Inflation is – still – expected to rise

Inflation is expected to rise gradually towards the two percent midpoint of the target range.

That was what the then Reserve Bank Governor said in the press release for the March quarter Monetary Policy Statement five years ago.

And today Grant Spencer (the unlawful “acting Governor”) said

Overall, CPI inflation is forecast to trend upwards towards the midpoint of the target range

So much time has passed, and so little has changed.  I could probably compile a complete set of those sorts of quotes, drawing from every OCR review for at least the last five years.

And this is how the Reserve Bank’s preferred core inflation measure has actually been performing.

core inflation feb 17

December 2009 was the last time core inflation was at 2 per cent.  And there is little or no sign that –  despite all the Reserve Bank forecasts –  that the gap has been closing.

The Reserve Bank doesn’t publish core inflation forecasts, but since they also don’t typically forecast price shocks (the sorts of one-offs that get sifted out in the core measures), their actual medium-term inflation forecasts are a reasonable proxy.   On the numbers published this morning, it will be September 2020 before we could expect to see core inflation back to 2 per cent –   if so, core inflation would have been below the (explicitly highlighted) target midpoint for more than a decade.  Even though over that whole period our Reserve Bank has not once come close to exhausting the limits of conventional monetary policy.

And the worst of it is that neither in the published statement this morning, nor in the press conference could the Bank’s second XI (holding the fort until the new Governor takes office next month) offer any explanation for why they are more likely to be right this time than in those previous five years of statements affirming that inflation was heading back to the target midpoint.   In fact, there was no sign of them even attempting such an explanation.

Over the years core inflation has been below target we’ve had the big boost to demand from the Christchurch repair process, a material further step up in the terms of trade (albeit with a fair amount of volaility), a significant reduction in unemployment, and the demand effects of an unexpectedly strong and persistent rate of population growth.  We’ve seen the end of the fiscal consolidation phase too.  And there has been no sign of core inflation picking up much, if at all.    What, we should expect to be told, is likely to make things different over the next few years?   And why have they got things wrong – again – over the last couple of years?

The Bank claims the output gap is now near-zero, but on their own (inevitably imprecise) estimates those resource pressures are a bit less than they were, and haven’t changed much for several years now.

In the press conference, there were several questions about the case for an OCR cut, which the Bank sought to bat away (not remotely convincingly in my view).  The “acting Governor” acknowledged that there is a risk that the next OCR adjustment could be a cut –  if the downside inflation surprises continue –  but repeatedly sought to play down the significance of the 2 per cent target midpoint, which –  as a focal point – was explicitly added to the Policy Targets Agreeement in 2012.  Asked –  channelling lines run in this blog –  whether it might not be time to take some risks, after eight years of (core) inflation below target, Spencer could only fall back on observing that inflation had been inside the range, and that what mattered was to be patient and confident that inflation would be back to the target midpoint before long.  In other words, trust us, even though that trust has been misplaced for years now.

Asked then whether there was not also a case for acting now to push up inflation to create more policy leeway (in nominal interest rates) when the next recession comes, Spencer could offer nothing more than the limp observation that “we have to have a good reason to change policy”, and that they wouldn’t want to change rates until they could be confident the policy could be sustained (even though the whole point of this particular proposal is to use lower policy rates in the short-term to generate higher policy rates in the medium-term).

I suspect that much of what is going on is the same old line was used to hear repeatedly from Graeme Wheeler – the “normalisation” of interest rates which are currently –  in the Deputy Governor’s words –  “very stimulatory”.   A common way of judging whether policy is “very stimulatory” or not might be to look at inflation developments, which suggest –  for now at least –  that the neutral interest rate has fallen.   The siren call of “policy normalisation” has tantalised central banks for much of the last decade –  none more so than the Reserve Bank of New Zealand, with two unwarranted and reversed sets of OCR increases –  and isn’t helping the cause of good policy.  Perhaps –  perhaps even probably –  at some point interest rates will move up quite a lot and stay higher, but that hasn’t a helpful guide to practical policy at any time in the last decade.   Actual (core) inflation, by contrast, has been.   The Reserve Bank now seems tantalised by the official rate increases in the US and Canada, but there is little sign of that becoming a generalised pattern across advanced country central banks –  partly because there is little sign of generalised increases in core inflation.

