By Bernard Hickey
Our Reserve Bank is rightly proud of being the first independent central bank in the world to focus solely on targeting an inflation rate and achieving it.
It became a model for the world that 30 other central banks have adopted. The great scourge of high inflation in the 1970s and 1980s was tamed and both consumers and employers alike became confident that inflation would be around 2-3% over the long run. They became confident about investing and employing people in the knowledge that inflation would not take off. The Reserve Bank set the Official Cash Rate, its only tool, at a rate that ensured the economy ran as fast as it could without generating inflation higher than around 2-3%.
Inflation targeting is a good thing, so why are all sorts of very serious people going all soft on the idea? No one thought that inflation undershooting that 2-3% level would be a problem, but it clearly is now, and not just in New Zealand.
Annual Consumer Price Index (CPI) inflation, which is the inflation rate the Reserve Bank has agreed to target, has been below the 2% mid-point of the bank's 1-3% target range since the September quarter of 2011. It has been below the 1% lower bound of that range since the September quarter of 2014.
Governor Graeme Wheeler specifically agreed with Finance Minister Bill English in September 2012 to target 'future average inflation' at the 2% mid-point of that range over the medium term. This week the Reserve Bank forecast CPI inflation would not get back to the 1% lower bound of that range until the December quarter of 2016 and would not get back to 2% until the September quarter of 2018. Assuming the Reserve Bank's latest forecast is right -- and it has wrongly forecast a return to target for four years -- then that means inflation will have been below the 1% level for two years and below the 2% midpoint for seven years.
The Reserve Bank is itself forecasting 'future average inflation' at 1.6%. That is a clear failure of one part of the target and you could debate whether seven years counts as the 'medium term'. That sounds like long term to most people.
Some people are saying New Zealand should just give up on the idea and just accept the Reserve Bank cannot get inflation back up into its target range. They argue that trying to hit the target is a waste of time in a world where other central banks are creating US$150 billion a month out of thin air to buy government and corporate bonds, and where central banks for two thirds of the global economy have cut interest rates to 0.5% or below. That makes our OCR of 2.0% look temptingly high to investors who already have US$13 trillion in bonds with negative yields, which means investors pay the Government to look after their money. Those investors are rushing to park their money in New Zealand dollars, which has pushed it up and made imports cheaper, which in turn is dragging even more inflation.
The inflation targeting quitters say lower interest rates here and overseas are not actually boosting real economic activity much and are simply pumping up asset values -- particularly property, stocks and bonds -- to dangerously high levels that could go bust with painful consequences.
That may be true in places like Japan, the United States and Europe, which have cut their rates to almost 0% or below and have been printing money for much of the last eight years.
But that's not the case here. The Reserve Bank still has 200 basis points of cuts up its sleeve and a 50 basis point cut this week, along with forecasts of more cuts, would have substantially reduced the New Zealand dollar. Instead Governor Wheeler delivered only one 25 basis point cut and promised just one more cut, which triggered a sharp rise in the currency to over 77 on the Trade Weighted Index. That made a mockery yet again of the Mr Wheeler's call for a lower currency and has made his task of getting inflation back to 2% that much harder.
Mr Wheeler also had given himself some breathing room to cut more substantially without further inflating the fast-rising housing market. He announced plans last month to limit rental property investors to having a 40% deposit nationwide, and is preparing debt to income multiple limits that could substantially reduce demand from highly leveraged buyers. The banks are helping too by not passing all the cuts on to mortgage borrowers.
So why didn't he take action to achieve his one target -- to do his one job?
Mr Wheeler said he couldn't control half of CPI inflation, which came from overseas, and he was worried that if he cut harder that would leave him less ammunition to deal with a bigger crisis in future.
The trouble is that decision is costing exporters and hurting people who would otherwise get jobs without that extra stimulus. The Reserve Bank forecast this week that the economy was already essentially at full employment, but that's not what Treasury estimated last week. It said the full employment rate of unemployment was closer to 4.0%, which is well below the current rate of 5.2% and which meant there was room to cut rates without generating more inflation pressures.
A higher-than-necessary currency is also acting as a handbrake on New Zealand's aspirations to increase exports and obtain all the productivity and real wage growth that goes with it. It means the Government is failing to reach one of its major targets of lifting the share of the economy producing exports from 30% to 40% by 2025.
