By Roger J Kerr
'Learn from your mistakes' is what we all tell our kids – which doesn't always work 100%.
However the managers of monetary policy should always look back and evaluate what they did in the past and examine the success or otherwise of a particular monetary policy stance.
If they made policy setting errors they should learn from those mistakes. I have eternal hope that the RBNZ did look back critically at the 2005/2007 period when they tightened policy with interest rate above 8.00%, when the economy was already on a track to much weaker growth (see the GDP growth chart below plotted against interest rates).
At the time they were pre-occupied with excesses in the residential property market pushing inflation higher. Having monetary policy too-tight-for-too-long at that time caused the subsequent economic recession in 2008/2009 and severely damaged the export/productive sector via the high exchange rate.
Today we have the inverse of that situation developing with the RBNZ running the risk of having monetary policy too-loose-for-too-long.
The danger is that inflationary risks build up in a stronger growing economy this year because the RBNZ delay monetary policy adjustments until it is too late to be effective.
The markets and the RBNZ are currently looking back at the flat economy over the second half of 2010 and concluding that there is low risk of inflationary pressures in 2011/2012 and thus monetary policy can remain "very loose" for much longer into 2011.
Mr Bollard has clearly stated that he wants to see conclusive and hard statistical evidence of growth this year before moving the OCR up.
My ongoing contention is that by the time he has the evidence and proof it will already be too late to pre-empt inflationary pressures.
The result is that the RBNZ find themselves behind the 8-ball in controlling inflation and have to push short-term interest rates up more rapidly and in larger steps than otherwise could have been the case.
The outcome of that situation is a sharply rising Kiwi dollar value and further damage to the all-important export sector - yet again!
Monetary policy errors have real economic consequences and lurching from one extreme to another has caused problems in the past. The RBNZ need to avoid being behind the 8-ball later this year and the early-March Monetary Policy Statement coming up is an opportunity for the RBNZ to articulate the risks of leaving monetary policy too-loose-for-too-long.
The RBNZ’s pre-occupation with the residential property markets as the key driver of the NZ economy (thus monetary policy settings) is also a dangerous in-built bias.
If they are waiting to see some life in the housing market this year before adjusting the OCR upwards, they will be looking at the wrong lead indicator.
The critical lead indicator to stronger GDP growth this year will be when and how farmers spend their much increased incomes form the record high beef, lamb and diary prices.
The RBNZ are firmly of the view that all the extra income will go to repaying debt (particularly in the highly indebted parts of the dairy sector).
The majority of farmers will however be reinvesting the additional cash in their businesses with fertiliser, fencing, contractors and machinery.
That increased spending has an enormous impact on provincial New Zealand and eventually feeds into the cities. The high prices are a big incentive to lift output off the land. As dairy land prices recover back up and farm balance sheets improve the bank lenders will relax somewhat.
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* Roger J Kerr runs Asia Pacific Risk Management. He specialises in fixed interest securities and is a commentator on economics and markets. More commentary and useful information on fixed interest investing can be found at rogeradvice.com
17 Comments
Completely disagree,
The only inflationary pressures in the developed World right now are from rising commodity prices which an OCR hike will do sod all to change. We also have a natural cushion against commodity price swings anyway since they are strongly correlated to our dollar’s value which minimises the impact of price rises.
Bollard is correctly looking through events which OCR hikes can't influence like the GST rise and commodity price rises
Roger, is it possible the RBNZ used a faulty input over the years?
It seems they systematically underestimated inflationary pressures over a decade or more. One way this could happen would be if the CPI systematically underestimated inflation. Steve Netwriter taks about this here
http://neuralnetwriter.cylo42.com/node/129
Perhaps the CPI just doesn't measure the right things.
The symptoms seem to be the RBNZ sets itself a 1-3% target but consistently achieves a 2-6% result as measured by the CPI.
If the measurement sytem is broken you would expect a poor result.
The argument for a 1-3% target seems to be "oh well, that's what the US seem to run at so we had better fall in line".
The CPI isn't the only thing that doesn't measure the right things.
I mentioned yesterday that GDP is a nonsense too.
If we all went out and destroyed everything in sight, the resultant repairs would put GDP through the roof. Growth for all, according to folk like this.
