Some thoughts on the Monetary Policy Statement

What to write about the Monetary Policy Statement?

The Governor continues to deny that any mistakes were made last year. I’m not sure why. As I’ve said before, perhaps the first OCR increases were defensible (certainly lots of onshore economists thought so), but to keep on hiking and then take a year to start cutting, quite grudgingly, even as core inflation stayed very low, was just indefensible. The Governor and his staff are human, so they will make mistakes. They should acknowledge this one and then move on. Unfortunately the continuing reluctance to admit any mistake, perhaps even to themselves, is colouring how they are running policy now. The OCR is still higher than it was at the start of last year – the only OECD country of which that is true – even as inflation expectations have fallen further. What is it about a situation of rising unemployment, near-zero per capita GDP growth, and well-below-target inflation makes them think we’ve needed higher real interest rates?

I was disappointed, if not overly surprised, by the questioning of the Governor at the press conference this morning. Here are a couple of questions I think we should expect the Governor to provide straight answers to:

  • Governor, the Reserve Bank – like its peers abroad – has been telling us for years that core inflation is just about to pick up, and it hasn’t. If anything, it has kept drifting down, and with the unemployment rate still rising it is likely to fall further. In the very first paragraph of your Annual Report last year you once again told us that inflation was heading back to the midpoint. Again it hasn’t done so. . How have you corrected for this persistent bias, and why should we (or the public) have any more confidence in your inflation outlook now?
  • Governor, given the Bank’s persistent forecasting bias – shared, of course, by local market economists – why not adopt a strategy that aims to get core inflation to something nearer 3 per cent. Given the (unintentional) biases you’ve shown to date, that might give us a good chance of actually getting core inflation up to 2 per cent.  If inflation really looked to be rising strongly – to something well above 2 per cent – surely you have plenty of time to correct when you actually see the material increases in inflation?.

There was, as far as I could see, no particular basis in the document for a belief that core inflation is about to head back towards 2 per cent. Indeed, there is almost an attempt to sweep those awkward measures under the carpet, and to focus instead on headline inflation. Yes, headline inflation will probably pick up to some extent, and perhaps it will even creep over 1 per cent early next year. The evidence for that proposition isn’t great, and the Bank’s own past published research has cast doubt on it. Some tradables prices will no doubt rise – some already have – but exchange rates fall for a reason and are often accompanied by falling non-tradables inflation.  It is those core or domestic components of inflation that really matter, and there was nothing in the Governor’s July speech or in this document to think the downside surprises have come to an end. Indeed, the Bank acknowledges that non-tradables inflation is likely to fall further (partly for one-off reasons), and as they are projecting the unemployment rate to carry on rising it would be surprising if their favoured core inflation measure did not fall further.

I’ve gone on quite a bit over the last few months about the apparent indifference to the unemployed. No one thinks that a 5.9 per cent unemployment rate is New Zealand’s NAIRU, the rate has been rising for several quarters already, and the Reserve Bank is now forecasting that the unemployment rate will rise even more. There is, conveniently, no chart of the unemployment rate in this MPS, but the tables at the back show them forecasting an unemployment rate up to 6.1 per cent next March, and only back down to 5.9 per cent a year later in March 2017. The unemployment rate was only 6.2 per cent in March 2010, just after the 2008/09 recession ended.  Seven years on they expect no material inroads will have been made on the unemployment rate.

That March 2017 unemployment rate of 6.1 per cent is well within the sort of window that monetary policy can do something about. But the Governor is doing next to nothing more about it (these unemployment forecasts are after taking account of today’s cut and one more OCR cut). Lest I upset some economists, I should be clear that I’m not suggesting that monetary policy has very much impact on the longer-term average unemployment rate, but it has a considerable influence on fluctuations around the normal or natural level (itself determined by some mix of regulation, demographics, and so on). If core inflation was already 2 per cent and clearly rising, higher short-term unemployment might be an unavoidable price of keeping inflation in check. But core inflation is now 1.3 per cent, and probably falling. There is really no excuse for the OCR still to be so high. This is one of those times when there is no nasty trade-off: looser monetary policy would raise inflation (which we need, to get back to target) and lower the unemployment rate. Targeting house price inflation in Auckland isn’t part of the Reserve Bank’s mandate.

I don’t really understand why this high unemployment rate doesn’t seem to bother more people. I don’t hear market economists talking about it, or business journalists. I don’t hear business lobby groups doing so. The libertarian economist Bryan Caplan wrote a nice piece a couple of years ago about the grave evil of unemployment, and the way that people on the right tended not to take the problem seriously. But curiously, I also don’t hear the political Opposition talking much, or with much intensity, about unemployment.

