I’ve been rather tied up with other stuff for the last few weeks (including here) which is why I’ve not previously gotten round to writing about the first piece of monetary policy communications from our Reserve Bank this year.  That was the “speech” by the Bank’s chief economist (and MPC) member Paul Conway given to anyone and no one in particular over the internet last Tuesday. It had been a couple of months since anything had been heard from any MPC members, in what are not exactly settled or uninteresting times, and it is still several weeks until we get the first formal monetary policy review and MPS this year. We really should be able to expect better……but then if it were that sort of central bank, lots of things about the last few years would have been done differently, including the Bank might not have lost the taxpayer the mindbogglingly large amount of $11bn or so (with not the least sign of any contrition or of anyone having been held accountable).

Conway’s fairly short piece was a puzzling document.  What was the pressing need that called for a speech on ‘the importance of quality research and data”? And what made it sufficiently pressing that they couldn’t even wait to find a real live function/audience to address? And if there is no particular function/occasion that needed a speech, but rather just something the Bank had chosen to do, wouldn’t you have expected (I certainly would) to have found some substance. The bit (the bulk) of the speech under that headline title was in fact much more notable for what wasn’t there. Is any serious observer going to dispute the likely value of quality research and data? And especially not against the backdrop of the actual New Zealand situation: poor (if very slowly improving) data and very limited volumes of macroeconomic and financial research (with the Reserve Bank’s own output in the last half dozen years notably diminished).

You couldn’t help but think that the “speech” was really just an excuse for putting out a page and a half of comment on recent economic data. I’m all in favour of individual MPC members putting their individual views and their analysis into the public domain (one of the few ways we see the quality of the analysis and thinking of these statutory officeholders). Perhaps all the more so when it had been two months since we’d heard anything, but then one was left wondering why they felt the need to wrap an entire speech around those brief comments rather than (say) just stick out a press release with the recent data comments.

But if the process was a bit puzzling, my main interest was the substantive content of the short address.

I’m going to take the material in reverse order. At the back of the speech there is a page a half of text on “a policy-relevant research agenda” and “the importance of quality data”.  On the first of those headings, the speech is simply devoid of content. One might have hoped they would be releasing some new research or touting how policy-relevant research papers had shaped their thinking and understanding over one of the most turbulent periods for monetary policy in decades. Or even just foreshadowed a couple of specific papers that were almost ready for release. Instead there was nothing of substance at all, just a stylised graphic highlighting areas they were interested in, a list looking pretty much like any monetary policy research agenda in recent decades for almost any advanced country central bank.

What of data? Better data would be great. At a macroeconomic level, New Zealand is one of only two OECD countries with only a quarterly CPI, something Conway glides over in welcoming the recent additions to the partial monthly prices data. We also don’t have monthly unemployment data, a pretty basic measure of excess capacity/slack, and all our main macroeconomic data comes out later, with longer lags, than most of our OECD peers. It really isn’t a satisfactory situation, when so much rides on reading the economy well. But what Conway offers is mostly honeyed words about “a consultation process” with SNZ “to better understand data needs and priorities”. If one wanted to look on the bright site I guess one could note that they are “exploring collecting much more detailed data from banks to support economic analysis and research” and “we are also developing new sources of higher-frequency data to incorporate into the MPC’s assessment process”, which sounds fine directionally, but so far doesn’t seem to have amounted to much.

Right up front, in the introduction to his speech, Conway claims that “the economy is now significantly different to how it was before COVID-19”. His claims appears to be that this is so for both the world economy and for New Zealand. Again, it is a lead-in to what is, at best, a once-over-lightly treatment: one page of text and two charts, and simply isn’t very persuasive at all (especially as regards the functioning of the economy as it affects monetary policy).

Inflation went up, to very uncomfortably high levels, and then is coming back down again. But what about how the economy works is materially different now than it was five years ago? Conway really offers no hints at all. Instead he notes that government deficits have been large and government debt has increased (as he notes, by more as a percentage of GDP in New Zealand than in the typical OECD country) but what, if any, implications are there for monetary policy? It isn’t obvious and Conway offers no suggestions.

Then when we get the common line about globalisation changing, with supply chain resilience and geopolitics more in focus. It is a common line, and this might have been an opportunity to illustrate the point with specific reference to New Zealand macroeconomic and inflation dynamics. But no…. I’m still a little sceptical that there is much to the story (of macroeconomic significance) and took that line too from a recent Martin Wolf piece in the FT. Perhaps there is a story that matters to the Bank, but Conway made no effort to get beyond the cliches.

We also heard - what we all know - that traffic through the Suez and Panama canals is down at present (the former for geopolitical reasons, the latter for climatic), but nothing at all about what it might, or might not, mean for cyclical or inflation dynamics. The Suez Canal, for example, was shut completely and for several years a few decades ago. In what way did it matter and to whom?

And then we got Conway’s take that “the pandemic has sped up the digital transformation”, which was he thought a good thing. I can’t claim to have read all the papers on the subject, but my impression had been that there just wasn’t much there (in terms, eg, of improved productivity). And if in some places more people are working from home (less a thing here it seems than in some US big cities) in what material way would it matter for a central bank?

Perhaps there were substantive points to be made. Perhaps there were things New Zealand (eg RBNZ) research might have shed light on. But….nothing.

