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The era of monetary policy based on inflation targeting is drawing to a shuddering halt. But nobody seems to know what to replace it with

The era of monetary policy based on inflation targeting is drawing to a shuddering halt. But nobody seems to know what to replace it with

By David Hargreaves

Well, the Reserve Bank did its best today, but the New Zealand dollar didn't seem to think it was good enough.

I have been critical in the recent past about our central bank sending some horribly mixed messages that have aggravated the situation regarding the currency.

The RBNZ now seems to have got its lines right, but it's still not making a real difference.

At the moment the RBNZ seems to be trying to navigate a kind of 'middle' path, with interest rates that aren't too low to completely boil the housing market, but ARE low enough to take the energy out of the dollar.

I think the reaction of the dollar today tells you that the mid course is not going to work.

A decision probably needs to be made right now either to simply leave interest rates where it is felt they should best be, or join the international race to the bottom - drop them to virtually zero - and see if that can fix the dollar.

But low interest rates have done nothing for the rest of the world.

The old theory of inflation targeting has it that low interest rates will feed into greater consumption, which will feed into economic growth, which will feed into inflation.

Post the 2008 GFC the theory has been broken and the extent to which it is completely broken is now stripped bare. The money that has been pumped into the global economy has in large part been diverted into fixed assets rather than consumption. So, asset price inflation is rampant, fuelled by debt, while economic growth still languishes.

I'm inclined to say that in this country we should completely throw away inflation targeting as the focus of monetary policy.

But the trouble is, if we do that, we could see a situation where the New Zealand dollar rises and rises to a point where our economy is completely stunted.

We are not there at the moment, largely due to the free immigration policy of this Government, which is pumping up overall rates of economic growth - although growth per capita is not rising by anything like as much.

The other alternative though, joining the race to the bottom, seems even more risky. You could drop interest rates all the way down, still find the dollar is elevated and in the meantime asset prices (in the New Zealand context that's houses, houses and more houses) keep going through the roof. Something would presumably give at sometime and it could be messy.

So, I think we do need to be bold and say that for now we aren't going to worry about inflation. But, of course there needs to be agreement with the Government that this is what would be done.

However, we are tiny.

Inevitably we are at the mercy of the global economy.

And it's the global economy that needs a re-think.

What does become clear is that the global economic system has not really 'recovered' from 2008. The structural overall of financial markets and systems that was, it seemed, made necessary, by the GFC, didn't happen.

More clever people than me need to get together and sort out this conundrum. It's urgent. 

Inflation targeting is dead. But what to replace it with? For now, targeting growth would seem the answer. But how best to do that?

In the meantime, little old New Zealand needs to just ride it out as best we can.

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agree with targeting growth, but this government would take that as a green light to fling the doors open wider still

Abandon monetary policy as a way to make an economy grow. Repeal the Reserve Bank Act and put the control of the economy back in the hands of the Government and impose a Tobin tax on all NZ$ trades the level of which to be determined by what level the NZ$ should be at.

There is no fix. Cheap energy is gone. Tinkering with policies cant change this. I think if you read the discussions on you will begin to see where shes heading.

Ah someone with a brain who can read and understand....

Oil prices down again yesterday and Saudi Production up.

Balanced and insightful article - a lot better than much of the shrill, self-interested diatribe that is often posted here as "opinion".

The answer to this one isn't easy but there are observations that one can make.

1 At the point where CPI inflation is too high, then increasing interest rates to dampen the economy seems to work and makes sense.

2 At the other end of the spectrum it does not work and produces undesirable outcomes like excessive borrowing that fuels asset bubbles particularly in housing instead of encouraging business to invest for growth and increasing productivity.

3 The existing model does not distinguish between the lowering of prices due to a depressed economy and price lowering due to increased productivity or lower import prices. The former is something that we need to worry about. In the latter case lower prices will leave more money in the hands of the public which is in it'self stimulatory and I can't see a problem. In the former case we need to do something that stimulates business to invest for growth and increased productivity rather that just a general increase in in money supply which seems to just fuel asset bubbles particularly when folk are feeling insecure about the economy and are more prone to seek out the security of tangible assets. In other words we need to closely target our stimulus to real business investment.

4 The way our banking system is structured relies on positive inflation which through the multiplier effect boosts the amount of money being deposited and loaned. This seems to me to be a stimulatory force without a real or justified basis. We all turn a blind eye to it because things seem to be going well and as a result the banks seem to me to benefit by huge and unjustified money creation. When inflation is low or goes backward this whole process stops or goes backwards; they loose the benefit of this unjustified wealth creation or even loose wealth by the same mechanism in reverse. It seems to me that this whole area needs to be re hashed so that they can neither make or loose money by inflation.