There are real costs to just giving up on inflation targeting. People don't get jobs and exporters don't grow sales or wages. There is also a risk wage and price setters will stop believing that inflation is steady around 2%. Inflation expectations have been dropping from 2-3% to under 2% over the last 18 months and risk creating a dangerous self-fulfilling prophecy of ever-lower prices and inflation. The Reserve Bank should have gotten ahead of the curve and front-loaded its cuts to arrest that slide in expectations.
The Reserve Bank may be missing its target, but we shouldn't give up so easily on the target just because it is hard to hit.
A version of this piece has also appeared in the Herald on Sunday. It is here with permission.
60 Comments
If the dollar doesnt drop Wheeler will be passing on losses to the goverment. He should double down on NZD shorts and play a strong poker face. Live market interventions only worked previously as USD strength took hold. Another round of US QE and Wheeler will have red felt on his face.
But that's not the case here. The Reserve Bank still has 200 basis points of cuts up its sleeve and a 50 basis point cut this week, along with forecasts of more cuts, would have substantially reduced the New Zealand dollar.
Prove your assertion. Both the SNB and BoJ failed to achieve what you claim is possible.
Spot on, SJ. Neg rates are creating dangerous distortions and someone will have to open the Pandora's box one day. Our economy is working at current settings, better in fact than many with ultra low rates. Bernard does beat his drum rather loudly with the same set of sticks.
So why didn't he take action to achieve his one target -- to do his one job?
Mr Wheeler said he couldn't control half of CPI inflation, which came from overseas, and he was worried that if he cut harder that would leave him less ammunition to deal with a bigger crisis in future.
The trouble is that decision is costing exporters and hurting people who would otherwise get jobs without that extra stimulus.
Hmmmm.. OCR down 150bps and counting without discernible expected CPI inflation and growth outcomes.
The mainstream, dominant view of monetary policy remains as if it were “accommodative” or “stimulus.” Low rates and/or balance sheet expansion are treated as one and the same in terms of economic effects. The mountain of economic evidence since the end of the Great Recession, however, argues that that view is backward; starting with the observation that the Great Recession itself was no recession.
This is a universal problem and not just one for which the Federal Reserve and the United States economy will suffer. As I wrote earlier today with regard to China’s recalcitrant imports and PBOC policy:
Instead, by view of the “dollar”, it becomes clear that China’s central bank policies rather than being “stimulus” were not proactive but merely reactive efforts to counteract the “rising dollar.” Thus, as in the US, Europe, and Japan, monetary policy doesn’t tell us anything about what will happen, it is rendered an indication of what already did.
This is the determined view of bond and funding markets all over the world. Low and even negative rates don’t indicate an economic friendly financial environment, they prove the exact opposite as financial agents are betting directly against it. Therefore, when policymakers tell us, as they constantly do, that interest rates and other monetary policies must remain “accommodative” for an extended period even after nearly ten years already so, what they really mean is that they are merely following the economy down. Read more
... in the time since Wheeler cut the OCR 150 points , our currency has gone where ? ... up , I think ...
And our savers have been punished ; and our housing speculators richly rewarded ...
... if the property " crash " happens , the mess will be so much bigger ...
The future isn't what it used to be , that's for sure !
Not "savers" but the "saved"
The currency going up could be explained by Wheeler not cutting as much as expected.
So the mess will be so much bigger because we didnt keep the OCR high?
What about SME's? those that provide jobs so ppl can pay the mortgage? killing them off with high[er] OCR is sure one great way to crash property!
Transferring wealth from one cohort of society to enrich another is not a policy that should be delegated to an unelected, but supposedly independent, state entity minus a political mandate to undertake such duties.