Most of whatever interest the speech commanded was inevitably going to be on Conway’s short comments on recent data.  When the MPC hasn’t spoken for two months, and was then last heard talking up the possibility of a further OCR increase, it was going to be lot of few drops of rain falling on travellers crossing a parched desert. It wasn’t as if that November MPS statement itself had been overly persuasive (this was the Bank that was talking of further OCR increases even as it forecasts showed inflation collapsing over the next few quarters).

Whatever you own view of the data, you can see why Conway might have wanted to be cautious. The Bank had been talking of a further OCR increase while the market was now very focus on when, and how aggressively, rate cuts would start (here and abroad).  Last week’s short comments seem to have been designed basically to try to dampen market enthusiasm, not necessarily because Conway and such of his colleagues who were consulted had a markedly different firm view than the market, but so as not to create a rod for the Bank’s back if, come late February, the Committee as a whole does conclude that there is no OCR cut in prospect any time soon.  The more the market had already moved, the harder it would be for the Bank to drive home its message (without quite nasty snapbacks in market pricing).

What, if any, insights were there in Conway’s comments? Not much.

There seemed to be three points:

• revisions downwards to the level of GDP over several years past don’t necessarily tell us anything much about the inflation outlook.  And, of course, every serious analyst already recognises this : if those data suggested the underlying productivity picture was a bit worse than had been thought, they don’t tell us much, if anything, about capacity pressures and how they are changing.    We already have the inflation data for those earlier periods when the level of GDP itself was a bit lower than had been thought.
• We (they) really don’t know what is going on with immigration (either the numbers –  itself a reflection of data weaknesses reintroduced to the system a year or two before Covid – or the net pressures on capacity and inflation).  There was a footnote suggesting NZIER had done some work for the Bank on migration and inflation, which is described as “forthcoming” but no useful insights were offered from that work.
• Inflation is falling but –  on the measure Conway chose to highlight (annual non-tradable inflation) –  still far too high.   But there was no supporting analysis at all.

Highlighting annual non-tradable inflation –  and suggesting it is a “rough approximation of inflation generated within the New Zealand economy –  was really a bit naughty in a couple of ways.   As other commentators have pointed out, non-tradables inflation is almost always higher than general inflation, and it is general CPI inflation that the MPC is charged with focusing on.  The MPC isn’t given an option of just being indifferent to tradables sector inflation.   And you’d expect central bank analysts and policymakers to be fairly heavily focused on recent quarterly inflation (especially when the OCR only got to the current level last May), rather than lagging annual measures. 

Conway mentions that core inflation measures are falling, but again chooses to illustrate the point using annual data only.   That said, what used to be the Bank’s preferred measure – the sectoral factor model –  is both annual and prone to revisions (up when inflation keeps rising, down when it keeps falling, but was already showing core inflation at 4.5 per cent, down from a peak of 5.7 per cent just a couple of quarters ago.

What about some of the quarterly core measures, probably reflecting the impact of monetary policy early last year?   SNZ provides a breakdown into tradables and non-tradables only at the 10 per cent trim level.  For tradables, the December quarter saw the lowest quarterly inflation rate since mid 2020, for non-tradables the lowest since the start of 2021.  The picture is pretty similar for the weighted median quarterly data.

But perhaps the thing that surprised me most about Conway’s speech –  in its reflection on recent data –  is that there was no sign of any cross-country comparative perspective.  Now, each country’s core inflation outcomes are ultimately the responsibility of its own monetary policy, but when core inflation in a bunch of countries rose pretty much at the same time, and then central bankers raised policy rates at pretty much the same time, and often to somewhat the same extent, you might think there would be value in posing cross-country comparisons, especially when many of those countries have more frequent and more recent data than we do.  The common story seems to have been that (core) inflation has been falling away, a little earlier and easier than had seemed likely to many at (say) the start of last year.  It isn’t obvious that New Zealand was a particular laggard in tightening (weren’t particularly early either) and so one might take some comfort from what is happening in other countries.

The comparison with the US might have been a particularly interesting one to touch on.  The US has, so far, seemed to have experienced a sharp reduction in annualised core inflation with, as yet, little sign of any substantial or sustained economic slowdown.  As Westpac’s Michael Gordon points out in a nice piece this morning, the US has been quite unusual on that score, and the economic data in both New Zealand and Australia have been materially weaker than we observed in the US (and that is especially so when one looks at per capita GDP growth).   Quite why the US outcomes have, to date, been so favourable is a bit of mystery, not often explored by commentators in an international context, but when our economy has been so much weaker it seems that our inflation outlook should generally be positive.  At very least it would be good to see some of this ground traversed in the MPS later in the month.

Before Christmas I wrote a piece here on monetary policy turning points in which I ended by noting that it wasn’t inconceivable that by the end of February an OCR cut might be appropriate here.  Whether the data support such a case may be a bit clearer by Wednesday afternoon (after the quarterly suite of labour market data are out), although I don’t suppose that whatever the data show an early OCR cut is at all likely.

There is an interesting piece in the Financial Times today on “Why central banks are reluctant to declare victory over inflation”.  Setting aside the fact that such language is more George Bush “Mission Accomplished” and never likely to be heard from central bankers –  my old line (with acknowledgements to von Clausewitz) about inflation was “the price of price stability is eternal vigilance” –  it nonetheless touches hardly at all on what must be one of the biggest factors weighing on the minds of central bankers.  Having stuffed up so badly (a description rarely heard, although it should be more openly acknowledged) and delivered us into very high inflation and all the attendant unexpected wealth redistributions etc, central bank reputations took something of a well-deserved hit (a change since 2019 that of course Conway chose not to mention).  They were too slow to reverse the easings of 2020 and the public paid the price.   For them, reputationally, perhaps the worst possible thing now would be to begin easing, cutting policy rates, only to find in a few quarters time that inflation really wasn’t securely settling near target.  There would be considerable public and political unease if they were soon tightening all over again.  By contrast, people are attuned to the idea that squeezing out inflation involves some pain, so why not take the free (to them) option until they are 100 per cent sure inflation really is on course).  

