Bernard Hickey looks at whether the Reserve Bank Governor is running monetary policy too tight and how long before he decides surprisingly low inflation is actually structural rather than cyclical

Bernard Hickey looks at whether the Reserve Bank Governor is running monetary policy too tight and how long before he decides surprisingly low inflation is actually structural rather than cyclical

By Bernard Hickey

Is New Zealand's surprisingly low inflation a structural change or just a cyclical thing that can be 'looked through'?

That's the question the Reserve Bank grappled with this week and it's lack of certainty on the answer is a causing exporters and businesses a fair amount of grief.

The Reserve Bank published its December Quarter Monetary Policy Statement and left it's Official Cash Rate on hold at 3.5% on Thursday, which wasn't a surprise.

It was the Reserve Bank's insistence on continuing to forecast increases in interest rates which surprised and disappointed some.

The bank's decision to keep its 'tightening bias' despite annual inflation of 1% being well below its 2% target showed it still believes that relatively strong economic growth will eventually turn into inflation.

The problem for the bank and the economy is that it hasn't so far, and it hasn't for a long time.

There are lots of good reasons beyond the Reserve Bank's control why inflation has been so weak. The 'stronger-for-longer' New Zealand dollar has helped press down on the prices of imported goods and services and those products that compete with the rest of the world.

The Reserve Bank has been just as wrong as everyone else in predicting the fall of the currency, which is notoriously difficult for forecast.

But the Reserve Bank's key task is accurately forecasting 'non-tradable' inflation, which includes prices in areas that don't compete with the rest of the world. These include central and local government taxes and rates, electricity prices, health and education costs, real estate fees, phone charges, construction costs and bank fees.

The problem for the central bank and those who hope for lower interest rates (and a lower currency) is that this non-tradable inflation is proving to be surprisingly low, given the amount of growth the economy is generating and the pressures on wages and prices that would normally generate.

All around the world, there is talk now that aging populations, globalisation of services, massive production capacity in Asia and Europe, and new labour-saving technology is pressing down on non-tradable inflation in a structural way.

Inflation hawks worry they are temporary forces and the inflation demons of the 70s, 80s and 2000s will return.

The doves think this low inflation -- and maybe even deflation -- is here to stay and interest rates should accordingly be set lower.

Long term interest rate markets, which are not set by central banks, have certainly placed their bets on this low inflation being structural. 10 year bond yields in Japan and Germany are below 1%. They are below 3% in the United States.

The Reserve Bank itself mused on this puzzlingly weak non-tradable inflation in its Monetary Policy Statement in a special analysis box. It acknowledged that the uncertainties about whether this was a structural or cyclical issue could mean it was over estimating inflation.

That matters because when the Reserve Bank over-estimates inflation it tends to run interest rates too 'tight' and drive inflation below its target zone of around 2%. This is the nub of the matter.

Getting that inflation forecasting wrong enough for long enough will eventually turn into a sackable offense for Reserve Bank Governor Graeme Wheeler because inflation will end up being lower than his target of around 2%.

The Reserve Bank's own forecasts show that annual Consumer Price Inflation will have been under 2% for 5 years until September 2016. The highest it rises to in its forecast track is just 2.1%. That's a long way from 'around 2%'. It's almost completely under 2%.

The Bank knows this is serious and is therefore looking again at its forecasting models to try to get it right.

"Research into what caused the inflation to be unusually low continues," it said in ending the analysis box.

Governor Wheeler is coming under increasing scrutiny about whether he has run policy too tight given the 20 consecutive quarters of inflation being under the 2% target.

The New Zealand dollar's 1.4 USc rise on the morning of the Bank's reiteration of its 'tightening bias' emphasised those concerns, particularly in a week when Fonterra slashed its payout forecast by 11% to an eight year low.

Businesses, unions and exporters are rightly wondering: where is all this inflation the you keep warning about?

Why are you keeping interest rates so high? How long before we can say that this low inflation is structural rather than cyclical?

No doubt, the Reserve Bank is scrambling for those answers too and Governor Wheeler will want some more certainty on the answer well before the end of his first five year term in 2017.


