The Reserve Bank’s MPC will deliver their next OCR decision on Wednesday. The consensus seems to be (quite strongly, and I have no particular reason to differ) that the Bank will raise the OCR by another 50 basis points. At 3.5 per cent, the OCR would then be at the peak level it was (inappropriately) raised to in 2014, at a time when core inflation was well below the target midpoint and the unemployment rate was lingering high.
I’m less interested in what the MPC will do than in what they should do, and on that count I’m less convinced that the consensus call would be the appropriate one. In times like the last 2-3 years, no one should feel overly confident about any particular assessment of what monetary policy stance will prove to be needed: there is inevitably an aspect of feeling your way, knowing that when all the relevant data are available there is a fair chance you will be wrong one way or the other.
It isn’t the easiest situation in which to be making an OCR decision. We aren’t at the very start of a tightening cycle, rather the OCR has already been raised by 275 basis points since last October, and if that cumulative increase isn’t overly large by historical standards, the cuts in 2020 were also much smaller in total than in most prior easing phases (that would be so even if one included the 2019 cuts in a calculation). And most of the OCR increases have been really quite recent – it was only in mid April that the OCR was raised above the 1 per cent it had been when Covid hit, and we all know that monetary policy works with lags, often quite considerable ones.
But here, in some respects, the MPC has made a rod for its own back. At present, the most recent inflation data we have are for the June quarter. The midpoint of the June quarter (where the CPI is centred) was mid-May, a point at which (although more was expected over time) the OCR had only just been raised beyond 1 per cent. We’ll have the next release of the CPI on 18 October, and it would seem a great deal more sensible to have held off making the next OCR decision until then.
The annual cycle of OCR/MPS review dates was set a long time ago, and there used to be a view that the latest CPI didn’t often matter much so there wasn’t a particular problem with setting review dates just before the CPI release. But that was back in the days when the inflation rate was pretty stable (and low), not when it was well outside the target range, having been rising strongly (at least in annual terms for some time). It was even worse in July when the OCR review took place less than a week before the CPI was released.
Policymaking is suffering too from decades of underinvestment in macroeconomic data. Even when we get the September quarter CPI, that will have been centred in mid-August, and by then (eg) the United States will have had their September monthly data. I gather the Reserve Bank has now come round to wishing there was a monthly CPI – belatedly, since this was the same institution that frowned upon the idea 20 years ago when the then independent review of monetary policy, undertaken for the then government, by a leading overseas economist, highlighted the omission and recommended remedying it. Same goes for most of the labour market data: the June quarter data (latest we have) is centred (again) on mid May (although the new monthly employment indicator does represent some improvement in the New Zealand data in this area). We really need to be spending a bit more to get good quality monthly CPI and HLFS data, as almost all other OECD countries have. As it is, combining poor data with a weak MPC is not a recipe for good, robust, and trustworthy monetary policymaking.
And not too far down the track we will face again the MPC’s extended summer holiday, with no review of the OCR at all in the three months from 23 November to 22 February. That long holiday last summer almost certainly contributed to the OCR being increased more slowly than it should have been.
If it were me, I would have been postponing next week’s OCR review until a few days after the OCR review, delaying the next MPS until early December, and scheduling an additional OCR review at the end of January (after the December CPI data are available).
As it is, on the data we actually have to hand, I’m sceptical of the case for a 50 basis point OCR increase right now.
Some of the straws in the winds?
First, there was the relatively weak nominal GDP growth for the year to June (most recent we will have for quite a while yet) – the June quarter was 5.9 per cent higher than the June 2021 quarter, among the very lowest growth rates facing advanced country central banks. Nominal GDP is considerably easier to measure than real GDP, and is a relevant consideration in thinking about appropriate monetary policy.
Second, asset prices have been falling quite considerably. I’m not a great believer in wealth effects from house prices, but materially lower house prices will blunt the incentives for developers to continue to put in place new houses, and residential investment is one of the most cyclical components of the economy. There is a stronger argument for wealth effects from share prices, and share prices have also fallen back (eg the NZSE50 is below immediately pre-Covid levels), also dampening incentives for firms to undertake new business investment.
Third, if international New Zealand export commodity prices aren’t exactly weak, they are nothing like as strong as those in Australia (ANZ and RBA series respectively in the chart).
And then there are the core inflation measures. Much of the media and political attention has been (perhaps understandably) on the annual rate of inflation (complete with petrol tax cut distortions). That annual rate may well have fallen back a bit in September (petrol prices and all that), but it shouldn’t really be the focus. Ideally, we want to look at quarterly core meaaures – indicators of what is happening behind the headline “noise”. (And here the Reserve Bank’s factor model measures aren’t very useful, since they work on annual change data and thus often in effect function as lagging indicators in the face of big changes, even if they probably often provide the best medium-term and historical view.)
Here are the trimmed mean and weighted median measures (note that you cannot just multiply these by four to get an annualised rate)
and here are a couple of SNZ exclusion measures (CPI ex food and energy is most often used for international comparisons, simply because of data availability)
and here is one I’ve quoted a few times over the years, focused more (at least in principle) on the more domestically-generated bit of underlying inflation
Remember that all of these series are capturing prices as they were in mid-April, just short of six months ago.
There are a few potentially useful official monthly series. I’ve long kept an eye on these two from the Food Price Index
and there is the monthly rental data
Every single one of these series show a (not unexpected) trough in quarterly inflation in the June quarter of 2020 (the first, out-of-the-blue, “lockdown”). But more than a few also suggest that the sharpest increases in the inflation rate were occurring a year ago (perhaps 12-18 months on from the biggest fiscal and monetary stimulus), and that since then the quarterly inflation rates have been (high but) fairly stable or, on some measures have already fallen back a bit. And most of the most recent observations date from a time when the OCR was only just getting past 1 per cent.
If any hawkish readers are wanting to jump down my throat, can I take the chance now to stress that none of these inflation rates – from months ago – should be considered remotely acceptable. They are miles above the 2 per cent annual inflation the Reserve Bank is supposed to focus on delivering. We want inflation much lower than is evident in the most recent data.
But, again, monetary policy works with lags. And those lags may be particularly important to keep in mind when, as this year (and of necessity given how slow all central banks were to start) policy rates have been raised so sharply and quickly. Perhaps also relevant was the point in this nice post from a few days ago by Maurice Obstfeld, formerly chief economist of the IMF, highlighting that many advanced countries have (belatedly) been doing much the same thing, and those effects are likely to be mutually reinforcing. Recessions now seem unavoidable in a wide range of countries, and it isn’t clear that most central banks are taking other countries’ pending recessions into account in their own domestic policysetting.
As I said at the start of this post, only a fool would be overly confident about what monetary policy will prove to have been required over the coming year. And successful policy at this point will probably prove to have involved tightening at least a little more than, with hindsight, was strictly necessary. But on the data as they stand in New Zealand – long collection/publication lags and all – and if forced to make a decision this Wednesday (and the MPC is not forced to, the date is their choosing), I reckon there is a better case for a 25 basis point increase than for a 50 point increase. The key thing, of course, is to convey a sense that the MPC will do what it takes to deliver something near 2 per cent inflation before too long. But at this point it isn’t obvious that aggressive further OCR increases are really needed in New Zealand (Australia, the UK, or perhaps even the US may be in different positions, between even more belated starts to tightening cycles and positive shocks to demand from (eg) commodity prices or fiscal policy).