Rodney Dickens says current official forecasts are tainted by wishful thinking and take no account of policies that will boost wage inflation. OCR cuts and fiscal stimulus will boost growth so that the labour market will be tighter next year than now

Rodney Dickens says current official forecasts are tainted by wishful thinking and take no account of policies that will boost wage inflation. OCR cuts and fiscal stimulus will boost growth so that the labour market will be tighter next year than now

A major finding of research of international interest rate behaviour I did at the Bank of England was that recent experience excessively influences people's expectations about the future.

In terms of the case for fixing debt, the experience over the last decade has been that shorter-term fixed rates have resulted in cheaper interest costs than medium-term and long-term fixed rates. 

There have been good local and global reasons for this. However, ideas based on recent and in this case not so recent experience, often end up failing. In the context of having been pretty much the only economists who forewarned of the large increase in interest rates between 2004 and 2007 I see quite strong parallels between the unfolding OCR cuts and the cuts delivered in 2003 that were followed by 13 OCR hikes between 2004 and 2007.

I'm not suggesting interest rates will increase over the next several years as much as occurred after the misguided OCR cuts in 2003. But the parallels are strong enough for borrowers to start thinking seriously about them and the implications for fixed debt.

Implications of recent experience overly shaping expectations about the future 

In the mid-1980s I spent 19 months on secondment from the Reserve Bank at the Bank of England in London - the UK central bank - researching interest rate behaviour for six major countries. The research focused on the behaviour of long-term relative to short-term interest rates. The result was a couple of research papers; the findings from the first one I nervously presented at an international economics conference at Oxford University.

One of the major findings from the research was that the experience of the last several years has an excessive influence on expectations about what will happen in the future. This can be shown in the context of the NZ interest rate cycle last decade that I see as having considerable relevance now.

Immediately before the large increase in interest rates between 2003 and 2008, long-term rates were not much above short-term rates. This is shown in the first chart below for 5-year versus 1-year fixed mortgage interest rates and in the second chart for swap rates that are relevant to corporate borrowers; highlighted by the two red arrows.

Long-term interest rates are largely driven by the market's expectations about what short-term rates will do in the future, that can be impacted by overseas factors, while short-term rates are market-led but are largely linked to the OCR. What this highlights is that just before the start of the huge increase in interest rates last decade the market didn't expect there to be much if any future upside in the short-term rates and, by implication, the OCR. The market's expectations about what would happen to the OCR were hugely off the mark.

It was the same story when it came to the economic forecasters. In March 2004 after the first OCR hike in January 2004 the Reserve Bank predicted little future upside in the benchmark short-term interest rate and twelve forecasters surveyed by NZIER on average predicted no upside over the next two March years (green and blues lines, respectively, next chart). The most hawkish of the 12 forecasters predicted that the 90-day bank bill yield would average 6% by the 2005/06 March year when it ended up averaging 7.3% (red line, 2nd chart).

Just like the market, the economic forecasters had no idea that a huge increase in interest rates would occur over the next several years. This was partly due to low quality analysis by the economists but to a large extent it was a by-product of the experience of relatively low interest rates by the standard of the day over the previous several years.

There are parallels with the OCR cuts in 2003 that should be ringing warning bells

As covered in the June Economic Roadmap report (see the special offer on the cover page), there are significant parallels between the experience last decade and what is likely to unfold over the next several years. The obvious one is that the low level of interest rates not just over the last several years but over the last decade will be heavily influencing the market and economic forecasters' expectations about the future. And now as was the case then the economic forecasters are justifying expectations of little future upside in interest rates using dubious inflation forecasts.

This is most notable in terms of the wage inflation forecasts. The first chart below shows the Reserve Bank's March 2004 forecasts for the unemployment rate and one measure of labour cost inflation that were used to justify predicting little future upside in interest rates. Assuming away the wage inflation threat didn't stop it from occurring nor did it end up standing in the way of a huge, market-led increase in interest rates.

The Reserve Bank is back at it in terms of trying to assume away the current wage inflation threat. For a number of years wage inflation hasn't increased much despite the Reserve Bank predicting upside but the labour market is now tight enough for it to be the other way around. Now increasing the wage inflation threat are a range of government policies, the Living Wage Movement and decisions by the Employment Relations Authority (as detailed in the June Economic Roadmap report).

The next chart tells the recent story about the Reserve Bank being back to assuming away a wage inflation threat at the very time it should be starting to focus on it and lean against it.

Following the introduction of full employment as a target of monetary policy in addition to the effective 2% target for CPI inflation the Reserve Bank started to include more detailed analysis of labour market prospects in the Monetary Policy Statements. This included forecasts for private sector average hourly earnings inflation shown in the next chart.

In August 2018 the RB predicted an imminent, large fall in hourly earnings inflation that didn't occur (the gold line). In February 2019 it predicted a smaller imminent fall that didn't occur while it continued to predict a downward path (green line). Most recently it predicts a huge fall in hourly earnings inflation next year followed by a partial rebound (blue line).

In my assessment these forecasts, like the RB's March 2004 labour market forecasts, are tainted by wishful thinking and seem to take no account of the range of government policies that will boost wage inflation and the prospect that the OCR cuts along with fiscal stimulus will boost GDP growth to the extent the labour market ends up tighter next year than it is now.

This article is re-posted here with permission. The original is here. Rodney Dickens also says: " In light of the importance of this issue that is covered in detail in the latest Economic Roadmap report I am offering the latest report to business and other major borrowers on a complimentary basis."