Micro management of economies is as effective as environmental management, the search for WMD's, or the war on drugs! Is it any wonder the whole world has been suckered into these efforts by the USA?
They have managed to export their deflation, much like they did with their last bout of inflation, by cajoling the rest of the world into following in their footsteps, even if it meant leaping off the cliff on a race to the bottom. They were first to jump, so now it seems they are ahead! But, that does mean we should follow?
Then again, most countries, including us, integrate a large 'fish ball' spinning about whilst wrapping in on itself, and swaying in the waves in a futile attempt to survive, whilst predators are darting from above and bellow taking bites at us. If we leave the safety of numbers, then it is highly likely we'll be eaten; if we wait 'till the end, well, we'll the last eaten. No help there! Looking forward we may be between the proverbial rock and a hard place!
Perhaps a little reflection might help. How did we get here? Obviously we didn't want to be here, and perhaps we didn't notice we were being led astray, which is really scary because the subprime debacle was flagged a plenty, and yet here we find ourselves, with our beautiful houses and with our beautiful wifes, how did we get here?
Expectation management, that's how! The Fed has engaged in expectation management for the last few years somewhat successfully, and it would seem we are once again following the leader of the 'free' world. The Fed ran out of options during the GFC. and expectation management was their only tool left. We weren't out of options then, we had a bit of inflation and reasonably high interest rates. We could have followed the example of Iceland, we were certainly better off, and be out of the woods by now. But we were told to expect and fear deflation, the green eye monster, and we did. We got onto the thread mill with the rest of the world and sang the mantra in unison with the Fed. In the search for yield bond investors drove the long end of our term structure down, and the Mini Fed followed in earnest reducing the short end of the curve in order to maintain a positive slope indicative of that cure-all-debt elixir inflation makes. Today, as indebted as we are, and with deflation in the pipeline, we are running out of choices! But in a fast downward moving frame of reference, everything seems aloft and well, even if it seems a little bit off. My suggestion is akin to what the ANZ chairman suggested. Get rid of debt, consolidate assets, acquire a stash of cash, in different denominations, and some gold as insurance for when the solids hit the fan, batten down the hatches, trim the sails and raise the storm jib, and get ready for the downpour and the brunt of the storm. The bigwigs know their system is failing and they are raiding the till on their way out, whilst at the same time managing expectations for the rest of the world.

I applaud you Hevi, couldn't have said it better myself.

We were led astray... or maybe not. Someone more clever than i wrote
"if a nation doesn’t possess sufficient indigenous energy resources to satisfy the aspirations of its inhabitants, then that nation must beg borrow or steal them from somewhere else, or collapse back to a level of natural sustainability. "
This is the story of how we got here, hanging on to the shoelaces of the leaders of the free world in plundering resources from anywhere but here.... The US effectively exports a digital currency (US$) in exchange for real resources courtesy of military power and unfortunately you are either in or out of the game. But the games beginning to look rigged...

Nicely summed up


Why is growth good? The present economic measure of growth can be interpreted as the speed at which we are making our environment unliveable and destroying the world around us.

At the beginning of the Enlightenment Voltaire and the other revolutionaries wrote dictionaries to provide a language to allow discussion of things in terms other than those that framed all debate at the time; religious dogma and the inevitability and rightness of aristocracies. That dogmatic language has been replaced in modern years by the orthodoxy of economic dogma, which frames all debate. Does increasing economic rate of consumption really make for a better quality of life for citizens?

Or as Einstein is attributed as saying: "the level of thinking that caused the problem will never solve it"

Until we can discuss outcomes in terms other than economic all solutions will simply be more of the problem

May be outsource to Goldman Sucks ? They and their ilk started this decline in the effectiveness of all current economic/fiscal policies...They will fix it for a fat fee...

Good comment, Scepticism. Growth is an imperative in capitalism. Economic theory and practice is part of exactly the same system. (And I'm a beneficiary of, and active player in, the same capitalist system.)

Simply, the free deployment of money is bound up with individual freedom and individual responsibility - they are, or have been, inseparable. And the free deployment of money has always sought the safety of the principal and reward for the deployment - hence growth. What has happened, though, is that responsibility has been removed from the financial powerhouses of global capitalism and transferred in its consequences, via states or multi-state institutions, to individual citizens.

Growth now is the hoovering up of money from the very many to the very few. States and central banks are complicit in this transfer, as willing servants or agents of the same financial institutions. Ever lower interest rates - no matter how ineffectual - are merely attempts to give mouth-to-mouth to the debt economy. And inflation, no matter how weak, an attempt to ameliorate the debt burden. But as the many become poorer (whatever their house valuations say), and as we move from a consumer to a conserver society, growth slips further and further out of reach.

It is surely time to look at the whole. Demagogues, now numerous globally, with their ignorant, hate-filled and destructive rhetoric, are the immediate and dangerous result of political and economic failure.

It's imperative to locate the money beyond that which closed sovereign borders thinking determines it is - ie eurodollars or now missing eurodollars.