The reality, of course, is that we would take years getting back to where we had already been.
Bring on real measurements.
More rubbish from Rog!
The graph is totally misleading, Rog talks up the blue line (showing annual growth) as if he's expecting it to continue pointing upwards. In reality we know GDP in the Dec quarter was likely between -0.2% and +0.2% hence annual growth would be just 0.3% to 0.7% in the Dec year, hence there is no question that annual GDP growth has already been through a turning (stationary) point. Assuming a good result for Dec say 0% and what feels like a 0% March too then annual GDP to March 2011 may well be below 0%.
So it's a given the next two points on Rog's blue line will be sharply lower. So what on earth is this guy talking about!
These articles are just embarrassing.
"... how farmers spend their much increased incomes form the record high beef, lamb and diary prices."(sic)
Pie in the sky stuff Roger.....the income will not be blown but saved instead. Farmers will not be hiring staff and if you expect to see a jump in regional job openings then you must also see flying pigs.
Inflation is on its way thanks to several factors. Bollard has no option but to raise rates and he is late already. Rising interest rates will slam the property sector and the rural debt bubble. Then NZ will slide deeper into the shite.
At some stage soon the lying will give way to the truth. The govt will have to come clean with the public about the economy being in a permanent recession level of activity until the 180 billion in household debt and the expanding govt debt bubble , are paid down.
BTW Has anyone thought about the fact that with CPI 2.3% in the December quarter, there is going to need to have been some bumper nominal GDP growth to make real GDP non-negative for the quarter?
The way the economy "feels", GDP could have been seriously negative in the December quarter!
Roger, the RBNZ will have a very good handle on what the cockies are doing with their extra dosh, the figures are also there for all to see on their website. Latest figures (Dec) do indeed show a substantial reduction in agricultural debt - $800,000,000 from Nov '10 to Dec. Sure, there is deferred maintenance going on but one thing farmers know for sure - the good times never last forever. They don't want to be going into the next downturn with big debt and a run down farm.
I think that the RBNZ will be looking for significant debt growth across all sectors before we see any meaningful rise in the OCR, as of December the numbers are flat or declining. Also I think they have learned from past mistakes - in a more Globalized world they are paying more attention to the credit volumes than to the (suspect) inflation numbers.
Mates with National/ANZ just had a %1 increase in rates, thats where the extra is going straight to the banks.
I the mean time the low cost USA milk machine is uping production fast.
Im finding it hard to believe that farmers paid that much back. I suspect its sales to equity partners and overseas buyers making up the figures along with some debt destruction.
But at 200 million a month its going to take forever. I think the huge increases coming through in US production is a genuine concern, along with energy and high costs etc.
Its interesting how people react. Ive a friend who winters 800+ steers a year he normaly pays about $800 a head this year he is having to look at $1400. 1.1 million to buy is more than his nerve so his looking at keeping lambs back and trying to get them on winter contracts. Other friends caught with low stock numbers have given up.
Im trying to take a longer term view and Im still thinking its a good time to keep away from farming especially dairy. The fact that many are piling in confirms my belief.
Under these conditions, large policy rate hikes would be necessary to cool housing markets. High interest rates would crowd out sound and socially useful investments. An additional difficulty for large countries and monetary unions is that housing market developments usually differ across regions or member countries. For example, during the latest housing boom, while prices were soaring in States like Florida or California, they were stagnating in many other parts of the United States. In the euro area, prices were skyrocketing in Spain and Ireland, but declining in Germany. Devising an appropriate monetary policy response to asset price developments under these conditions is not easy."
The whole paper is worth reading.
I think a lot of its tentative discussions of multiple angles, is overly cautious. They DO indentify the reasons for the problems we face today, but bury it in a lot of bureaucratese backside-covering.
It is the height of central banking hubris, to assume that the base interest rate is the appropriate tool with which to address a housing bubble that is caused at root by serious supply inelasticities. As the OECD mildly puts it above, "High interest rates would crowd out sound and socially useful investments".
I remember Don Brash when he was Governor of the RBNZ, complaining that urban planning that forced land prices up, was going to make his job more difficult. The OECD report also discusses the way that inflating house prices feeds credit-based consumer demand via equity withdrawals. Owen McShane actually correctly predicted this in a paper done for the RBNZ in 1996. He deserves a medal today.