There was one new interesting development in the Monetary Policy Statement.  Buried in a footnote was the report of a new point estimate for the NAIRU of 4.7 per cent (in the press conference, they added a range of 4.0 to 5.5 per cent), based on some as yet unpublished research work.  I welcome the publication of the estimate –  a step forward –  but I’m a bit sceptical about their number (which is actually higher than the NAIRU estimate the Bank had in its models a decade ago, and there are good reasons to think NAIRUs –  here and abroad –  have been falling over time).  But if they really believe the story that the output gap is zero and the unemployment gap is zero, and their own data show (see chart here) that there is nothing unusual about the current relationship between core tradables and core non-tradables inflation, then it raises some questions they don’t seem to have attempted to answer.  Given that actual core inflation has been persistently low, it would suggest that inflation expectations are also well below the target midpoint.  As I’ve illustrated again recently, that is certainly the case in bond market indicators (unlike say the case in the US), but the Bank continues to assert that there is no issue and that inflation expectations are securely anchored at 2 per cent.  Something in their story doesn’t seem to add up.

In a way, today’s Monetary Policy Statement doesn’t matter much:

  • Spencer himself retires in six weeks or so, just after the next OCR review,
  • a new single-decisionmaker Governor will take office, and we have heard as yet nothing from him about his approach to the role,
  • there will be a new PTA, which the government has not yet given us any details (although there have been some suggestions that the 2 per cent midpoint reference might be removed),
  • the statutory goal of monetary policy is to be amended later this year (presumably also requiring a new PTA), but with no details yet, and
  • a statutory Monetary Policy Committee is to be put in place shortly, including with outside members.

In other words, what Grant Spencer thinks today about future policy isn’t that important and obviously isn’t binding.  But there is no reason why the analytical part of the document could not have been a lot more persuasive –  if in fact the existing senior management team has a compelling story to tell.  As it is, they don’t seem to.

At the end of the press conference, Bernard Hickey invited Grant Spencer to reflect on his involvement with many Monetary Policy Statements over the years (going back to the very first one in April 1990 –  which I drafted most of, and Grant was my boss).    He offered only two brief thoughts: flexible inflation targeting had proved to be a good framework, and the (slightly cryptic) patience is a virtue.   I wasn’t sure if that latter observation was as close as we were going to get –  from a thoroughly decent senior public servant –  to an acknowledgement that the 2014 tightening cycle, driven by a combination of conviction that inflation was about to take off (above 2 per cent) and repeated talk of “policy normalisation”  –  had been a mistake.

If so, we should be grateful, but it is still important that the Bank shouldn’t be so paralysed by its previous mistake –  an inevitable human tendency –  that it fails to do its job.  It is increasingly difficult to see why we should confidently expect core inflation to get back to 2 per cent on current policy, or what harm might be done from signalling more strongly the possibility of a lower OCR.  After all, as both the “acting Governor” and the chief economist said, the aim isn’t to be exactly at 2 per cent each and every quarter, and if anything a period of inflation a bit above 2 per cent –  not sought, but if it happened –  might actually help to rebuild confidence that the target really was centred on 2 per cent, not operating as a ceiling of 2 per cent.

11 thoughts on “Inflation is – still – expected to rise

  1. As a retiree partly with a lifestyle that is nibbling our savings an inflation rate of 2% sounds better as a ceiling than a target.
    You say Grant Spencer has been at the RB since at least 1990; looking at your graph it seems as if the target of 2% has been achieved on average over the entire period of his employment. Certainly comparing your graph for NZ inflation with an imagined graph for UK inflation from my leaving home in 1968 for say 20 years would be like comparing rolling meadows with a mountain range.
    I’m happy with what NZ has given me since arrival – a currency that has lets us plan our families future.


    • In the current climate of no inflation then 2% as a ceiling makes sense. But we have seen inflation move up above 3% in the periods preceeding 2007 which meant that the RBNZ needed more room to maneuver. 2% as a ceiling would have meant that the RBNZ would have interest rates above 10% and local industries decimated much earlier than after 2007 and our 2007-2010 recession would have been much longer by several years.

      I think economists underestimate the role that macroprudential tools have on the wealth effect underpinning inflation. With the equity restrictions still at a high 35% on LVR, you basically have kneecapped the wealth effect when you can’t borrow to spend up willy nilly.


  2. Grant first joined the RB in the mid 70s, but was out of it for most of the period 91 to 04.

    As in the UK, inflation in the last 20 years has been much lower and less volatile than in the previous few decades. That is a considerable improvement, partly (but only partly) due to central banks.

    As to whether the target should be a ceiling of 2%, of course that is really a matter for the politicians, and at present it isn’t a ceiling. But bear in mind that lower inflation will, over time, result in lower – nominal – interest rates. For anyone living on fixed income earnings, the tax distortion is real – we tax the inflation compensation component of int rates even though it isn’t real income – but that distortion could be fixed at source.


    • Lowering the OCR does not help if credit liquidity is still too tight. The wealth effect can’t kick in when you can’t borrow to spend up. The current use of macroprudential tools with 35% equity LVR restrictions still makes borrowing far too difficult.

      Also our Australian banks operate as a cartel grooming their large installed base of depositors and borrowers to maximise record profits each year. ASB has already announced its record 6 months profit increase by 13% from last year. Wait for the rest of the Australian cartel banks to report similar record profits as well soon.