One problem then is that the interests of the individual central bankers –  mostly still holding the offices they did in 2020/21 – aren’t necessarily well-aligned with the wider public interest.  To be 100 per cent sure that inflation was well on course towards the target midpoint also necessarily then means quite a high risk of overshooting (both that inflation ends up going below target midpoint –  as in so much of he pre Covid decade, here and abroad) and that output and employment are unnecessarily sacrificed.    That, in turn, might be less of an issue in the US, where the economy has held up, then (say) here where we’ve already had last year some of the very weakest per capita GDP growth of any OECD country.

Much of the discussion about the possibility of rate cuts this year tends to proceed –  perhaps not consciously but it is the effect –  as if the two choices were to keep rates at current levels or to take them quickly back to neutral (wherever that unobserved variable might be –  our RB thinks somewhere under 3 per cent).  But those aren’t the choices central bankers actually face.  I very much doubt it would be prudent for interest rates to be anywhere near neutral right now, but relative to how things looked when the OCR got to 5.5 per cent first in May 2023, there is a lot more reason now to be confident that the worst is past.  Back then it was purely prospect but now we have some hard evidence, and we know that monetary policy works only with a lag.  More disinflation is, as it needs to be, in the works.  It isn’t impossible than an OCR of 5 or 5.25 per cent would now be better than one of 5.5 per cent.

Of course, none of any of this was in the Conway speech, which really did seem to be just about buying time/space to get the MPC through to the end of February (after its inexcusable three month summer break).

In conclusion….well, this was Conway’s

It was really quite remarkable for its avoidance of any responsibility. You’d note know from this that any central bank’s conscious and deliberate choices played any part in inflation being well above target for three years in succession.  When you can’t acknowledge your part in a really bad, costly and disruptive, set of outcomes, it is really hard to be confident that you are really any sort of “learning organisation” or that the much-vaunted (but as yet unseen) research will be for anything other than support rather than illumination.

Central bank monetary policy speeches are rare enough in New Zealand. On the rare occasions MPC members do speak we deserve better than Conway’s effort. The Governor is due to speak next week. HIs speeches to the Waikato Economics Forum have tended to be substance-free zones, but I guess we can always hope.

And I hope the Minister of Finance and her advisers are taking note, and are looking to find and appoint rather better people to fill the two MPC vacancies arising in the next few months.

I ran this chart in a post the other day

The fall in New Zealand’s per capita real GDP (averaging production and expenditure measures) over the last year has been quite striking set against other advanced (OECD) countries for the same period. We are equal second-worst, and quite a bit worse than the next country with its own monetary policy (Sweden) - I’m mainly interested in the inflation situation.  The fall in real per capita GDP in New Zealand thus far isn’t much short of the fall experienced in the 2008/09 recession.

With recent data it is certain there will be revisions and thus it isn’t impossible that the last year might end up looking a bit less bad. But for now, the published data are the best official guesses - for us, and for fiscal and monetary policymakers.

The OECD has data on quarterly real per capita GDP, going back a fair way (a lot further for some countries than for others, but pretty comprehensive for current members from the mid 1990s). I was curious how common falls in real per capita GDP had been in that database.

For the 1980s there isn’t data for many countries, but we find large annual falls in real per capita GDP as follows

• Australia 1982/83
• Canada 1982 (at worst about -5% per annum), and
• the United States 1982 (the recession that saw them get inflation down.

Coming forward to the early 1990s we find

• Finland 1991/92 (some mix of domestic financial crisis and the fall of the Soviet Union)
• Canada 1991
• Iceland 1992
• (New Zealand would probably be on the list but our official population series begins in the middle of the early 90s recession)

Moving on a few years and we have

• Chile 1998/99
• Israel 2001/02

In 2008/09 all but a handful of countries saw a significant fall in real per capita GDP.  It was, of course, the recession that ushered in the decade or so of surprisingly low inflation.  At worst, per capita real GDP fell by about 5 per cent per annum in the US and 6 per cent in the euro-area (and about 4 per cent here).

In and around 2012 various euro-area countries (but notably Greece) did dreadfully, but the euro-area as a whole only saw real GDP per capita falling at about 1 per cent per annum during that period.

Covid intervened –  when we shut down economies for a time and deliberately wound back economic activity – but otherwise there are no big falls in per capita GDP on an annual basis in places with their own monetary policy until……New Zealand right now.

What we have seen over the last year isn’t normal or small, but a large fall, of the sort seen in advanced economies only in pretty adverse times. 

Why focus on real per capita GDP?  The public commentary tends to focus on GDP itself, with all the attention on whether the total size of the economy is rising or shrinking.   But for most economic purposes, and certainly for inflation purposes, it isn’t a very relevant measure.  Zero per cent growth in GDP means something a great deal different if the population is static or falling than if it is growing at 2.5 per cent per annum.  It is (much) more likely that excess demand pressures are easing if  –  absent really nasty supply shocks – per capita real GDP is falling, even if there is still some headline growth in GDP itself.