But how about asset price inflation and Bubbles? Well, there is a powerful proclivity for letting asset prices run. An inflationary bias in asset markets certainly “makes it more profitable to speculate than to produce.” And the larger the speculative Bubble the more powerful the constituencies that arise to demand government involvement, intervention and manipulation to sustain Bubble Dynamics. Misguided policymakers will endorse destabilizing asset inflation as confirmation of sound policies (Greenspan, Bernanke, Draghi, Kuroda…). In one of financial history’s most misconceived policy blunders, central bankers specifically targeted asset price inflation as the primary mechanism for post-crisis system reflation. Read more
Bernhard misses the point again. He is largely right but gets the causation wrong. The NZD is too high. In that he is correct. The destabilising factor is not just the QE of foreign central banks, it is the outrageous export surpluses that China, Germany and Japan run with the rest of the world. They are just better at manipulating their currency than we are. The BIS have a paper about this:
http://www.bis.org/publ/work424.htm
This means that we are forced to import excess capital (which is what the too high exchange rate reflects).
http://www.rbnz.govt.nz/statistics/s7
Thus the RBNZ and Treasury should have looked at discouraging capital we don't need. Instead we gaily import heaps of foreign dosh every month to bid up house prices. We do this by competing with each other to increase our indebtedness. He who indebts himself most, wins. How stupid is that?
New Zealand, diluting citizen equity since 1973:
http://www.rbnz.govt.nz/statistics/key-graphs/key-graph-current-account
Roger you certainly make a point, but might I suggest that the NZD/USD currency pair is encumbered in the confusing national credit based reserve currency status owned by the US.
Others have voiced their opinion on such matters:
Issuing countries of reserve currencies are constantly confronted with the dilemma between achieving their domestic monetary policy goals and meeting other countries’ demand for reserve currencies. On the one hand, the monetary authorities cannot simply focus on domestic goals without carrying out their international responsibilities; on the other hand, they cannot pursue different domestic and international objectives at the same time. They may either fail to adequately meet the demand of a growing global economy for liquidity as they try to ease inflation pressures at home, or create excess liquidity in the global markets by overly stimulating domestic demand. The Triffin Dilemma, i.e., the issuing countries of reserve currencies cannot maintain the value of the reserve currencies while providing liquidity to the world, still exists.
When a national currency is used in pricing primary commodities, trade settlements and is adopted as a reserve currency globally, efforts of the monetary authority issuing such a currency to address its economic imbalances by adjusting exchange rate would be made in vain, as its currency serves as a benchmark for many other currencies. While benefiting from a widely accepted reserve currency, the globalization also suffers from the flaws of such a system. The frequency and increasing intensity of financial crises following the collapse of the Bretton Woods system suggests the costs of such a system to the world may have exceeded its benefits. The price is becoming increasingly higher, not only for the users, but also for the issuers of the reserve currencies. Although crisis may not necessarily be an intended result of the issuing authorities, it is an inevitable outcome of the institutional flaws. Read more
This means that we are forced to import excess capital (which is what the too high exchange rate reflects).
http://www.rbnz.govt.nz/statistics/s7
It makes sense to highlight that New Zealand generally no longer imports capital in the sense of selling borrowed foreign currency to buy NZD. This is now achieved by currency swaps with a foreign counterparty. The latter borrows NZD whilst our banks borrow USD, hence the only real floating exchange is interest on the respective currencies and the basis the NZD recipient has to pay - and collateral calls if the exchange rate deviates too much from the pre-arranged swap levels.
But of course it does place us in the unenviable position of constantly short "dollars", since these contracts have defined end dates. Rollover risk is huge if the value of NZD/USD moves significantly over the course of the contract, or counterparties refuse to lend and or swap in the future.
As you point out, we have a flawed system of foreign exchange whereby countries are free to manipulate their exchange rates as they see fit, providing they are willing to accept the consequences that the Triffin dilemma relates to. The trade surplus countries choose a lower currency and the US chooses a higher one than would arise in a self balancing system as Keynes recommended and the US over-ruled at the Bretton Woods conference.
Keynes's view was validated when Bretton Woods fell apart and the US chose to make the USD the reserve currency on a free floating basis. The only constraint was to devalue the USD slowly enough that OPEC would keep accepting USD for oil. The reason the US chose this path was to fund their military. It also created a ready pool of unemployed young men by exporting their jobs to the trade surplus countries.
I'm not sure New Zealand is constrained by the link to the USD as you suggest, you are far, far, more familiar with these linkages than I am. I was just argueing from first principles based on a double entry analysis such as Michael Pettis uses.
As an aside, I personally think the governments' infatuation with increasing exports as a % of GDP is stupid. It justs make you subject to your customers circumstances or desires. Exports are not a problem, it would be better if they were higher value added, and therefore better paying, and a smaller share of GDP.
