The Governor of the Reserve Bank has this afternoon delivered his annual speech to the Canterbury Employers Chamber of Commerce. In many respects it was an elaboration on last week’s brief OCR review statement – “we might have to cut the OCR, and risks are tilted to the downside, but we don’t really want to”.
Beyond that, it wasn’t an impressive effort. Once again, the Governor simply does not seriously engage with the arguments made by those who suggest that a lower OCR would have been, and would be, preferable. Instead, he basically makes up an inflation story that simply isn’t supported by the numbers, and attacks straw men. The defensiveness is disheartening.
Lets take the numbers first. On several occasions the Governor repeats the claim that “Annual headline inflation is currently 0.1 percent. This is primarily because of the negative inflation in the tradables sector, and the decline in oil prices in particular.”
First, you can’t just ignore tradables prices – when the target is expressed in terms of CPI inflation, and around half the index is tradables. CPI inflation is a weighted average of tradables and non-tradables inflation, and tradables inflation is typically lower than that for non-tradables. Perhaps one might set tradables to one side for a time if the exchange rate has just been moving very sharply – exchange rate changes do tend to affect the level of domestic tradables prices (and so temporarily affect the inflation rate). But the peak in the New Zealand TWI was 18 months ago now. If anything, the lower exchange rate has been holding up, perhaps only a little, tradables prices in the last year. And non-tradables inflation in the last year was only 1.8 per cent. If inflation was really consistent with the target midpoint, we should expect to see non-tradables inflation around 2.5 per cent. It is a long way off that at present.
Second, the Governor repeats the story from last week’s statement that really it is mostly about falling oil/petrol prices. But it takes no sophisticated analysis to read the SNZ CPI release, or consult the Reserve Bank website, and find that CPI inflation ex petrol was 0.5 per cent last year – at a time when the exchange rate has been falling. The Governor also invokes the cut in ACC motor vehicles levies in his defence – which would be fine, except that he completely ignores the offsetting government decision to increase tobacco excise tax yet again. SNZ publishes a series of non-tradables inflation excluding government charges and the alcohol and tobacco component. That series increased by 1.8 per cent last year – exactly the same as the overall non-tradables inflation rate itself. In other words, administered government taxes and charges do not explain low headline inflation, and neither (to a great extent) does low petrol prices. To argue otherwise – without much more supporting analysis – just isn’t supported by the data.
Here are a range of analytical and exclusion measures that one might reasonably look at in assessing current core inflation
|Annual inflation, year to Dec 2015|
|Sectoral factor model||1.6|
|CPI ex petrol||0.5|
|CPI ex food and vehicle fuel||0.9|
|CPI ex food, household energy and vehicle fuel||0.9|
|CPI ex cigarettes and tobacco||-0.3|
|Non-tradables ex govt charges and alcohol and tobacco||1.8|
As he did in last week’s release, the Governor focuses on the sectoral core factor model measure – which just happens to be the highest of any of the inflation measures. Since previous OCR releases had not focused on specific core inflation measures, we might have hoped for either a balanced assessment from the Governor, or a more in-depth case for why we should regard the sectoral factor model as the best measure. Why not, for example, (and at the other extreme) the trimmed mean (which has had quarterly deflation in three of the last five quarters)? But there was simply nothing : just assertions. (Incidentally, even if the Governor is correct that the sectoral factor model is the best read, it is quite a slow-moving smooth series, and a deviation of 0.4 percentage points from the target midpoint would not be insignificant. )
So perhaps we can debate quite where the underlying rate of inflation really is – as I noted last week, neither the Governor, nor anyone else, knows that with any certainty. But the Governor doesn’t engage in that debate, he reverts to attacking straw men.
Once upon a time – a quarter a century ago, says he gulping – a wise boss at the Bank objected when I was drafting Monetary Policy Statements attacking anonymous views of outsiders (“some commentators said”) and suggested that if we wanted to deal with criticisms we should identify them specifically, and respond to what people had actually said. It took more work, but he was right.