The problem is that we cannot extract from our statistical database what is true money conceptually, either in the transactions mode or the store-of-value mode. One of the reasons, obviously, is that the proliferation of products has been so extraordinary that the true underlying mix of money in our money and near money data is continuously changing. As a consequence, while of necessity it must be the case at the end of the day that inflation has to be a monetary phenomenon, a decision to base policy on measures of money presupposes that we can locate money. And that has become an increasingly dubious proposition. Read more

Major eurodollar credit creation machines have fallen into a state of ruin - witness Deutsche Bank.

I do wonder if say the Reserve Bank has any idea at the source, or authenticity, of the supposed NZ$100 billion traded each day. I strongly suspect the vast majority of it is fictitious, where international banks with licences to do so, will buy or sell as their whims dictate, lots of $100s of millions, knowing that some minutes, hours or days later they will reverse the position. Only a small fraction is required to facilitate NZ trade. I suspect only a small fraction actually has anyone paying interest on it, although there no doubt margins in arbitrage that are interest like. Does it matter? Maybe not, but it reinforces your point that no-one could actually find all the NZ$ if they tried. Or trillions of eurodollars and other virtual currencies.

Open spot postions earn or lose pips closely coincident with the current OCR in the TOM/NEXT roll market. The spreads are wide and mids have to be used to calculate the embedded depo rate for the individual currency in the pair quote. View more It's big business, as are the forwards. Mainly speculative.

Money is what most of us receive in exchange for labour. Many things we use our money to purchase are only user interfaces for the services which they access. Just think how many items you would not buy if the network currently supporting them did not function. All of those items were used as tokens to capture and hold the value of your labour and use it in the form of capital to capture even more. Carry that thought to its inevitable conclusion, inflation simply stretches the timeline.

Big correction, money is a token for energy, not labour. A barrel of oil represents something like 11000 hrs manual labour,... this is the real basis of the economy. Lawyers, accountants, bankers etc think they are worth horrendous hourly rates, but actually its fossil fuels that do the actual work

Some people get onto these crazy whimsical notions here, shaping all of their comments to reflect it.
This is one of those comments.

Sure, money can be a token for energy, but it is not a substitute for energy.
Capital is the substitute for labour and technology in economies.
Growth is not relevant to the amount of energy we put into something, it is relevant to the marginal products of labour, capital and technology.

Growth is not relevent to energy???? Its actually close to 1:1 with world GDP...
i suggest this might be worth a read

At the risk of boring people with thoughts that I've posted before, following are thoughts on sensible targets for monetary policy, and even more importantly, a couple of other tools to achieve those targets.
1) Reasonable price stability- 1-3% inflation, although with some flexibility to go to say 5% at times of very high private debt. Similarly nominal wage growth of 1-3% with flexibility to go to 5% to amortise high debt.
2) Low unemployment as a proxy for GDP per capita.
3) Balanced current account. This to ensure the exchange rate is giving the correct signals to consumers and suppliers of tradable goods and services of what is sustainable over time.

In terms of tools, the commercial fractional reserve banking system works well enough to achieve the above in "normal" circumstances where the OCR was say 3-6%, and mortgages at say 5% to 8%. Clearly at anything like close to zero rates the whole system and incentives break down, as has been obvious for some years now.
So extra tools are needed. By far the most obvious one is printed money. What exactly it was used on and the channels it makes it to consumption are important.
Spending on infrastructure domestically is the most sound long term approach, although may have a lag effect on consumption and employment.
Purchasing (and therefore effectively reducing at no cost) government debt is very popular among other countries. Purchasing corporate debt is becoming more popular.
Purchasing overseas assets including shares and bonds with printed money is frankly taking the piss with other countries, but the Japanese, Swiss, Germans and Chinese are doing it by the trillion in an extraordinary act of broad daylight international theft. Funnily enough, if they weren't doing this, and we were still heads stuck in the sand doing nothing, then we would be worse off. We are clearly happy to pay a considerable margin (and a huge cost to our trading industries) for the privilege of using their central bank printed money, but we are reluctant to print our own. The Brits have just started printing 60 - 70 billion a month.
Printing to fund tax cuts or direct gifts to citizens isr the steroid way of getting things going. I would suggest there are other alternatives here before that is required.
If and when the targets listed above are met, then don't print any more. Raise interest rates if they go above target.
Increasingly the international finance media are coming around to the above, which I have been banging on about for years. Already "Austerity" is over, and infrastructure spending is trendy, while helicopter money is a matter of time. The western G20 won't let the above mentioned countries take the spoils, they will print themselves.
Will we continue to be the suckers?

The uk printed 70 billion. Once. It is not each month. But I wouldn't put it past the them to do more.