      Great to hear that there has been some relaxation of the banking license to China Construction bank to leverage its groups trillion dollar balance sheet to provide infrastructure loans but whether the RBNZ will relax that for the rest of the Chinese banks to compete in the residential or commercial business loans is yet to be seen. The Commerce Commission is just not doing their job in ensuring there is more competition instead of the interest rate margin gouging that is currently occurring.


  3. There is no incentive for the RBNZ to target 2% and every incentive to follow the “conventional wisdom” AKA do what bigger central banks are doing. As long as they can say they are following the “conventional wisdom” they cannot be fired, or even blamed, for any bad thing that might happen.

    Reserve Banks can do whatever the hell they like as long as other reserve banks are also doing it, this is the same principle for commercial banks too.

    They don’t actually care what the best inflation rate would be and neither do the politicians.

    Liked by 1 person

    • Actually we have not been doing what the bigger central banks have been doing. When the US launched its QE, we were in the middle of a Christchurch Earthquake which needed funding to the tune of $15 – $30 billion quickly and urgently. It would have been the most appropriate time to have launched a mini QE of our own. This would have kept us inline with what the rest of the large central banks was doing.

      This is what the RBNZ should have initiated. Instead they left the National government in deep water having to fund a large disaster out of normal operating tax revenue. The end result?

      1. A decimated EQC fund totally depleted and fighting to scrimp and save every penny making life hell for damaged property owners.
      2. drawing from operating tax revenue means depleting the public sector of funds leading to homelessness, increased level of crime, no pay increments, more social problems, no spending on infrastructure etc

      The NZD would have floated down together with the fall in the other major currencies instead of the NZD rising instead. Inflation would be in line with the 2% we sought if we had done a mini QE.


  4. Its worthwhile remembering of the effect of compounded inflation on savings. The government’s 2% target means halving the value of my savings in 35 years. Of course those savings are invested (too much in property however…) and 35 years would be a generous retirement for me but about average for my younger wife.
    Taking the maximum and minimums from your graph (3.4% and 1.3%) gives 21 or 54 years and remembering working in the UK at 20% then just 4 years. Small changes to inflation makes big differences to the life of retirees.


    • But, as I noted, a higher inflation target will, on average over time, involve higher nominal returns (whether higher nominal interest rates or faster rates of increases in eg house prices). As I say, tax muddies the water – for fixed income assets although not for increases in house values.


  5. I watched the announcement too and I was pleased to find I actually understood all the questions and jargon pretty well given my lowly autodidact status in macroeconomics.

    I was thinking exactly the same thing: “where is this mysterious thing call inflation that everyone keeps going on about being just around the corner?”. Personally I’ve never really experienced much inflation in my working life as a Gen X. Particularly of my wages. The real value of my mortgage seems to stubbornly persist over time and not inflate away. Hence our family’s subdued consumption – in fact ever-decreasing consumption. Make do and mend is our motto. Which I guess is good for the environment at least. Simple pleasures like public libraries and parks are the best. But surely high housing costs reduce inflationary pressures as kiwi households en masse make do and mend.

    Surely, also, the explanation for low wage inflation is to be found in our labour underutilisation and underemployment stats. The actual measure of unemployment doesn’t really measure unemployment. If you are only working for an hour a week, you hardly have much bargaining power with wages. Also if you haven’t done an active search in the last four weeks doesn’t mean you are not still looking for a job. I know quite a few people desperate for more hours.

    Liked by 1 person

  6. You must be pleased that the government appears to be also questioning if the NAIRU is estimated too high, and is considering giving the RB a dual mandate which includes inflation?

    “the Government is reviewing the Reserve Bank Act with the aim of including a mandate to maximise employment alongside the Reserve Bank’s current single mandate to target low and stable inflation — currently defined as 1-3 percent…
    there are few signs in Statistics New Zealand figures of any sort of wage inflation breakout, and others, including the Treasury, see the NAIRU as closer to 4.0 percent, or even below 4.0 percent.

    It is an especially hot topic for the new Government because it wants to drive unemployment below 4.0 percent…

    Finance Minister Grant Robertson said this week after the MPS and release of the December quarter labour force figures that he had long held the view that the changing nature and structure of labour markets here and overseas meant the NAIRU levels talked about by the Reserve Bank needed to be revisited, and that unemployment could be pushed below four percent without an inflation break-out.

    “History tells us it is possible to see unemployment fall below these levels without a major impact on inflation,” he told Newsroom in an interview.”


    • Yes, generally the talk is encouraging. What it amounts to – even around the RB – remains to be seen. Individuals make a lot of difference, and the incoming Governor has not revealed anything of his hand at all, and of course the new committee they plan to legislate for is as yet totally unknown.


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