A version of this article first ran on the Herald on Sunday. It is here with permission.

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Don't blame Wheeler.
Blame Key and English for allowing the fiasco to develop as a help to avoiding governing.
When just about every other Anglo country has used QE to push their own competitive advantage we stand aloof and godlier than them.
All we do is cause ourselves grief.

No, Wheeler and the RB are failing to see there is a new paradigm of expensive energy's impact on the [global] economy and its going to be like that and indeed worse as time goes by.
So the OCR needs to be structurally lower from now on and counter-cyclic to energy costs to try and compensate for it.  If that doesnt happen and the RB raises the OCR to counter "inflation" caused by rising energy prices it will be a double whammy, unstable and of severe consquences IMHO.
JK and BE are of similar outlook and we can see equally wedded to a broken digma, but then so are Labour.
To stop the mad investment in property the RB and Govn need to deploy other tools like the LVRs of this world. A CGT and removing tax deductions for property on PAYE for instance, otherwise we are cooked.
cider gravy anyone? do baste yourself well.

Excellent article by Bernard. 
Interest rate settings have little impact on Auckland house prices so raising rates on those grounds appears futile. 
Demand driven inflation does appear to be dead. 
What little inflation there is is coming from monopolies/duopolies who increase prices regardless of their customers - local bodies, electricity providers, etc
wage and salary growth (outside of senior management) sits around 1.2%, and no Union or employee lobbying power
Household and farm debt is still high, with little ability to survive significant interest rate increases, especially newer borrowers who started at 5 or 6% 
Govt budgets for all govt depts and publicly funded Orgs are all on a sinking lid policy and are facing large deficits and under funding for 2015. 
More deflationary pressures from the Govt.  
The Govt and RBNZ are doing a good job in driving deflationary pressures - perhaps this is. Globally approved imperative? 

Surely in a credit based money supply the correct measure for inflation is the rate of the expansion of credit. M3 money supply is essentilaly the same thing so will also suffice.
Looks to be trucking along quite nicely at about 6% for the last four years, question is where is it all going?

Returns to capital rather than labour?

Just the sort of penetrating question I expect and like from you, it sharpens my thinking.
My time is short today but I will throw some speculators out to start the ball rolling, trick is knowing where to look I suspect. Perhaps velocity is dropping? Real Estate (in aggregate) could account for some, but not all. Debt servicing, which would also affect velocity as would investments. But any class that lowers velocity means more credit has to be created elsewhere to make up the shortfall, so isn't likely the answer. Government spending, both local and central perhaps? That should be easy to find.  Is this close to what you were thinking?

returns to Capital rather than Labour.....    That is the simple truth...
The irony is that if it was flowing to labour  ( higher wages)...  the Reserve Bank would be fighting that... tooth and nail..  ie.. much higher OCR
Simply...  If M3 is gowing at 6%  but average wages is only growing at 3%....   then the effects of that money supply growth are most likely being  manifested, more in  assett price growth..??
the double whammy...   is that all the costs that affect ones standard of living.. go up at higher rates ..than wages...

Why low inflation?
How about:
Still elevated mortgagee sales -
 "Auckland mortgage broker Steve McGowan specialises in assisting people facing mortgagee sales. "People are still hurting out there, so I am very busy, which is not a good thing," he said."
Household debt levels that are still eye watering -
Add to that a Loanable Funds glut (with corresponding falls in TD rates) and mortgage credit growth now under 5%p.a.
Despite claims to the contrary, there is plenty of evidence consumers can't/aren't/won't consume like they used to.
Throw in a positive oil supply shock with negative short-run inflation implications, and there you have it.

A well articulated response Mike. A credit based system works until somebody can't pay. I also doesn't work in reverse.

Yes very hard to control when usurary is legal. (yes, technically an etymological contradiction).

Leverage allows capital to work at very thin amounts and often those unwilling to calculate the problems out long hand, fail to understand it's nature.
   What also makes it hard is the (I hate the term is this usage) unearned income means that multiple tranches can be setup with small returns, without too much diminishing return*.
In fact, having setup one or more leveraged tranches, it is often easier to identify more opportunities, unlike labour where increasing the time sold becomes harder.