And, as I’ve noted before, I really wonder what the Governor says to the unemployed people when he runs into them? How does he justify the Bank having run monetary policy in ways that delivered years of above-trend unemployment, scarring permanently the prospects for some of the people concerned. Mistakes happen, but the minimally decent thing to do is to acknowledge them and apologise. And how does he justify not adopting a more aggressive policy now, a stance that might get more of the unemployed back to work sooner?  The Chief Economist gave us a little lecture about the neutral interest rate having fallen 3 basis points a quarter for the last decade, but whatever neutral is –  and no one knows –  there is no sign that keeping medium-term trend inflation near 2 per cent requires an OCR as high as it is now.

I was encouraged by one aspect of the Governor’s press conference. He seems to be becoming slowly more uneasy about the situation in China. In answer to one question he uttered the dreaded d word – deflation, observing that if there was a substantial depreciation of the yuan that would export deflation around the world. He actually sounded worried. Given that almost every emerging market currency has depreciated markedly against the USD in the last 12 months or so, and that the Chinese are rapidly running through their foreign reserves, he probably should be worried. But if he is worried, he should be doing some preparation, focusing on keeping inflation expectations up, and on removing the obstacle that the near-zero lower bound poses for monetary policy. We still have some way to go to get to zero, but that space is steadily diminishing, and if the Bank’s Statement of Intent is any guide, he is doing nothing pre-emptive about managing the risk.

I wonder how the Bank’s Board and the Minister of Finance feel about this Monetary Policy Statement. Is the Minister yet asking for advice from the Board and/or Treasury on just what is going on?

33 thoughts on “Some thoughts on the Monetary Policy Statement

  1. “An unprecedented number of building firms are going bust despite a post-quake construction boom in Christchurch.

    Inquiries by The Press reveal twice as many businesses connected to the rebuild failed in the first three months of this year(2014), compared to the same period 12 months ago.”

    It may be rather coincidental but interest rates started going up in mid 2013 in anticipation of the RB tightening in March 2014. You can blame it on inexperience of the new builders but it is more than likely increased interest rates. Policy makers do not make the connection between higher interest rates is equivalent to a bomb going off to a builder who work on miniscule margins.


  2. I am continuosly dumfounded when economists believe that our tiny population of 4.2million people is way too many on land the size of Japan with 125 million people.


    • as I’ve said, our optimal population might be 2m or it might be 200m. But the big challenge is when the population is being increased by govt decision while savings rates are modest. that puts pressure on real interest rates and the real exchange rate (and would do even if the RB were doing its job perfectly).

      and actually the richest countries in the world (per capita) are almost all quite small populations, typically getting the benefits of natural resources.


      • Not just natural resources – Sweden (Ericsson) and Finland (Nokia) managed to give birth to 2 of the largest Telecom Network Equipment manufacturers.

        Business RnD spending also a lot higher than New Zealand.

        Not forgetting university education is essentially still free (relatively low registration fee excepting ) in the Scandinavian countries (Iceland, Denmark, Sweden, Norway, Finland) for EU/EEA students.


      • NZ household cash deposits is $150 billion. For a working population of around 1million people, that is a decent level of savings. If you add investments in equities, listed and unlisted entities of $700 billion, that is a whopping $850 billion in savings. I would not put NZ in the poor category. The only real pressure on interest rates is applied by the RB and not by our more than adequate savings.


      • NZ’s national savings rate over 40 years has been below that of the median OECD country (while our population growth rate has been materially faster than the median country’s)


      • I wondered what you think of the RBNZ requirement that banks must fund a portion of their loans from domestic savings? I think it was 80% when I saw it a few years ago. Could an argument be made to increase it over time?


      • The risks around very short-term foreign capital were very real going into the last crisis. In general, I don’t think banks should be told how to run their businesses, but……it is clear that there is a moral hazard here, and if banks take excessive liquidty risks central banks will bail them out when crises hit (as we and other countries did in 2008). I wouldn’t favour requiring banks to fund domestically, but the RB’s CFR requirement is focused on “stable” funding – ie domestic retail deposits, and long-term wholesale funding. If banks can raise 10 year debt abroad, I don’t see a place for govts to stop them.


      • It is actually more risky for a bank to be relying on local savings. It is far better for a bank to fund long term property loans with long term debt. Funding long term property debt with short term savings which local savings tend to be is foolhardy.


