and demand see's its price rise which will finally tip the entire [global] economy into a Depression IMHO.

Your comment on wages bears no relation to reality. Wages are rising and have done for years.

Your comment on power also doesn't match up with the data. Power prices haven't risen by 4-5% for a number of years and in fact have fallen over the last year.

What's in you head just doesn't match the real world.

which power company are you with mine has never gone down.

I would be very interested to know if there is some stratified data on wage increases. I realise it is anecdotal, but from many people I've talked to over the last few years I suspect almost all wage increases may be concentrated at the top wage brackets, with many people on middle/lower wages seeing no improvement in around 7 years now.

I think that now RBNZ will now act on 11 August instead of talk.

The appearance of quantitative easing was all Milton Friedman, as he had written about the general idea as far back as A Monetary Theory in 1963. In 1998, he famously admonished the Bank of Japan for what he called the "interest rate fallacy." They were, he believed, confusing low interest rates for loose monetary conditions. History recorded the opposite in clear and convincing fashion. Richard Nixon's "shock" of 1971 and the rest of the decade did not occur under low interest rates at all, rather they would move only in the other direction. The Great Depression, by contrast, saw an unending trend of nothing but ultra-low yields and rates. Monetary economists were, by the 1990's, utterly confused.

They still are, apparently. Interest rates in 2016 all over the world are also heading in only one direction, and it is not the direction that we need. Yet, it is reported everywhere in the media from the mouths of central bankers that this is "stimulus"; that is, after all, what QE is believed to have been all about. The goal of the monetary intervention is to buy bonds and lower the interest rate; that there are now much lower interest rates seems to suggest QE's success, or at least that conditions are now even that much more "stimulative."

It misses a central observation similar to what afflicted Nixon's thinking that wage and price controls would somehow alter the Great Inflation into general prosperity. Even assuming that rates are reacting to central bank transactions overall, the very fact that it has to be repeated over and over, pushing rates lower and lower, still suggests a further overarching cause. It still adds up to Friedman's interest rate fallacy.

The incidence of low rates as a longer-term phenomenon is exclusively associated with "tight" money periods - in the real economy. QE by theory is supposed to be a temporary condition, where the assumed "liquidity effect" of lower rates in the short run are effective such that interest rates then rise over the intermediate term (also creating an orthodox conundrum of assumed efficient markets to be dealt with by "forward guidance" in its original form). It is this later "income effect" that QE is after. Read More

It is intriguing that nearly all central banks are following similar ultra low interest strategies, pretending they will increase inflation, despite now years of evidence to the contrary, across many many markets. It makes you wonder whether they are all completely stupid, whether they have another agenda in mind, or whether they just follow the herd in order to be seen to be doing something.
I suspect a mix of the latter two elements, given it seems unlikely that most are in fact stupid.
So what agendas are they following: I suspect two. Namely to kick the can down the road for their banks and financial institutions, which generally have captured the central banks. Ultra low interest rates let everyone hide bad loans. And to keep their exchange rates competitive, which at a national level most countries deem to be important, for good reason, but I gather international convention suggests shouldn't be overtly targeted. A couple of countries- Switzerland and Japan come to mind- have also seen the opportunity to buy up for free vast swathes of global assets with their version of printed money.
So how does the RBNZ compare to a motley band of disingenuous global central bankers? One senses the RBNZ understand the folly of going ever further towards zero interest rates, so you could give them a modest tick there. But keeping above everyone else is destroying the exchange rate competitiveness, without the RBNZ even publicly contemplating any other monetary tools, has to be a fail. Similarly their failure to even get close to their inflation target, again without thinking of other tools, is poor to say the least. On this will Mr Wheeler be the first RBNZ governor to never once make the target?


Yip, print money and grab as many of the world resources and assets before the whole house of card comes down. Thats essentially the only game left. Growth is dead so inflation is dead. All statistics are now meaningless altered numbers to keep the facade up (eg US unemployment, growth, stock markets) ...
The RBNZ is powerless without the govt also doing something to prevent NZs assets being gobbled up ... which Shonkey doesnt give a rats about.

Just print it and spend it locally, why borrow or lend..