  * ie one can setup up two or twenty projects with modest returns but because one doesn't lose "hours per day" even more can be setup up, there is no particular physical maintainence limit; unlike labour where the high pay rate for labour vs low rate creates great inequality, as both parties have real limit to how long they can work each day.

Or visa versa - low interest rates are causing deflation in prices.
Cheap money flowing into what would otherwise be marginal investments (e.g. shale oil, ship builders, dairy conversions) are raising production beyond the markets need. Some of these junk bond outfits have been getting money at sub 5% rates.
These central bankers have a lot to answer for - dicking around with things they don't fully understand.

These central bankers have a lot to answer for - dicking around with things they don't fully understand.
Yes indeed,  ...the [so-called] Ph.D. standard [that runs our world] Source

With Christchurch house prices stabilising and lower dairy payouts, Auckland house prices seem to the only reason to keep the OCR where it is with the idol threat of raising it.
 Why not have a two tier system where the countries most accelerating areas ( currently ack housing ) would have an appropriate OCR and the rest of NZ had its own OCR.  Areas could be  moved in and out of the different tiers as deemed fit.
 Simply Ignoring the obvious two tier house price inflation we currently have is not a solution.

The problem with a two interest rate system is that money is fungible, So we'd need two currencies to make it work.  I don't think it will be an overall benefit to NZ if we give auckland it's own currency.

How about only applying LVR rules to Auckland.    Seems unfair to burden a FBH in Dunedin becasue of Aucklands housing issues.

If prices are that much lower in Dunedin than Auckland, the FHB should not have any issue getting 20% deposit together.

Because I'd leverage my out of Auckland property to buy Auckland property with the lower rate. Am already seriously considering refinancing my mortgages in a foreign currency with a lower interest rate.

The bank's decision to keep its 'tightening bias' despite annual inflation of 1% being well below its 2% target showed it still believes that relatively strong economic growth will eventually turn into inflation.
Funnily enough, the term (ie 12.349 yr (based off the 15/04/27, 4.5% NZDMO notes)) breakeven inflation rate stands at 1.8024% based on Friday night closes for the interpolated duration matched 25 and 30 year linker yields.

NZ's surprising low interest rates?  Compared to rest of the world my 7% - 24% is quite high.

Which NZ are you living in Bernard?

Bernard's in the NZ where socialists and corporate welfare join hands and demand free money. He'll be a list MP within a decade.

He is living in the NZ of surprising low inflation.  Try re-reading the article.

You're right.  I re-read it several times before I posted, I must have interest on the brain.

As for the "surprising low inflation".   Well doh... your economy is tanking in most of the country, what does he think the inflation rate is going to do.

At least in Auckland there's spending money from foreign property sales, and commissions flowing around  but for the rest of the country it's desert material.  And as long as Auckland and everywhere else are assumed to have the same forces and pressures it's going to keep going worse.

Tight monetary policy and ongoing threats of tighter policy, and tight govt spending is driving Zombie Towns Syndrome in the regional areas. 

All the usual money guys are here - can we get a couple of genuine fair-dinkum manufacturers and builders on here to put their bibs-worth in
Talkin' to a builder this week who said his building costs have risen by 10% in this current calendar year which is not yet 12 months old
Sure, the cost of large screen TV's and iPhones and gadgets and other stuff has gone down
If you are renting and want to get your own place there is a squeeze goin on - you wouldnt know it if you read these articles - nope, it's all low to zero inflation or deflation

" can we get a couple of genuine manufacturers and builders on here to put their bibs-worth in"

Probably but my Mandarian is terrible.

Wheeler has little choice as, although few seem to recognise it, he actually has two targets, one being price stability (i.e inflation/deflation), the other, financial stability. Unfortunately Auckland is a very large component of the NZ economy and its been well shown that provide an Aucklander a lower rate, he'll ratchet up what he's prepared to pay for a house, or upgrade houses because he then thinks he can afford to, and "you can't lose money buying property". Hence the already long term unsustainablity of house prices to incomes that are threatening his financial stability targets sometime in the future - more fuel for the fire certainly isn't in his mandate.  