That said, all such comparisons, especially across time, take one only so far.  In an era of really strong underlying productivity growth, even a moderate GDP or real per capita GDP growth might be consistent with easing excess demand pressures, and if productivity growth is historically modest –  as it has been in much of the advanced world for almost 20 years now – even falling per capita GDP might not be consistent with much or fast easing in capacity pressures. 

But a fall of 3.5 per cent in real per capita GDP over the last twelve months probably deserves more attention than it has been getting thus far (even if headline unemployment has still been quite low).

When the Reserve Bank MPC came out late last month with its last words on monetary policy before its extended summer break, my post then was headed “Really?“. It was a commentary on the disjunction between the Reserve Bank’s inflation forecasts on the one hand, that showed quarterly inflation collapsing (not really too strong a word for it) over the next few quarters, and on the other hand the Bank’s OCR projections that showed a better than even chance of a further OCR increase early next year and an OCR at or above current levels well into 2025.

It wasn’t as if the Reserve Bank even gave us a compelling story as to why (a) they expected inflation to be just about to collapse or b) why they were talking in terms of further OCR increases. It just didn’t make a lot of sense, and they seemed doomed to be wrong on one count or another. And here remember the lags (something the Governor himself reminded people off in his press conference): whatever core inflation is going to be by the middle of next year is (unknown but) baked-in already. Changing monetary policy would make little or no difference to most of next year’s inflation.

Now, it is quite fair to note that there hasn’t been much sign so far in the official CPI data of the core and persistent parts of inflation coming down much, if at all. As ever in New Zealand, things aren’t helped by infrequent and lagging data (our last comprehensive CPI data are reading things as at mid-August). Neither the trimmed mean nor weighted median measures are done on seasonally-adjusted data (SNZ, please fix this), but the latest quarterly observations for both measures were about the same as in the September quarter a year earlier. We do have a seasonally-adjusted quarterly non-tradables inflation data, and the latest observations are down from the peak, but the September quarterly inflation rate was still no lower than June’s. There is enough in those official data to suggest core inflation has definitely peaked - which isn’t nothing - but having gotten things so wrong a couple of years ago you can understand why MPC members might still be a little nervous if they were just looking at the CPI (although if you were really that nervous why project such a sharp fall in inflation so soon?)

The issues are compounded for the Reserve Bank - and anyone else trying to make sense of what is going on now and what might happen soon – by the fact that two big and powerful countervailing forces have been at work. On the one hand, we had the OCR raised by 525 basis points in little more than 18 months, an usually large move in such a short space of time (the only move really comparable was in 1994 - focus then on the 90 day bill rate). And, on the other hand, record net migration inflows. In isolation one is a sharply disinflationary force while the other has added to inflationary pressures (although on the Bank’s forecasts net migration is forecast to be sharply lower next year, and if so that is likely to be a disinflationary shock). Since the Bank’s models - and anyone else’s – didn’t do very well at all in picking the sharp increase in core inflation, there is probably little reason for them (or anyone else) to have much confidence now.

All that said, it is getting increasingly hard not to think that inflation is about to fall away pretty sharply, and would keep doing so for some considerable time if the OCR were left at current levels or even raised a bit further.

There are straws in the wind from the partial (monthly) price data that SNZ releases. Indicators from the labour market suggest it is much easier to find staff (much harder to find a job) than was the case just a few months ago (at the level of anecdote I’ve been surprised by stories from my university student kids about how much problem many young people they know have had getting holiday jobs). The experience of several other countries is also not likely to be irrelevant - where inflation has also (finally) seemed to have begun to fall away faster than seemed to likely to policymakers earlier this year (and bear in mind that if the RBNZ was not one of the first advanced country central banks to raise the OCR in 2021 (it was about 7th), it was moving earlier than central banks in the US, the euro-area, Canada, or Australia.

But then there are things like the GDP data. This was from my post on Saturday

Now, it is fair to note that on some international estimates New Zealand had a larger positive output gap than most other advanced countries when inflation pressures were at their peak last year. On that basis, it might take more work - more loss of output - to get inflation back down here than in many other advanced economies. But when you have the second worst growth in GDP per capita of any OECD economy (and materially weaker, on current estimates, than the next country with its own monetary policy - Sweden) it might seem like a reasonable hunch that enough has been done. Of course, there will be revisions to come, but the December quarterly GDP release (ie last week’s) is generally the least unreliable because it benefits from the recent updates of the annual national accounts.

Now, is it impossible that inflation could stay high - or fall only very sluggishly - even if GDP (and GDP per capita, which is more important here) are very weak. In extreme scenarios of course not. But the economy hasn’t been suffering from really nasty adverse supply shocks over the last year, extreme political instability is not a feature (transfers of office happened as normally as ever), and……inflation expectations have stayed encouragingly subdued throughout the last couple of years, and are modest now.  In a rag-tag sort of way the system seems to have worked (central banks messed up really badly in 2020 and 2021 - and that can’t be lost sight of – but when all the alternatives had been explored seem to have done what was required). The high inflation of the last couple of years is going to be a nasty memory for quite a while (here as elsewhere), but there is little sign anyone much thinks inflation is going to settle outside the target range.

Worriers may point to recent pick-ups in confidence survey measures. This (Westpac) one just turned up in my email inbox

Being off the lows here still leaves it not far above troughs in the most recent two severe recessions in New Zealand. All the confidence measures are still in contractionary territory, and the medium-term mood is about as bleak as ever.

