Reserve Bank’s mandate on inflation likely won’t survive Covid

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OPINION: The Reserve Bank on Wednesday launched its first round of interest hikes in seven years under the most adverse circumstances.

Some business owners have questioned whether it makes sense for the Reserve Bank to raise the official exchange rate as the government loses its grip on Delta’s spread.

Banking economists, on the other hand, rightly felt that the central bank had little choice.

Even with the increase in the official cash rate to 0.5 percent, the Reserve Bank does not appear to be chasing inflation.

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Even with the increase in the official cash rate to 0.5 percent, the Reserve Bank does not appear to be chasing inflation.

The Reserve Bank is, after all, mandated by the government to try to keep inflation “between 1% and 3% on average over the medium term,” with particular emphasis on the midpoint.

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It has historically interpreted the “medium term” as the second half of a three-year forecast horizon.

This has the practical consequence that no action taken by the bank can be proven to have failed until at least two years after that action has been taken.

Inflation has already passed the upper range, reaching 3.3% in the June quarter, and the Reserve Bank estimates that it will soon exceed 4%.

But ANZ chief economist Sharon Zollner notes that even after the 25 basis point hike, OCR remains “extremely stimulating” at 0.5%.

“We still have really negative real interest rates.”

The Reserve Bank expects inflation to return “to the mid-point of 2% in the medium term”.

Governor of the Reserve Bank Adrian Orr

Robert Kitchin / Tips

Governor of the Reserve Bank Adrian Orr

But he has to say that – given that this is the result he is bound to achieve.

If the Reserve Bank were planning something different, they would actually admit that they were already ignoring their inflation mandate.

The question is whether his predictions are credible.

In reality, if New Zealand sees an inflation rate of 2 percent over the next two years, it will only be the result of the collapsing economy.

Inflation is currently at 3.2% (and rising rapidly) in the UK, 3.8% in Australia and 5.4% in the US.

Britain currently looks like a canary in the coal mine when it comes to global inflation; Bank of England Governor Andrew Bailey explains why he raised his inflation forecast in August.

Like colliding tectonic plates, powerful forces are pushing New Zealand and global inflation up.

Most intractable is the huge increase in money supply caused by quantitative easing.

The US Federal Reserve, the European Central Bank, the Bank of England of Great Britain and the Bank of Japan have spent US $ 9 trillion on QE since the start of the Covid and now have US $ 25 trillion in their pockets. balance sheets.

The latter figure represents more than a quarter of the value of all companies listed on all stock exchanges around the world.

Quantitative easing and lax monetary policy in general have helped to inflate asset prices – mainly house prices and stock prices – thus improving the situation of their owners on paper and giving them a false idea of ​​their future. collective purchasing power.

Finance and Expenses Committee / Facebook

Reserve Bank Governor Adrian Orr expressed concern in August about the situation recent homebuyers may soon find themselves in.

This can only be resolved in the long run through inflation, collapsing asset prices or sustained increases in productivity.

At the same time, Covid and issues, including Brexit and Evergreen’s growl, have taken their toll on supply chains around the world.

Some of these supply chain issues may be short term, as the Reserve Bank suggests.

But others, including a computer chip shortage that has plagued a variety of industries, look more thorny.

Productivity growth is unlikely to come to the rescue.

Easier monetary conditions have heightened people's sense of wealth and fueled demand by pushing house prices and equity investments to skyrocketing levels.

Richard Drew / AP

Easier monetary conditions have heightened people’s sense of wealth and fueled demand by pushing house prices and equity investments to skyrocketing levels.

Covid has encouraged e-commerce and made remote working more acceptable, which could increase productivity.

But the overall impact of Covid may be to slow productivity growth, in part by limiting mobility in the labor market and due to the health-related overhead costs it imposes on businesses.

There are other cold winds blowing.

Climate change – and efforts to mitigate it – have the potential to restrict the supply of many goods and services globally.

Rising geopolitical tensions with China can be expected to have the same effect as they affect international trade and the normal conduct of business.

ANZ Chief Economist Sharon Zollner said inflation targeting was going to stop being

PROVIDED

ANZ Chief Economist Sharon Zollner said inflation targeting was going to stop being “almost so much fun,” but there was no point in doing it only when it was easy.

Under these circumstances, central banks around the world may only be able to contain inflation by repeatedly throwing buckets of ice at their economies.

But the Reserve Bank is now also obligated by its government mandate to “support maximum sustainable employment”.

Something is going to have to stretch or break. Common sense, the weight of history and especially politics all dictate that this will likely be the inflation target.

Asset prices, including house prices and stock prices, are unsustainable and are going to have to come down in real terms, one way or another, after all.

Tolerating a higher rate of inflation over a period of a few years would arguably be a less disruptive way to rebalance asset prices and wages than the alternative, which is to push nominal asset prices down, in other words a crash. scholarship holder.

Inflation can also be somewhat helpful, reducing the large sovereign debts that governments around the world sit on – in fact, many are probably relying on it.

Zollner warns that the Reserve Bank is waving the white flag on inflation too soon.

Central banks were made independent from governments because politicians weren’t prepared to go to great lengths to tackle “stagflation” in the 1970s and instead chose to support jobs and growth, she says. .

She argues that the current economic situation “looks a lot more like the shock of the 1970s.”

“There’s no doubt it’s getting harder and harder – inflation targeting won’t be that fun.

“But if the first time you see a similar shock, you say ‘well let’s rethink the inflation targeting regime’, then you’re basically saying you only want the inflation targeting regime when it is. is easy “.

“In this case, you haven’t really achieved the goals of inflation targeting in the first place, which is to anchor inflation expectations through thick and thin.”

Leo Krippner, a member of the economics department at the University of Waikato, notes that raising the inflation target from 1% to 3% in anticipation that it would not be achievable would inevitably raise inflation expectations and become to some extent a self-fulfilling prophecy.

Asset prices, including house and stock prices, are unsustainable and will have to come down in real terms, writes Tom Pullar-Strecker.

Monique Ford / Stuff

Asset prices, including house and stock prices, are unsustainable and will have to come down in real terms, writes Tom Pullar-Strecker.

“I think the 1 to 3 percent inflation mandate remains appropriate, even when the environment might make it difficult to achieve,” he says, accepting that this is one of those times.

“It gives the public confidence that inflation will not become a dominant issue to consider when making economic and financial decisions in their daily life.

“Once people realize the ongoing costs of higher inflation on their behavior and the economy, history shows that it takes an economically painful and prolonged effort to bring it down.”

But there comes a time when the pretense becomes unnecessary, and soon after, there is a time when it becomes counterproductive.

Shifting the targets to inflation could contribute to uncontrollable inflation.

But that risk will need to be weighed against the corresponding danger that bending the poles or repeatedly missing the target could completely nullify inflation targeting as a credible monetary tool.

The Reserve Bank was the first central bank to be required to target a specific inflation rate in 1990, initially targeting a rate between zero and 2 percent.

The more flexible 1 to 3 percent mandate under which it has operated since 2002 is equally arbitrary.

No one should get too attached.


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