It is possible that 50% of the "economic growth" in NZ 2000-2006 was the result of housing-equity-withdrawal consumer spending. It is well known now that our "tradables sector" was shrinking through this period of "economic growth". The Labour Government enjoyed "bubble tax revenue" and found ways to spend it all AND to commit to future spending at the increased level. Now the party is over and no-one at the top level is talking about the return to econ reality.
A dollar of debt is a dollar of debt. Cutting interest rates cannot continue to have the same stimulus effect indefinitely if the public gets nearer and nearer to a maximum conceivable level of debt in dollar terms. The "housing bubble" cycle is a new game altogether, that central bankers cannot win. Had the RBNZ kept interest rates lower, it is highly likely that our housing bubble as expressed in median multiple terms, would have inflated even further than it did; as Australia's has.
As it is, Australia especially, is a case study in favour of Alan Greenspan's protest that his low interest rates did NOT cause "The US Housing Bubble". (NZ is a similar case study). Firstly, Mr Greenspan is quite right to say that "The USA" as a whole, did NOT have a housing bubble, but a number of localised bubbles, especially in California. Australia's housing bubble has gone as big as California's at its peak, with interest rates that bear NO RESEMBLANCE to the Greenspan looseness.
The obvious explanation is "supply"; and regulations regarding development. Hugh Pavletich is right.
Rodney Dickens might be another one who is about to be proved right, with his recent analyses that "housing" drives the economic cycle, not the other way around. That is his explanation for his now correct prediction that NZ would not in fact recover from this recession.
I think that the currently falling "money supply" is a symptom of something else that must be addressed, rather than a cause that itself must be addressed. I think that the land market and the housing market is simply too big a part of the economy to "distort", and expect monetary policy to be able to cope with the consequences.
Interestingly, Britain has had urban containment policies since 1947, and recent papers by Paul Cheshire and his colleagues at the LSE make VERY interesting reading regarding the way we might be headed yet. But this phenomenon has gone "global" now; as the OECD Report points out; they have never recorded so many simultaneous house price bubbles around the world before, let alone so many with that level of volatility. I believe this is because "urban containment" has gone global as popular planning policy.
This recession is a perfectly natural consequence of inflicting the economy with a popular media-driven social democratic consensus that we must cease to actually use resources, especially land. This would be bad enough of itself, but bubbles in the prices of the newly restricted major resource is inevitable as well.
I also wonder just how fiendishly clever a certain Mr George Soros might be, lavishly funding environmentalist and conservation groups, raking in capital gains from his property holdings, and making a killing "shorting" everything when the crash comes. Does that "figure" to anyone else too?
For a long time everyone has carried on as though resources are unlimited however a transition is underway towards thinking that maybe they're not so unlimited after all. I've got the feeling its going to be a difficult transition.
I personally think hugh and phil are correct - limiting land supply drives up prices and creates a more volatile market with more extreme booms and busts. The real question is this:
Is it preferable to restrict resource use and have a more volatile market, or have free access to resources and a less volatile market?
Think about that in the context of oil as well.. if you think it will run out eventually of course.
running out isn't the issue. Peaking is.
From there on, expansion is silly - gives you more infrastructure to maintain, on top of the stuff you already have.
Needs a holistic look at where we are going - food production will become more local, so distribution will alter.
as to you question, it's no question.
If you leave it to the market, our kids are dead.
I kid you not.
They may well be anyway, given the sheer numbers in existence (population), but I'd like to think we were capable of better than that.
I don't think bleating on about 'median miltiples' is the answer, though. :)
Thank you Phil and fair enough but we had section prices more than doubling here in Kerikeri over 36 months ('03 - '06) and no real supply constraints. Even with no red tape you can't just click your fingers and, voila, instant subdivision.
There was definately a mania dynamic (get in before the prices rise even more) operating, aided be very loose lending practices. 400 sections now on the market, prices down 40% and only a trickle of sales.
I guess it's differant in urban areas and no doubt we had significant numbers of Kiwi urban and offshore buyers stoking the fire Quite a remarkable turn of events to witness first hand and sad for a lot of unfortunate young famillies suffering today because of it.
Regards,
Kiwidave
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