Right on the button Mr Grant
Take a step back in time, a time before the wheelman's appointment
The seeds of this saga begin with the failure of 63 finance companies .. companies that had been allowed to flourish under a poorly regulated regime, don't ask, don't tell, regulators who failed when the blowtorch was applied .. created an environment that encouraged people, the young and the old, the halt and the lame to place their wealth in the hands of a bunch of cowboys, whose ultimate demise sent a powerful signal to all segments of society .. a society that learnt a painful lesson .. to invest in "things" you can see and touch .. things that dont lose value and thereby money
And that's exactly what is happening .. govt is learning that they (govt) reap what they sow .. and because they didn't supervise the financial system properly, people, all those people mentioned above, no longer trust the financial system, and the government, whose ability to supervise can be characterised as abject failure
And, the government is either powerless or unwilling .. bit late .. they allowed it to happen
How long will it be before people forget, and turn to finance companies again

Very true iconoclast, that may well have contributed to the cause, but as the homeowners in California, Florida, and many other states and cities in the US and europecan testiy to, you can actully lose shiploads on housing if you buy into a market with unsustainable house price to income ratios, the only question is when the chickens do come home - so having directed them into housing, they then finish them off some time later.... such is the way with fear and greed.

"a poorly regulated regime, don't ask, don't tell, regulators"
Yes and that hasnt been fixed and no signs it will be.

Actually I think you also have a selective vision as well. 
So if the OCR remains this high and we go into deflation, recession and lose jobs that also will see loss of bank stability as FHBs etc default.  On top of that we have farm debt and a lower OCR I assume will mean lower mortages for the  farmers in what looks like dire need as the payout collapses.
For the "aucklander" (who is frankly barmy) we will ahve to look at other tools similar to the LVR. In fact we have to, because killing the National economy of farmers and employers because of irrational behaviour in Auckland housing isnt a great outcome either.
These pressures if you are indeed interested in the future look closer and more severe to me than Aucklands already x2 bubble popping.  In fact pop these and Auckland pops as well, all one big house of cards.

Unlike you Steven, I am a mere mortal who doesn't know whats going to happen, but I'm backing what is obviously Wheeter's more informed assessment of the economic outlook i.e. that Auckland housing represents a far bigger financial risk to the economy than the risk that a low dairy pay-out forces NZ into such a servre recession that farmers get bankrupted and banks get into strife. Unless you know that the pay-out is going to be $3 something, and stay there for more than a season and a half, you're just guessing with considerably less information and expertise.

I dont know either, however its not impossible to sit down and look at the as many possible impacts and consider ther risks of them occuring rather than being myopic and single focus.  So for the OCR rate being too high, even easier, we can look at what cockups other RB's have done before us and we have Sweden as a classic outcome of rising the OCR to far and too fast send its economy into a tail spin, cause and effect in real life is pretty compeling evidence to me.
Oh and its not just dairy its also other manufacturers. 
Also why recession and THEN some farmers going bankrupt? caused by a low payout than the other way around?  Given leverage I dont see that $3 is as low as needed, so where do you get your expert view that $3 is it?
From what Ive been reading somewhere under $5, approaching $4 is going to cause an impact.  On top of that direct stress such low payouts mean farmers as one of the few main injectors of $s into the rual community will not be spending? and that will cause an impact there also.
Someone put up a % increase and decrease of housing across the country and apart from Auckland and a few others spots many others were flat or even dropping, hence a high OCR or even higher is going to make them suffer.
Payout stay low, well it seems that oil is projected to stay low for 18+ months and maybe longer, so yes mabe a season or 2 of sub $5 is quite possible. That might be a bell weather to watch.
Less expertese, well Im reading economists like Steve Keen and Paul Krugman who so far seem to be far more accurate in their projections than many others, especially the Austrian/Rand contingent who are being shown as utterly clueless.
Oh and finally what or is there an asymeterical impact?  If there is and I think there is then lowering the OCR for a season or 2 maybe well be the lesser of 2 evils.
Guess its choose your poison, I'll choose lowering the OCR thanks.