One reason sometimes mentioned for why central banks would be cautious is that - after the mistakes of 2020 and 2021 - it would be quite unfortunate if they were to sound softer now only to find that inflation was hanging up and that renewed tightening was eventually needed to finally get things back near target.

As a psychological consideration it is no doubt real.  But central bankers shouldn’t be purging their own “guilt” or past incomprehension by holding tight indefinitely. Rather they need to recognise those personal biases etc and correct for them.

Against that backdrop I found it useful to look back at some of the last big easing cycles that the Reserve Bank presided over. A couple of weren’t very enlightening: the increases in the OCR in 2014 were never justified in the first place so when they were finally unwound didn’t offer much. And in the mid 90s there was enough weirdness - and volatility - about the management of monetary conditions (for those with long memories, think of the Monetary Conditions Index). But I had a look at 1990/91 and at 2008. In both cases, short-term interest rates fell by 500+ basis points (in the first case, accommodated by the RB – this was pre OCR – and in the latter by direct Reserve Bank decision). In both cases, inflation had been or become quite a problem. In 1990 core inflation had been stuck around 5 per cent and the goal – a couple of years out - was 1 per cent (midpoint of the 0-2 per cent range), and in 2008 headline and core inflation had moved persistently above 3 per cent, the top of the target range (best current estimates have core inflation peaking in that cycle near 4 per cent).

Go back to 1990/91. The first negative GDP quarter was March 1991. That data won’t have been available until late in the June quarter of 1991, but by the month of March 1991 90 day bill rates had already fallen by about half (250 basis points) of that total fall that year. At that point, the most recent (December) quarterly inflation data were hardly better than they’d been a year earlier (although it was to fall away very sharply in the next few quarters). Two-year ahead inflation expectations were still about 4 per cent.

With the benefit of hindsight, if anything we were too slow and reluctant (for a long time) to let interest rates fall that year. Much as we expected inflation to fall, we (like almost everyone else) was taken by surprise be the speed and size of the fall.

What about 2007/08, when the inflation target was much the same as it is now, and the monetary policy implementation system (the OCR) was the same?

Going into 2008, the OCR was at 8.25 per cent, a level it had been raised to in mid 2007 (at the time on the back of rising international commodity prices, when core inflation had already got troublingly high). What was to become labelled as the “global financial crisis” is conventionally dated as beginning in the northern hemisphere in August 2007 but even by mid 2008 it wasn’t seen as a huge factor in New Zealand (within the Bank there were competing views) - the galvanising events (eg Lehmans) weren’t until September that year. The world oil price had peaked - at still all-time highs - a bit earlier that year.

The New Zealand economy could hardly be said to have been in fine good heart. The lagged effects of several years of OCR increases were increasingly evident. But the unemployment rate by mid year was only a little off its lows (3.8 per cent), there’d been just a single quarter of falling GDP published (and some of that had been weather-related), but the first OCR cut was in July 2008.  Two-year ahead inflation expectations are the time were about 2.9 per cent (a touch higher than they are right now). I recall the MPC/OCRAG debates at the time, which with hindsight were a bit surreal as there was much discussion about whether just possibly we might be able to cut by as much as 100 basis points over the following year (actual 575 basis points, and probably should have been more).

With hindsight - and here I would put more stress on hindsight – we were too slow to start moving then. It was perhaps understandable given where core inflation was, and the difficulty of anticipating the full gory mess about to break on us from abroad, but it was too slow. But my point was that it was long time afterwards before it was clear that core inflation was actually back near target or even that the unemployment was back around some sort of NAIRU (it was early February 2009 before the Bank knew the unemployment rate had got to 4.4 per cent).

Have there been mistakes in the other direction? Of course. The 2020 monetary policy easing was clearly a mistake. But there have also been a couple of times when we (the Bank) thought we’d done enough only to have to resume tightening (one might think of 2005/6) but the message from the data now is becoming fairly clear. At some point - perhaps before too long - much the bigger risk is likely to be holding the OCR at peak for too long.

Go back a year or so and there was quite a bit of debate about what the neutral OCR might be? No one really had any idea, and in truth no really does now. But……the developments in core inflation globally (and in GDP and jobs ads data locally) given us a much stronger reason now to be confident that policy rates are contractionary than perhaps we’d have had at the start of the year.  And central banks do purport to run a system that puts quite some weight on forecasts of inflation. In practice, there is less reliance than is implied by the rhetoric (and models), which reflects the fact that forecasting is hard.

In debates here and abroad about the appropriate stance of monetary policy one often sees mention of two things. First, the notion that “the last mile” might prove materially harder than the first steps downwards in inflation. Mostly that seems like handwaving, especially when the focus is – as it should be - on measures of core inflation. There doesn’t seem to be much evidence from past cycles (including in New Zealand when we were first securing something like price stability in the early 1990s) of a “last mile” problem, and it seems no more plausible this time when inflation expectations have been subdued (and when in New Zealand the exchange rate remains fairly high and stable). The other argument is that central banks need to be sure we are going to get back to target. That is an argument that puts no weight on forecasts at all. I’m not one with any particular confidence in published central bank forecasts, but in most past big falls in inflation it would have proved to be a mistake (as indeed it was two years ago when central banks were slow to tighten).  As time passes, there is more reason for confidence than there might have been even six months ago. Even in principle, that confidence isn’t enough to suggest policy rates should be back to neutral - wherever neutral is - but it should be enough to suggest that less contractionary settings might be required to give one the same level of confidence one was seeking 6-9 months ago when policy rates were first approaching what now seems to be the peak. We don’t have any real idea as to whether the OCR settles at 1.5 or 3.5 per cent, but it seems most unlikely it will settle anywhere near 5.5.