What I left out was suggestions, as I wanted to highlight the simplicity of the argument. A trade deficit outflow and a capital inflow are just two sides of the same transaction, there is no information about causation. We are just poor at defence, not weak at offence.
How to stop the force feeding of unneeded capital into NZ?
1 Minimum reserve requirement of 8% against residential mortgages, not 2% as at present (25% weighting). This is dereliction of duty on the part of the RBNZ.
2 Extend the Core Funding Ratio to further favour onshore funding from depositors rather than wholesale funding from overseas. Maybe 100% for 2 years rather than 75% for one year.
3 A Bank Excise Tax. Say 1% of the $418,000,000,000 loan book per annum as a fee for the privilege of being granted a banking licence.
I'd support your suggested changes. If the flow of capital reverses we'd be extremely vulnerable. Internalising the reserve funding requirements while increasing it to a responsible level makes a lot of sense.
Excise tax on banks of 1% is fine. It'd help balance out their tax evasion.
That worries me the most. Foreign investors would sell houses, dump NZD to try to get their money out of the country. Banks with debts in foreign currencies would then have to pay a lot more for their current finance, or would need to add capital to maintain their positions. Hopefully export income would help counter any potential instability.
You would probably enjoy listening to this Roger. https://www.theinvestorspodcast.com/history-of-us-dollar-richard-duncan/
A slow delivery and probably nothing you don't already know, but useful to get different angles on the same subject. More useful in the later part where he talks about China printing money. Creditism, as Duncan calls our current system, means exactly what you say about double entry. Credit in one place is a debt somewhere else.
Watch him on a video if you can. The reason for him being dry is that he is desperately trying to translate the million thoughts in his head into simple words that the average person will understand. He is clearly an introvert (INTP or INTJ) that is able to deeply immerse himself mentally to analyse the subject matter. You would trust an introvert analyst or economist over an extrovert for this reason, less self promotion and better logic.
It must be understood that NZD denominated debt (noted above) issued by highly credit rated supranationals etc gives cause for foreign investors to soak up excess NZD sold to fund foreign currency priced imports that inevitably were not funded by export receipts, hence the current account deficit is financed.
err, I think you have this backwards. A high dollar costs the holders of other currencies more of their money to buy in New Zealand. A low NZ dollar makes it cheaper for them to do the same thing. In fact, they could buy more for the same cost (or pay more) if our currency was lower.
If we were first to inflation target maybe we could also be first to try helicopter money? Would immediately devalue our currency, bring in inflation, and if we spent it on infrastructure, help with the housing crisis. I read somewhere that we did actually do this for our state house building in the 50s.
avatar99,
Show me the evidence that it would achieve what you suggest. Why would it 'immediately devalue our currency and bring in inflation'? The bit about infrastructure just doesn't make any sense. The point of 'helicopter money' is to give it directly to individuals in the expectation/hope that they will spend it on consumer items. QE gives it to the banks and has so far failed to do the job.
The notion that a lower currency will improve the trade balance and ditto exports is accepted so uncritically. In reality there is little correlation and the time lag for improvement is far longer than most commentators are willing to understand.There are a myriad of other factors that are far more important. In regards to the currency , it is all about price. The NZD does not exist in some linear realm , and at present there are many factors that support a stronger NZD currency until those factors unwind.
Bernard : it is 14 months since the Reverse Bank began cutting the OCR , down from 3.50 % then ....
.... since that time , how much extra mortgage debt has been added to our total housing leverage ? .... $ 50 billion , $ 100 billion ??? ... the $ 500 billion total residential housing debt level now dwarfs our nation's entire GDP !
The Guv'nor ought to have kept raising , lifting the OCR to a long term sustainable 5.00 % .... as Paul Keating once said in Australia , " it is the recession we have to have " .... and that is the line Wheeler should have followed , wringing the excesses out of the housing market , and forcing the government into action ...
... if we get a re-run of the GFC , what ammunition have the world's central bankers now got to fire , to dig us out ?
Total Household debt
2014 200bn (10bn consumer, 190bn housing)
2016 230bn (11bn consumer, 220bn housing)
30bn change in 2 years ... so growing at 1.25bn a month .... slightly concerning
Non Resident Debt
2014 10bn
2016 16bn
6bn change in 2 years.... so growing at 250m a month
Total Household & Foreign Debt 1.5bn a month or 18bn a year ... is this sustainable ?