Steven, my $3 something wasn't a considered number, just a extreme that we know will apply substantial pressure. For the moment the issue isn't so much the final pay-out for this season, its the outlook for the next one. The banks will support all the good farmers, thats  not an issue, and if Spierings is right with his confidence in a $6.25 pay-out for Jun-15-16, then dairy will get through this ok but the rural communities will feel some pain over the next 12 months. The problem is of course, Spierings or anyone else for that matter can't know that with any real degree of confidence anymore than someone can say for sure that its a long-term disaster for dairy. The RBNZ will adjust as things pan out as it has a tight rope to walk but with plenty of critics/"experts" just waiting for it to fall. The Govr isn't paid enough !

So how long for instance do recessions last typically?  18months?
My point I guess is as some "peak oilist economists" are saying just what the economic view is over the other side isnt known but is likely to be volitile, confusing, contradictory and contractionary.  So the Q is how does the RB work/react in such achangable future, especially if they have not even recognised there is a change and how big it is and are not helped by the Govn.
Finally consider how wrong many business people, Pollies and "right wing" economists have been over the last 6 years. Just why when they are still singing from the same hymn sheet should it come right? are we relying on luck?
I'd have some confidence in their outlook if I could see they had seen and weighed up such factors, but since it looks like they have not, I dont.
"The Govr isn't paid enough !"  may well be true, I'd add that he isnt supported enough by the Govn of the day either.

Wheeler is not more informed.

He has more information - buy it passes through so many kidneys before it reaches him that it's seldom reflective of market.  This is because many of the people selecting, collecting, weighting, and displaying the information aren't directly working in the industry.  They're alongside the industry, not in it.  And they give the information to people who aren't in the industry and aren't even exposed to real world forces (government employees, degreed experts who are told what the information is _supposed_ to show).  This results in Wheeler (and most CEO's ) not having any real idea whats going on

Grant A
Which is why there's such a push all around the world to use Macro-Prudential controls to control that leverage in the real estate and banking systems. The Reserve Bank did pretty well with its high LVR speed limit.
So their adamant position against more Macro-Pru was a bit of a surprise.
In this Auckland market with flat building consents, record high net migration and falling fixed mortgage rates, it's effectively a green light for another boom in the Auckland market.

Yes totally agree Bernard. The one thing that really surprised me with the MPS wasn't  the restated furture tightening bias, which seems to have surprised those uncomfortable with their lot, but the comment that they had no plans for future macro prudential changes. You're right, it is set up for a boom and that scares me, especially for young people for whom the reality at some point could set their lives back years. There can be no possiblity of hikes in the next 12 months so the answer has to be other measures, and although many are debated, and I don't know the best options, I suspect they're are working on some all the same.

Yes, I too think the RBNZ has become strangely indifferent regarding the Auckland situation. They have moved on and are leaving it to the government it seems.

Or they see that Auckland is an outlier situation that they cant contain without hurting the rest of NZ. "leaving it to the government" I think they (Govn) should be, the Pollies are getting a free ride off teh RB and have had one long enough.

There can be no possiblity of hikes in the next 12 months.
Whoa there. Are you sure Graham Wheeler isn't just waiting for Janet Yellen to catch up? There is a limit to how much the RBNZ can put up interest rates without stuffing up the NZ economy unless either the NZD falls or Bill English runs a deficit. As and when the US start really looking like they will put interest rates up (Thursday?) the rush to close those USD carry trades will become a stampede for the exits. The NZD will get severely trampled if that happens. Just speculation on my part but you have to be on guard.

Very fair comment Roger, you can never say zero chance, I'd more correctly say low chance. But youre right, if you assume anything in this environment you're asking for a fall. A US tighening will be a major global event for interest rates,  but the conitations of which arent all that easy to work out

Yes it's going to be 50/50 next year re a Fed rate move. The bulls are saying yes, however Krugman is saying no.
The RBNZ has stretched as far they can for now, they need Janet to make the next move. 