I’m still quite deeply perplexed by the Reserve Bank’s stance last month (assuming that it wasn’t - and they say it wasn’t - just about playing games with markets to hold expectations up). It is less than satisfactory that (a) they’ve gone off for a three month summer break (in contrast, the Cabinet seems to get about four weeks between meetings), (b) that there are no speeches or serious interviews exploring the issues, outlook, and risk (without a Parliament there wasn’t even the theatre of an FEC hearing [UPDATE: Shortly after this post went out the RB put out an advisory that there will be an FEC MPS hearing at 8am on Wednesday}). We are left with no insight on the Reserve Bank thinking, or the range of risks, hypotheses etc they are exploring or how well they are marshalling evidence in support etc. It is our inadequate MPC on display again, summoning no confidence in them whatever even if (just possibly) somehow they are right.

If the meaningful dataflow this year is largely already at an end - hard to see the HYEFU or the micro-budget telling us much – the CPI data in late January, the suite of labour market data in early February, and the monthly spending indicators (including those banks are now producing of own customer activity) should be telling us (and the MPC) a lot.  If things are as weak as many recent indicators have suggested and inflation pressures are (finally) abating fast, the possibility of an OCR cut in late February shouldn’t be thought completely impossible or inappropriate.

I’m not a huge fan of central banks publishing medium-term economic forecasts (or projections as we were usually schooled to call them). As I understand it, decades ago the Reserve Bank of New Zealand only started publishing them because the Official Information Act was passed (and in those days the forecasts made little or no difference to policy so there wasn’t even an arguable ground for withholding). My scepticism only increased as the projections assumed an increasingly significant place in the policy communications, including the move to endogenous interest rate projections from 1997. It isn’t that a central bank’s forecasts are likely to be worse than anyone else’s, just that medium-term economic forecasting (cyclical stuff 2-3 years ahead) is really a mug’s game, and those medium-term forecasts rarely if ever have much impact on the accompanying OCR decision. OCR decisions are almost always, and necessarily (given the state of uncertainty, limited knowledge etc), driven by the latest data releases, which are at best real-time contemporaneous, and more often relating to periods a month or three back (the latest NZ GDP data are for the quarter that ended in March). And that is as it should be. And yet in my experience of the Reserve Bank forecasting and policy process, inordinate amounts of time (including time of the Governor) was spent on numbers for periods so far ahead they would, almost inevitably, be quickly invalidated; often more time (and more senior management smoothing, for messaging purposes) on where we thought things might be in 2 years than on where we think they are right now. I recall a speech some years ago now from a retiring senior European central banker who suggested that perhaps central banks shouldn’t bother publishing for horizons much more than six months, and that line still has some appeal to me. It isn’t about trying to withhold information, but about having nothing useful to say and no robust grounds on which to say it. None of that is a criticism of the Reserve Bank, or their peers abroad, it is just the state of (lack of) knowledge.

Of course, the international trend has been in the other direction, with more central banks publishing more forecast information, and for the time being we are where we are. The Reserve Bank of New Zealand was once considered a leader in forecast transparency, but there are some areas in which they really aren’t very transparent at all. Thus, despite the (quite appropriate) policy focus on core inflation, the Bank does not publish forecasts (even for the next few quarters) for any of the measures of core inflation, and despite the evident seasonality in the inflation data (sufficient for SNZ to publish seasonally adjusted series), the Bank’s inflation projections are not seasonally adjusted (in contrast to almost all quarterly quantity series). On core inflation, even the Reserve Bank of Australia, publishes projections (albeit at six-monthly rests rather than for each quarter) for annual trimmed mean inflation

But if I’m sceptical of the merits of published forecasts, that doesn’t mean those forecasts have no information about the central bank’s own thinking at the time of publication. In fact, the numbers can be – and often are – a significant part of the Bank’s storytelling and tactics, in support of a current policy stance. And how those numbers change over time can also be revealing.

You’ll recall – I highlighted it in my post last Thursday – that one of the good features of last week’s MPS was the upfront acknowledgement that core inflation was hanging up, and that if anything domestic inflation had been a little higher in the most recent quarter than the Bank had been expecting. For example, the minutes record that “measures of core inflation remain near their recent highs”, a point reiterated a couple of times in chapter 2 (the policy assessment). In case there is any doubt, they have a chart showing the core inflation measures grouped around 6 per cent (annual rate). The target, you will recall, is 2 per cent – the midpoint (that MPC is required to focus on) of the 1 to 3 per cent target band.

The Bank doesn’t use one of my favourite graphs, of quarterly core inflation

…but they don’t really need to. They seem to be in no doubt that core inflation has been hanging up, in ways that are at least a little troublesome.

Of the published forecasts, the closest one to showing their hand on the outlook for core inflation is the forecasts for quarterly non-tradables inflation. Non-tradables inflation tends to run persistently higher than tradables inflation (for this century to date, annual non-tradables inflation has averaged 3.4 per cent while annual tradables inflation has averaged 1.4 per cent), and so even as tradables inflation has been abating, non-tradables inflation has been running at an annualised rate 6.6 per cent, a bit higher than core.

Looking out to the medium-term, the Bank seems to consider that non-tradables inflation of about 3.3 per cent will be consistent with inflation being at 2 per cent (for the final year of the projections, to September 2026, they show things being settled at those rates).