We welcome your help to improve our coverage of this issue. Any examples or experiences to relate? Any links to other news, data or research to shed more light on this? Any insight or views on what might happen next or what should happen next? Any errors to correct?

We welcome your comments below. If you are not already registered, please register to comment.

Remember we welcome robust, respectful and insightful debate. We don't welcome abusive or defamatory comments and will de-register those repeatedly making such comments. Our current comment policy is here.


Comment Filter

Highlight new comments in the last hr(s).

Interesting as always. Oh the wonderful view from hindsight ay? Forecasting is an industry, in fact many industries, & hindsight tends to show up our inadequacies, if indeed, we bother to look for them.
I've been budgeting for over 20 years in our small business & have never got it right once. It's great when you over-sell & under-spend, & to be fair, I've tried to do that intentionally for at least half of those years (as I've wised up) but it's still a tricky game trying to guess what's going to happen - even 1 year out, let alone more.
This year we've been caught out over-spending, which doesn't feel that great to be honest, but we have have also over-sold, keeping the actuals the same, although our %'s are down of course.
We're also lucky enough not to have any debt currently. I say that refering to the suggested truth of the above article playing out over the next year or so, which as it also points out, is quite hard to see. Cést la vie!

"...increasing the wage inflation threat are a range of government policies, the Living Wage Movement and decisions by the Employment Relations Authority..."

This to me is the key element in the Gubmint Budget which has been woefully understated. One only has to look at the domino effect set off in Vote:Education to see Wage Inflation a'roarin' down the track:

  • Secondary teachers strike, are told there's No Mo' Munny, then there is, then a satisfyingly massive wage fillip.
  • Primary teachers, smarting from the lack of relativity, and no longer believing there's No Mo' Munny, strike in turn, and are (perhaps) placated with Lotsa OPM.
  • ECE then looks over the fence and is dismayed at being the last cab off the rank. Expect Fun.
  • Primary Principals then have their turn
  • And we have not touched Tertiary, Admin/support staff in ECE, Primary, Secondary, Tertiary, or the relativities across in the private sector with ITO's etc.

And that's only one (admittedly large and articulate) sector....Living Wages to all Council contractors is another pressure building in the background. So the tyre repairer to the gravel contractor who's subbing into a road revamp gets the Living Wage? It's a classic failure to evaluate a BOM explosion.....and Councils are uniquely bereft of any economic nous whatsoever.

Rodney is perfectly correct in averring that Gubmint has well underestimated the inflationary effect of all of this.

Fifteen years ago China was still about to start bingeing on credit and coal.
Aucklanders & dairy cockies were about to start binging on credit.
Now what?
Growth is dead
Interest rates are only going one way.


Interest rate cuts will work next time. Surely.

Anything studied in the 2000’s is already irrelevant, a 1990’s economics degree is practically worthless and any study from the 1980’s may as well be consigned to the history books. What’s worrying though is that the text books they use haven’t changed and we still load kids with debt to learn models that don’t work anymore.

Any comparison of rates pre the repeal of Glass Stiegall to the period since (1997) is meaningless. The occasions that they have tried to normalise rates and the economy has had a cardiac event within 18 months. Essentially most Western nations can’t raise without collapsing housing and private debt.. increasing Credit growth and the constant trade of financial assets (which are not GDP) is essentially the foundation of many modern economies... the great debt for equity trap.

Scary but seems on the button. Das Kapital is however still a worthy read.

Debt levels are much higher now compared to the 90s and early 00s so any increase in retail rates KOs growth. Look at the last months of 18...the Federal Reserve misread the strength of the economy, and their bias to rate rises proved wildly out of line. The world is still on the brink of a major recession, and the big issue is what central banks do when they use up the reserve rate lever. So this article seems more of the same, I’m afraid. Dare I say it, Trump has had a better handle on the inability to raise rates in current conditions than central bankers.

With the extent we're now handing out nigh on free money maybe central banks (and their governments) will next have to resort to a UBI to keep people spending. It's harder and harder to move back to having money needing to chase an actual return.

UBI was always the correct policy to stimulate the economy. Stimulate it from the bottom up, if you do it from the top, you merely get a trickle down. For there to be jobs, there needs to be businesses, for there to be businesses, there needs to be customers. The labour market has been dismal since the 70's when compared to the growth in productive potential. The bottleneck is in lack of demand due to excessive inequality. Most businesses could easily expand capacity if only there was the demand.

A UBI or citizens dividend would have been the way for everybody to benefit from the development and advancement of our economies, compensation for being isolated from your nations natural resources due to quotas, mineral rights, land rights, frequency rights, intellectual property in the public domain etc. And it would have enabled the demand that you need to take advantage of the massive improvements in productive potential.

Indeed. And can add increase in oil price potential and in grain prices due to USA failing crop due to flooding. Interest rates should rise in 2020 but will they? In 2011-13 in uk central bank ignored inflation exceeding target because economy was too weak

Mr Dickens has been very careful not to make any predictions as to what he thinks will happen. I assume he believes that we will see wage growth creating inflationary pressures to the extent that the RB will be forced to start raising the OCR-and not just a little,but a lot.

Now,it seems increasingly likely that global growth is going to slow significantly and other countries will keep cutting rates. Can you imagine what the effect on our $ would be,were we to head in the opposite direction?

I will watch events unfold with interest.