It just seems to me that what makes thinking about everything economic in NZ difficult is the fact that the level of the NZD is usually a more powerful influence than anything else.
As an example, how much have Auckland house prices gone down in the last few months if you measure them in USD? There are two reasons for asking this: firstly, they are part of the cost base of the country, part of the country's capital assets and this affects our overeall return on capital, a key component of our productivity.
The second reason is more abstract. In order to measure something you need to use something external to the thing you are measuring, as far as this is possible. So using NZD to measure prices in NZ is exactly like using the stretchy tape measure that Mitre 10 had in their adverts- ie, not much use.
Just to make the subject even more mind bending, by my rough calculations the total real value (ie measured in USD, the best proxy we have) of NZ Household Debt has gone down by about 11% since July.

Bernard and Grant I think the Reserve Bank has realised that the solution to inflated house prices lies in 'breaking the land bankers' as you have recently articulated. This is a regulatory problem, that at its last resort means the Government enters the market as a beneficent agent. Buying cheap farmland that with a new regulatory environment is quickly expediated into lower priced housing developments, which puts a ceiling on speculation for existing houses.  
Exactly how the regulatory framework is reformed is a hotly debated political problem which an independent Reserve Bank probably should keep away from as much as possible.
The Reserve Bank has protected the financial system and FHB by the LVR limits, now it is up the democratic political process to take the next step.

However, the OCR is still set at a relatively high rate.  This is still an over hang from the 90s and 2000s where the mode was to suppress any/all signs of inflation.  This is no longer an effective approach. 
There is no reason why a mortgage holder in Wanganui with a house which is likely to be declining in value to be paying a very high (globally) rate of 6.5% 
this high rate policy is having a significant negative effect in regional cities and areas. 

I've said it before Bernard
Monetary Policy (central bank) and Fiscal Policy (government) are two opposing forces that should strive to be in equilibrium
What you are seeing is an example where Fiscal Policies should be being implemented by Govt to overcome fiscal problems. If Govt doesn't act, that puts pressure on the RB to take monetary policy action that it shouldnt have to, in order to counteract distortions arising from "inert" passive fiscal policy
NZ has been in the middle of a rocketing-boom-period where fiscal policy should be putting away some of the surplus for when the downturn comes. Govt has been running deficits during times of plenty, which dictates the Reserve Bank has to run a tigher monetary policy than it should have to.
Lastly, (I have stated this before) The RBNZ Governor has his hands tied by an agreement with Govt. I was surprised Wheeler accepted the position and didnt give them the 2 fingered salute. Why take on a job where your hands are tied before you start?
So, Bernard, if wheelman is his own man, dont expect looser monetary policy anytime soon, in spite of all the banshees here. If he does, you know you are in trouble. Lots of trouble

13 June 2014


If manufacturing businesses and agricultural/aquacultural/horticultural business are using mechanisation to increase efficency in production then this must lead to lower employment figures (as the machinery is doing the work that labourers beforehand would have done). This means after a (usually) one-off fixed cost expense the companies will have lower spending on workers (so less spending = lowerinflation/disnflation/deflation). Of course with less wages, workers/consumers have less money which means they will spend less (so less spending = lower inflation/disnflation/deflation).


Firstly, assuming these companies are exporting the majority of their goods then money made from that should flow back to NZ however in practice most of this money will flow back to shareholders/directors/CEO's. Since shareholders/directors/CEO's are usually wealthy they won't increase spending on many necessities that are manufactured in NZ BECAUSE 

they were already buying enough in the first place to satiate their needs.

Secondly, exported goods will be hit by tarriffs, and NZ companies with wholly owned subsidiares need to pay overseas wages and exchange rate changes (so a lesser impact on inflation here. Having said this the reverse must also be true as well [as in overseas companies will be hit by tarriffs by the NZ government as an example so this should lead to an inflationary pressure] and overseas tarriffs and wages most likely won't find their way back to NZ).  

So how is low inflation a surprise?

Wheeler's job has to be the easiest in the world. All he does is postulate on a small hike every 3 months, then do nothing. And for that he gets paid a fortune!

It's not just Mr Wheeler. I read in a PDF recently that there's 128 people at the Reserve Bank, who earn more than $100,000 a year. What do they all do??

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