Would explain why banks are making record profits.
Bernard your position assumes that the OCR is directly related to the value of our currency. Is there any evidence that this is correct in the crazy world that we now live in. There seems plenty of evidence to the contrary - Japan, USA. If the problem that you want to solve is a high currency then maybe it would be more effective to be looking at factors that are affecting it more directly, perhaps as per Rodger and Stephens discussion above. As I have said before I strongly suspect that CPI inflation/OCR model does not apply at low or negative inflation. Just because it works at higher inflation values, the accepted wisdom is that it applies across the full spectrum of values is just an assumption, and it seems more likely that this is wrong.
We need fiscal action in NZ - monetary policy has run its cause. Inequality in NZ is disgraceful - NZ always complains about budgetary constraints - it simple - start taxing the rich; get ahead of the game as that is the way the rest of the world is heading in the next 24 months. The status quo is being disrupted & political donations are having less success as democracy takes hold around the world.
Not sure about "taxing the rich", I think it's a bit more complicated than that. Most rich people I know are some of our most useful and productive citizens. We don't want to all be poor together, but stop being taken advantage of by those who peddle ideas that benefit them and not us. The feeble civil servants who offer poor advice have some responsiblity here.
https://www.project-syndicate.org/commentary/globalization-new-disconte…
NZ is so insular - so much "old money" in control - stiffles productivity. Most rich people you know may be the most useful & productive you know. Taxing the rich is very demographic. Not about tall poppy, about sharing the burden in a fair way. Inequality stats don't lie - you have to look at the whole - the rich are getting much richer so they need to pay their share. Regardless, it is going to happen - people are voting against status quo. Do you think Phillip Green is one of the most useful people too?
Well if we aren't going to tax the rich, to more fairly distribute wealth, then we are going to have to pay everyone else more in the first place. Either way, you can't have a few hogging all the money, and in doing that, hogging all the resource. Call it guillotine insurance.
How much of the forex trade internationally and in NZ is pure speculation ?
If that is a large percentage then government intervention won't really work, will it ?
We have a very experienced forex trader as PM and may be that is why he could not care less about RBNZ fiddling at the margin with the OCRs ?
I am normally a fan of Bernard's posts,but not this time.
I don't think there is a shred of evidence that a 0.50% cut would have done much to bring the NZ$ down significantly,given that the RBA and the BOE have both also cut their rates and are likely to cut again. We are all in a race to the bottom .Perhaps a cut of a full 1% would have had some effect,but that was never an option.
An inflation target of 1% to 3% with a mid point of 2% is not a law of nature. We could easily shift to say 0% to 2%, with a mid point of 1% and that would be an easier target for the RB to hit. Our exporters have coped with higher exchange rates in the past and have generally done ok. F&P Healthcare is an excellent example of this.
The logic of reducing the target is flawed. 2% has been identified as a good level so just because it isn't easy at the moment doesn't mean we should change it. It is just like when inflation was 5%, we didn't change the target to 4% to make it easier. Even though the exporters have survived with a higher currency, it doesn't mean it is good for them. Much of the profits which could have been reinvested to be even more successful or used to give pay rises etc. have been lost to foreign exchange. The instability of the currency will also have restricted some investment decisions. The solution to becoming richer is not export less import more and sell it amongst ourselves.
The logic of reducing the target is flawed. 2% has been identified as a good level so just because it isn't easy at the moment doesn't mean we should change it.
But we could include factors that fully reflect the cost consumers have to fund by consuming other's money today.
Shamubeel Eaqub: It's time to include house prices in inflation calculations
So lets get this straight, the patient is unwell and weak, but we are not going to make him / her better so he/she is in robust good health in the event of a downturn. No we are going to keep him weak so that if he starts to get weaker we can inject more.
"Mr Wheeler said................. he was worried that if he cut harder that would leave him less ammunition to deal with a bigger crisis in future."
Frankly to me this to me is retarded.
capitalism required capital which required people like workers to sacrifice some current consumption for future gain commonly called savings. We no longer need savers that’s why we have lower and lower interest all we need now are consumers financed by debt.
Debt is eating tomorrows lunch today enjoy your childrens meal you greedy people
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