By contrast, we hear today from the Governor the lofty declaration that “the Policy Targets Agreement is a relatively simple document [arguable, but we’ll let that pass] we continue to be surprised at the wide range of interpretations that we see in the media and in the commentaries”. Really? But the Governor gives no indication as to whose interpretations he has in mind, and what those interpretations might be. I see comments occasionally from people who argue that the Act or the PTA should be changed, but I don’t recall seeing any very great divergences over the last few years in the interpretation of the PTA itself. Yes, there is some uncertainty about what, if anything, the longstanding obligations to “have regard to the soundness and efficiency of the financial system” and to avoid “unnecessary variability in exchange rates, interest rates and output” might practically mean – but there is nothing new about that, and the Bank itself can’t give an straightforward answer to those questions (a lot, inevitably, is “it depends on the specific circumstances”). But the debate about the conduct of monetary policy over the last few years has mostly been squarely within an entirely conventional framework. The Governor and his advisers (and initially many of the bank economists) expected inflation to pick up and hence thought the OCR needed to be raised a lot. Others were more sceptical. But both sides of the argument operated largely within a forecast-based model – suggesting that the OCR should be adjusted in line with the medium-term outlook for inflation. As it happens, the Bank – and those who adopted the same line – were proved wrong – but it wasn’t really a dispute about the PTA itself. They were forecasting differences and – while forecasting is hard – the Bank and the Governor have been repeatedly wrong-footed by the data. They had the wrong model. Again, some of their international peers made the same mistake – others were just constrained (or thought they were) by the near-zero lower bound.
The Governor also devotes space to attacking a related straw man. Indeed, this one is the centrepiece of the press release he put out with the speech:
“Mr Wheeler said that the Bank would avoid taking a mechanistic approach to interpreting the PTA. Some commentators see a low headline inflation number and immediately advocate interest rate cuts:, he said. A mechanistic approach can lead to an inappropriate fixation on headline inflation”
This is just the flailing around. All his predecessors have also sought to avoid taking a ‘mechanistic’ approach to the PTA, so there is just nothing new or interesting in the assertion that he doesn’t want to be mechanistic (although some have argued that “mechanistic” might describe his own 2014 stance). Perhaps more pointedly, I’d challenge the Governor to name a single commentator who has suggested that policy should be run in reaction to current headline inflation. I can’t think of any. I’ve been more dovish than probably any other commentator over the last year, and if anything I have repeatedly criticised the Governor for an unwarranted focus on headline inflation in his OCR releases (when he was arguing that the lower exchange rate would soon have inflation back to rights). Who are these “mechanistic” people the Governor has in mind?
It is good to know that the Governor will “continue to draw on the flexibility contained in the PTA”, but in the end the PTA requires the Bank to focus on keeping inflation near 2 per cent. It simply hasn’t succeeding in delivering that sort of outcome – in fact, not once since the current Governor took office. I’ve suggested that one practical approach to those repeated errors might be to aim for inflation a little higher than 2 per cent. If the past forecasting errors continue – and they may, because no one fully understands what is going on globally – it is more likely that actual inflation will end up around 2 per cent. And if the forecasting errors do go away, actual inflation would come in a bit over 2 per cent – not ideal, but not the worst outcome after years of undershooting, and consistent with the sort of flexibility the PTA provides. Perhaps that is one of the strange interpretations of the PTA the Governor has in mind? But it certainly doesn’t argue for driving policy off current headline inflation.
The country really deserves more engagement from the Governor, and some intelligent debate. There are puzzles in the data that aren’t easy to resolve (there are new ones in today’s HLFS). Resolving them and getting appropriate good quality policy from the most powerful unelected official (and agency) in New Zealand isn’t helped by some mix of lofty condescension and attacking straw men – cases no one is making – rather than grappling with the alternative issues and arguments.
With all the resources at the Governor’s disposal, we should expect more from him than is evident in this defensive piece. Those charged with holding him to account – the Board, the Minister, and Parliament’s Finance and Expenditure Committee should be asking hard questions, of him and of themselves.