In the nearer-term they have generally been having to revise up their forecasts for non-tradables inflation. Here is how RB forecasts evolved over the last year towards the actuals for the two quarters in the first half of 2023.

And here is the SNZ series for non-tradables quarterly inflation on a seasonally adjusted basis.

That last observation is modestly encouraging although (a) per the previous chart, it was quite a bit higher than the Bank was expecting, and (b) there is no sign of anything similar in the analytical core inflation measures themselves. Better than the alternative I guess, but nothing to hang your hat on (and as I noted earlier, when writing about inflation outcomes to date the Bank does not do so in the MPS – it is appropriately uneasy about core and domestic inflation holding up).

As it happens, the Bank has also been revising up its forecasts of Q3 non-tradables inflation – its latest view for the current quarter is (a touch higher) than any of its projections for the quarter over the last year.

But….seasonality matters. The Bank doesn’t publish its inflation forecasts in seasonally adjusted terms. But if we compare the actual data, seasonally adjusted and not, we can back out some approximate seasonal factors, and convert the Bank’s projections into (approximately) seasonally adjusted terms (more technically oriented people could no doubt do it more formally).

This is the result

On these projections, non-tradables inflation (projections for which have been revised up to new highs) does fall a bit in in the September quarter, but then by the December quarter – measured centred on 15 November, now less than 3 months away, starting less than 6 weeks from now – suddenly the whole domestic inflation problem is solved. In (rough) seasonally adjusted terms, non-tradables inflation is back down to 0.8 per cent for the December quarter, a rate not seen since the start of 2021, and a rate consistent with all the inflation problems being solved. Annual rates take a while to come down to be sure, but any policy-setting agency would be firmly focused on quarterly tracks and…..within three months we are there (at least according to the Reserve Bank).

Quite the contrast: revising up the Q3 forecasts (a quarter we already know a bit about) and revising materially down the December 2023 and March 2024 forecasts, which we don’t yet know anything firm about.

I won’t bore you with the charts but it is not as if they are suddenly expecting a much sharper rise in the unemployment rate. Actually, unemployment rate projections for the next 6 months have been revised down quite a bit.

It all seems like a rather miraculous good news story. and yet one that the Bank left buried in the website tables and made no mention of at all, not in the MPS itself or at FEC.

Suggesting they don’t really believe it themselves. How likely is that we’d go from an entrenched (core) inflation problem now (and in the most recent published quarter) back to something consistent with the target midpoint in a matter of weeks? Frankly, it doesn’t seem very likely.

One possibility – and who knows if it is the explanation – is that they really don’t want to raise the OCR again. That might be for political reasons, or because they like this idea of being (one of the first) central banks to reach a peak rate (or some, conscious or unconscious, mix of the two), but had those quarters from 2023Q4 into next year been a bit higher – domestic inflation abating more gradually, consistent with the fairly modest recession forecasts – they would have been under a great deal more pressure to raise the OCR now or in early October. Neither explanation would be to the Bank’s credit. Perhaps neither is the correct story, but then we don’t have any explanation at all from the Bank. If they really believed inflation was collapsing as we speak, surely they’d have told us?

There are some other odd features in the numbers. Take the wage forecasts for example. The Bank doesn’t publish forecasts for the only data we have on wages rates themselves (that is the stratified LCI Analytical Unadjusted series). As I’ve shown previously, inflation in private sector wage rates seems to be levelling off (but not yet falling).

The Bank publishes forecasts for the LCI itself, for the private sector. The LCI is not a measure of wage rate but is designed to be a proxy for something like unit labour costs. Over the decades inflation in the headline private sector LCI has averaged somewhere not too far from the core rate of CPI inflation.

Eyeballing the chart might suggest that annual increases in this measure of the LCI of around 2 per cent might be roughly consistent with inflation at target.

Here are the Bank’s forecasts for LCI inflation

Note first that straight line. No model will have produced that, but rulers are a handy tool for forecast teams responding to gubernatorial whims. But more importantly, note that again they think the job is all but done – those quarterly rates of increases come down hardly any more (that apparently now being consistent with core inflation at the 2 per cent target, but again with no explanation). But then this measure of wage inflation holds up at a remarkably high levels even as the unemployment rate rises from the current 3.6 per cent to 5.3 per cent and only gets back to 5 per cent by the end of the projection period. It doesn’t make a lot of sense and simply isn’t very plausible.

None of it makes much sense. And these days, with a central bank whose Governor and Board chair just make up stuff when it suits, it is impossible to take anything they say or publish at face value. Which is a terrible place to be, when so much power is vested in the Bank, and so much havoc and loss wreaked, with no sign of any effective accountability at all.

I did an interview with Mike Hosking this morning on monetary policy and inflation, against the backdrop of this afternoon’s Reserve Bank Monetary Policy Statement. Where we differed seemed to be around wages. Hosking asked how did wage inflation get so high, contributing to the ongoing inflation problem, and suggested that wage earners should now hold back in order to help bring inflation down.

Such lines aren’t unknown, even from central bankers (the Governor and other senior Bank of England people have run such lines recently, and not emerged well from the experience). I think they are almost entirely misplaced. Inflation (well, core inflation anyway) is a monetary policy failing, a symptom of persistent excess demand across the economy (for goods, services, labour, and whatever). One symptom of that excess demand was the incredibly tight labour market – record low rates of unemployment (not supported by microeconomic structural liberalisations) and firms crying out for workers, reporting extreme difficulty in finding them etc. All those pressures appear to be beginning to ease now, but employment growth has been very strong even recently, the unemployment rate is still well below most serious NAIRU estimates, and the participation rate is far higher than it was pre-Covid.