    • I am dumfounded that economists would even think that it is important to have a high level of savings. Sure that might be important when the world’s borders equate to the limits of your own country back in the glory days of the British Empire. Increasingly with a interconnected world, there are no borders and we have access to savings from the rest of the world freely and cheaply printed.


  3. Surely its the responsibility of the Government to be more proactive/concerned about labour market policy/stimulus rather than the Governor? Seems to me that until we figure out a way to reverse the multi-decadal trend which has seen capital’s share of income continue to erode labour’s share, we can have no real expectation of the kind of inflation you (and the world) are looking for. More of the same expectation that monetary policy stimulus will fix it won’t make much difference, as demonstrated by the performance of the ZIRP economies. Any amount of more “McJobs” isn’t the solution, rather it is a symptom of the root problem;


  4. There is a hardcore level of unemployed that choose to remain unemployed. There is also some aspect of data distortion of aged migrant parents who are not eligible for NZ Universal Super for at least 10 years that would be labelled as unemployed for as least 10 years before they become entitled to NZ Universal Super.


  5. Is the RBNZ able to modulate inflation? Is the whole structure of monetary policy based on a misconception? Isn’t the RBNZ modeled on the Federal Reserve which has seen a 93% degradation in the value of the dollar over the course of it’s history.

    We all seem to assume that because the RBNZ can affect short term interest rates that (a) they should and (b) it will affect inflation. Is this the case? I can see that the RBNZ can add or subtract fuel to asset price inflation and can help or destroy business and thus employment, but that is not inflation.

    I can see that the Finance Minister can cause inflation by running a too generous budget deficit.

    As regards the neutral interest rate, surely there is a market mechanism we should be using to set the OCR in normal times. The RBNZ would then only intervene in a crisis, not without good reason.


    • Interesting question. Of course, the RBNZ had overseen a huge depreciation in the value of the NZ dollar since it was established.

      I think the evidence is that the RB can affect inflation, but of course there are big underlying forces at work that the RB needs to react to – having interest rates v high in the 70s and 80s to keep inflation in check, or very low now. There is no obvious market mechanism, at least for the nominal interest rate, because the establishment of fiat money allowed things like that 93% depreciation


      • Of course the RB can affect inflation. Just keep raising interest rates until they you decimate the economy. We saw that with Allan Bollard. The NZ economy was in deep recession prior to the GFC in 2008/2009. The GFC saved the NZ economy when Allan Bollard dropped interest rates dramatically.


      • It’s a big subject so I’ll try to stay focussed. I think the question is about whether the RBNZ is the best institution with which to seek to control inflation. I believe the RBNZ has helped reduce inflation by restoring fiscal responsibilty.

        If the RBNZ puts interest rates up to a high level we get the following effects:
        1 The value of all assets is reduced. The present value of a future income stream comes down, whether this is a government bond or an apartment.
        2 Marginal development projects become non viable, whether they are based on profit or expected capital gain. For example, building stops.
        3 Profitability of highly indebted businesses come down, which may threaten their viability if their margins are thin and they cannot recapitalise.
        4 Banking viability is threatened as the value of their reserves and loan collateral is reduced by 1 above.

        If the RBNZ puts interest rates down to a low level we get the following effects:
        1 The value of all assets is increased. The present value of a future income stream goes up, whether this is a government bond or an apartment.
        2 Marginal development projects become viable, whether they are based on profit or expected capital gain. For example, building restarts.
        3 Profitability of highly indebted businesses goes up, which may restore their viability if their margins are thin and they cannot recapitalise.
        4 Banking viability is restored as the value of their reserves and loan collateral is increased by 1 above.

        My contention is the present system gives priority to point 4. This may be appropriate if you are the central bank of the world reserve currency, and may indeed be vital in that situation to preserve your global dominance. Is it true in New Zealand’s case?

        By contrast, a fiscal deficit, whether it be by reducing taxation (my favoured choice as each individual gets to apply the money in the best way for their circumstances) or increased spending (wasted on vanity projects all too often) immediately puts more money in the economy. It seems to me a much better way to create inflation.

        The present system seems to me to be a destructive one as it leads to ever lower interest rates and ever higher asset prices. Eventually this destroys the productive economy and creates a rentier society. It encourages investment with borrowed money that are unviable with equity. It leads to a society where wealth is based on one’s skill as a property speculator.


      • Just a couple of quick thoughts on your monetary vs fiscal choice. Yes, we could use tax cuts here, although at some stage would need to raise taxes (or cut spending again) to close the deficit. Perhaps you’d argue for doing in boom times, but that has historically proved very hard to do.