Switzerland and Japan come to mind- have also seen the opportunity to buy up for free vast swathes of global assets with their version of printed money.

In Japan's case this is certainly so - but it comes at a price. Japanese banks sourcing scarce USD funding for foreign investments in exchange for overflowing central bank located ledgers of printed QQE yen have created an unexpected demand for the USD/JPY pair to purchase negative yielding Japanese sovereign debt. Of course, I refer to cross currency basis swaps which I have mentioned on previous occasions, including yesterday.

The two-year JGB that yields negative 0.36 percent earns 1.4 percent if dollar funds are used to borrow yen. That's 80 basis points more than the yield on U.S. Treasuries of similar maturity. Their perverse attractiveness could pull more foreign money into Japan's negative-yielding notes, pushing their already elevated price even higher. Read more

Stephen, always good links, and I did read that yesterday. No doubt there is a cost; but who bears that cost? Is it not the overseas investors? In the meantime Japan keeps their currency competitive; has nil or negative cost government debt, and is buying up trillions in domestic and foreign assets. Even if their government is bearing this cost, the other benefits appear to me to outweigh any such cost by far.

The Japanese banks wear the negative basis cost and reward the USD lender. In addition the negative basis draws third party bond buying speculators towards domestic Japanese sovereign debt - hence recent USD/JPY strength, before last weekend's election result. The eurodollar debt rollover costs are a definite negative for the Japanese economy which has built a very significant foreign empire funded beyond their own currency.

Inflation is low because people are cutting down on real expenditure in order to pay the interest on their inflated (yes thats an intentional pun) house prices. Oh and fixed incomes have fallen with ocr cuts. High indebtness is reaching saturation so low ocr will do nothing to spur "real" economic growth

bingo, i think thats whats happening too quality guy...and should we look at how we report inflation and cpi, as housing costs sucking the rest of the economy dry e.g. essentials like housing and food given a higher weighting

Sorry, how have fixed incomes decreased with OCR cuts? Are you talking in real terms, or nominal?

I'll give you a quick low down on the CPI - it represents items that are consumed. More importantly in this case, it includes all housing costs, bar the cost of purchasing second hand houses. There is a simple reason for this, the products consumed to make this house have already been factored into a previous CPI measure. Additionally, there is no consumption associated with the purchase of a second hand house, hence it would be counter-intuitive to include it in a consumption index. Its the same reason we don't include speculative bullion in the CPI, along with some paradoxes that might occur if basing overnight rates on the nominal value of long term assets.

Stephen... what you describe will certainly impact superannuation funds worldwide. We all know that wen its time to retire the money wont be there. Low yeilds are a disaster in the making for pensions. So lets borrow our way to retirement. Ha most people have no idea wots gunna hit them.

Do you think jk knows whats gunna hit us? Hes a smart guy. So wots he doing with his own cash? I bet u its being moved out of nz in anticipation of a currency collapse. Hes a master at this. Its in the interest of his mates that this sham goes on. Plenty of yen and usd to buy yet before they are derisked eh

I have been asking why inflation has not been higher given QE and this leading to higher prices with "too much money chasing too few goods". There is an interesting theory proposed in the "Seventh Sense" that QE exacerbated the problem in that the money did not go to consumers who would have spent it and grown economic activity from the multiplier but to the wealthy who dont spend it but save it. Money also went into increasing productive capacity. On the supply side investment and orders moved to countries with lower wage rates so supply continued to match demand, hence not the expected price rises and the continuing malaise of westerners feeling the working mans blues caused by minimal wage rises etc. Worth a read

Steve Keens modeling predicts that if private debt grows much faster than GDP there will be a crisis. A high level of private debt also leads to a fall in the income of workers, and that's independent of whether the workers have mortgage debts or other debts. Quite interesting that there a transmission mechanism which sucks money from workers to the finance sector which is independent of whether the workers themselves hold debt.

Reserve Bank governor took a chance reducing interest rates several times and look at the results with still increasing NZ dollar, increasing house prices and creating problems with deflationary wages. Better to subsidise the farming industries in the interim whilst there is plenty of cheap money around.

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