If anything, it is surprising we have not seen stronger growth in wage rates. Here is a simple chart showing wages (the stratified LCI Analytical Unadjusted index of private sector wage rates) and prices (the CPI) since just prior to Covid.

Over that 3.5 year period real wages have hardly changed (in fact they are slightly down, but the difference at the end of the period is less than 1 per cent). Even allowing for the fact that the inflation took everyone by surprise – most notably the central bank and its MPC – it isn’t really what I’d have expected this far into an inflation shock. Note that over time you’d normally expect real wages to rise as trend productivity improves, but the best estimates so far suggest little or no economywide productivity growth in New Zealand over the Covid period.

Now, as I noted in yesterday’s post the terms of trade for the New Zealand economy as a whole have been falling, reducing purchasing power relative to the real output of the economy. Perhaps wage rates have been doing something unusual relative to overall capacity of the economy to pay?

In this chart, when the line is rising (falling) private sector wage rates have been rising faster (slower) than nominal GDP per hour worked.

The orange line is the average for the couple of years immediately prior to Covid. As you see, the final observation (Q1 this year, as we don’t yet have Q2 GDP) is almost exactly at that pre-Covid level. Wage rates have not risen in any extraordinary way relative to the either prices or overall economic performance in the last year or two.

The gist of Hosking’s question was that if only workers now took lower wage increases the adjustment back to low inflation might be easier. At one level, I guess it just might, but only in the same way as if firms decided to increase their prices less (the CPI is, after all, ultimately just a weighted average of firms’ selling prices). But things don’t work like that, and it isn’t even clear that they should (there is a lot to be said for decentralised processes for both price and wage setting). As I noted in response, the labour market these days mostly isn’t a union leviathan confronting a combined employers’ leviathan, but a decentralised process in which individual firms and their workers make the best of the situations they find themselves in. Firms want/need to attract and retain staff and have to pay accordingly, and when employees have other options they can either pursue them or suggest they need to be paid more to stay where they are.

Core inflation is an excess demand phenomenon, which can be reinforced to the extent that people (firms, households, whoever) have come to fear/expect that inflation in future will be higher than it has been in the past (and whatever weight one puts on them that is what inflation expectations surveys are now showing). What we need isn’t firms or workers to be showing artificial “restraint” but the central bank to do its job, to adjust overall demand imbalances in ways that once again delivers core inflation sustainably near 2 per cent. Unfortunately, that can’t just mean heading back to things as they were at the end of 2019 when inflation was low, on the back of years of low inflation, but rising: achieving the reduction from 6 per cent to 2 per cent is the dislocative challenge.

Changing tack, as I mentioned yesterday one of the key things I will be looking for in the MPS today (more or less regardless of what immediate policy stance the Bank takes) is evidence of engagement with the question of why (core) inflation has come down so much in some (by no means all) other advanced economies and not in New Zealand.

To illustrate, here is the US trimmed mean CPI (monthly annualised)

The weighted median series looks much the same.

And here are the Bank of Canada’s annual core inflation measures

But it isn’t only in North America. Here are the Australian core measures (both now showing much the same story)

And yet here are the NZ measures

The trimmed mean appears to have fallen from a peak 18 months ago, but is hardly falling at all in the last couple of quarters, while with the weighted median it is not clear that there has been any reduction at all. Both are at levels a long way from the target midpoint.

At one level, perhaps the US and Canadian inflation reductions are less surprising. Their central bank policy rates are now at or above the pre 2008 peaks. By 21st century standards these are now high interest rates for those countries

New Zealand makes quite a contrast……but Australia even more so.

I don’t understand quite why core inflation has already clearly come down in Australia at what seem to be quite modest interest rates. If you look carefully at those core inflation charts you will notice that core inflation started rising two quarters later than in New Zealand, and now seems to be clearly falling more and sooner.

Relative to New Zealand, Australia has had a better run with commodity prices

And whereas Australia usually has a higher unemployment rate than New Zealand, at present they are roughly the same, suggesting that if anything Australia may have an unemployment rate further below NAIRU estimates than New Zealand does.

There must be good explanation for what is going on, for why core inflation has not yet fallen (as it has not in some other advanced countries) but to be persuasive such explanations need to be able to encompass credible explanations for why things have gone better (inflation fallen earlier and faster) in the US, Canada, and Australia. Those stories matters: on the face of it, the US and Canadian comparisons might suggest that the RBNZ has simply not done enough, but the Australian comparison (in an economy with a very similar Covid experience, and also a more similar labour market experience) might reasonably suggest the opposite. One sees stories from the UK and North America ascribing inflation to the low post-Covid participation rates, and (in the US) some easing in inflation perhaps being down to a recovery more recently in participation. But of these four countries NZ stands out as having the largest rise in participation (true even if some might discount the latest quarterly rise) and apparently (thus far anyway) the stickiest core inflation.

Perhaps the explanation will eventually be shown to have been some mix of “the cheque was in the mail” and “New Zealand data were published more slowly and infrequently than many other countries” – plenty of places already have July inflation data, in some cases July unemployment data, while we have only mid-May inflation and unemployment data, and have a two month wait for more.

Or perhaps there is more of an economic story. I hope the Reserve Bank can offer some serious analysis this afternoon.