        There isn’t much sign that asset prices, across the board, have moved to even higher real levels since interest rates collapsed post 2007. That really just illustrates that interest rates have fallen for a reason, not necessarily a well-understood one. In most oECD countries, real house prices aren’t far from 2007 levels and even in NZ Akld prices are far higher but those in most of the rest of the country are materially lower in real terms.


      • Thanks Katharine, they are jolly bright fellows, are they not? I do prefer the commentary of people who actually test their theories with their own money. Much more scientific than the bureaucratic model I think. Michael Pettis is good in this regard, he seems to be a respectable economist even though he actually understands balance sheets and cash flows and is a successful trader in his own right. The academic world has split economics from accounting and finance which is a pity. I came across a paper that identified the characteristics of the people who saw the last crisis coming and those who did not. Basically the ones who understood accounting and double entry bookeeping had no problem while the ones with a strictly economics background were clueless.

        As an aside I find the graphs in the Monetary Policy Statement rather wishful, in that most of them seem to expect a trend reversal sometime in the near future. Usually trends persist for longer than people expect and picking the turning point is not easy. Sort of “She’ll be right” monetary policy statement without much real substance.


  6. getgreatstuff, Michael

    The party could be ending relatively soon for Brunei wrt reported remaining oil reserves.

    As for the gulf states , the current oil price may weigh heavily on their respective GDP – Saudia Arabia (admittedly not mentioned by Michael) having to draw down over 100 billion us in financial reserves to cover a funding shortfall.

    Also quite a lot of their oil fields (Burgan in Kuwait for example) are mature – if not already in decline.

    As for Kuwait, Qatar – don’t forget they’re now embroiled in what could be a protracted and expensive conflict in Yemen.


    • Yes, I deliberately didn’t mention Saudi Arabia

      But my point isn’t that oil guarantees a high living standard forever, but that abundant natural resources make a big difference, esp when there are not too many people. Compare Norway and the UK, or Kuwait vs Syria, or Equatorial Guinea with most of Africa. For advanced economies, it is rarely the only factor (cf Equatorial Guinea), but Norway was only a middling advanced economy until they got the oil, and no one really doubts that Australia’s mining industry has made a material difference to Aus fortunes over the last 25 years. For us, the comparable shock was refrigerated shipping and falling transport costs in the late 19th C that made frozen meat, and dairy, viable large scale export industries. We’ve had nothing comparable since, but just keep bringing in people, even though we have the huge disadvantage of distance. My argument is that we’d prob have been better to have not had any material immigration since World War 2. which would leave us with an agric/pastoral sector much the size it is now, “supporting” perhaps 3m people rather than 4.5m. I argue that incomes per capita would be higher now if we’d done that – can’t prove it of course.


      • Most of our agric/pastoral produce is exported so we over produce for our small population. It does not matter that we have 3million or 4.5 million, we do not consume what we produce. We are the largest milk exporter in the world. The only reason we do not make the profitable margin is because the RB plays havoc with our exchange rates and interest rates. Our high interest rates adds unwanted costs to operating margins and our high NZD means that our margins are reduced in export markets..


      • Yes, I would agree that Norway got a boost with North Sea Oil – It is striking how they managed the windfall compared to Australia though- Norway building a substantial sovereign wealth fund, Australia effectively catching Dutch disease.

        It’s quite possible reduced immigration may have led to led to a higher per capita GDP. I guess it depends on the value of increased exports (as a result of immigration) . Current GDP growth via immigration does seem to be driven by increased consumption rather than actual export oriented production. I doubt baristas / burger flippers will add much to the GDP figures.

        I still pertain though that NZ needs to move up the food chain wrt adding value to exports.
        Fonterra still appears to aiming for low value compared to Danone / Nestle etc. Maybe they should consider buying whittakers and going global???


  7. Not sure about Fonterra trying to get into the consumer goods market. No one suggests BHP-Billiton or Rio Tinto should get into manufacturing motor vehicles. But Fonterra to divest its consumer goods divisions and set them free to grow, like Fisher & Paykel did with Fisher& Paykel Healthcare 15 years ago. Now that’s another story,


    • Bruce – seem to remember Fonterra splitting was voted down rather recently (still trying to track down a link). Would agree that Fisher & Paykel Healthcare is now the star performer compared to F&P (appliances). NZ Inc. really needs to value add.


  8. Brian, yep, the dairy farmer owners of Fonterra seem reluctant to allow the ‘flower to bloom’. Ended up with the Fonterra Shareholders Fund – in which investors can hold ‘units’, a ‘Clayton’s’ share. Brings back memories of Fletcher Challenge ‘letter stocks’ – another conglomerate that tried to be all things to all people.


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