Fair correction. They have announced £60bn of debt purchases over the next 6 months I see- the amount had stuck in my head. They also are declining to let the Chinese pay for their nuclear plant plans, just as the Aussies are also today declining to let the Chinese buy their electricity grid. But each government will want the money; printing here we come.

It was 60bn of government bonds and 10bn of corporate bonds.

Theresa May made the right choice on the nuclear plant. It is an enormous white elephant with truly awful guarantees on the price of electricity for the next thirty years at more than double the current market cost, and then you have the question about how dumb it is to have the Chinese involved in sensitive infrastructure.

Nuclear is great, but the future should be smaller cheaper assembly line built modular reactors not expensive bespoke monsters like that. Hopefully the Thorium fuel cycle reactors get commercialised in the next few years and we get cheap/safe/clean powerplants as a result.

good luck whilst I agree about printing to fund building of infrastructure john key calls it a wacky idea, after all is it not just better to borrow and run up the credit card.
after all are not all debts are great in the eyes of a banker

No, idea would be good, it would weaken our currency, make exports more competitive, cause inflation, encourage less rubbish importing... it would make imports more expensive and increase our foreign debt but Shonkey was doing that anyway.

I have wondered why increasing the money supply hasn't been considered before, for exactly the reasons stated above. Is it because it too is seen as fueling the property market? If so we are in a position where the over heated property and asset market is holding the country to ransom. Central and local govt have a lot to answer for regarding this, in my view. The hands off approach to freeing up land in greater Auckland combined with the lack of infrastructure spending has caused this problem - nearly a crisis I think! The market simply laughed at the RB announcement yesterday. It was a D minus for sure. I am still an advocate for printing, maybe it would help pay for the infrastructure needed in and around Auckland.

1 -
Reasonable price stability @ 1-3%; we have this already.
Moving to 5% at times of very high private debt...? Well, that's one way to incentivise taking on personal debt and penalise private saving.
Nominal wage growth of 1-3%, going to 5%? What's the point of this if you have the same inflation conditions?
Low unemployment as a proxy for GDP per capita?
This doesn't make sense - why would you need a proxy for that? Why not just target it directly. We could wipe out unemployment tomorrow by changing the definition - I don't see us being any more well-off, however.. In the face of high immigration, the correlation/causal effects (if any) would be significantly impacted.
Targeted balanced current accounts would eliminate investment and savings smoothing over the long term, meaning that big ticket expenditure could only occur at a zero condition. You want to see infrastructural investment halt, this would be the best way to achieve it.

Extra tools: 'Printed Money'
We have this already, and the RBNZ uses it when necessary.

Print 5 billion a month while the currency is at undesirable levels. Reduce national and council debts. Purchase building materials (not shoddy Chinese stuff though). Build infrastructure. Build public transport. Build housing. Just build ffs.

I hate to say it but ....

Tool up for an effective defence force.

Too late. "DURING war games played off the coast of Florida last year, a nuclear-powered French attack submarine, Saphir, eluded America’s sub-hunting aircraft and vessels with enough stealth to sink (fictitiously) a newly overhauled American aircraft-carrier, Theodore Roosevelt, and most of her escort. An account of the drill on a French defence-ministry website was promptly deleted, but too late for it to go unnoticed."

"Well, the Reserve Bank did its best today,"

Really a 0.25% cut was the best? Give me a break.

I think inflation targeting works well. But the current system does not. Because there has been massive inflation which has been underreported and interest rates have been too low to counter it. Look how career’s and work have lost most of their value compared to housing inflation. CPI doesn’t work, it doesn’t contain people’s biggest outlay which is housing on a realistic basis. Even RPI was a fiddle by politicians to under report inflation. What is needed is an inflation rate which contains an accurate basket of expenses and assets to set interest rates. And therefore if the cost of housing is about 50% of your budget and going up in double digit inflation, inflation must also really be at least 5+%. CPI is a dishonest measurement and interest rates are too low.

Correct. In all reality we have almost witnessed hyper inflation in regard to housing costs/prices really. Economists like to change the values by changing the meaning of words. Capital gain for example is really just an insidious form of renaming inflation and making it sound wonderful

What meanings have economists changed recently?
Please give me one example...Don't be confusing economists and policy makers, either.

It has been explained numerous times here why assets are not included in a headline CPI calculation. It is by your own fault that you have not understood the requirement for this.
For some reason you think that you are missing out on something by having asset prices excluded, but the actual reality is that including these in inflation calculations would be so much more dire than excluding them.

bla bla bla. I have explained it to you and so have others. Your ignorance on this matter has been noted. That is all.

lower interest rates-->higher house prices-->more borrowing. Increased borrowing for the same houses. No wage growth. Real growth .5% with 8% increase in private debt in the last year. We will continue down this path like the rest of the world until were faced with nearly 0% rates. THEN WHAT???

Turns out overnight rates are not zero bound. Onwards down they go...

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