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Wednesday, November 02, 2005

Common Sense v Pig Headed Dogma

Not until yesterday morning did I realise the major difference between the approach to inflation control adopted in Australia and New Zealand by their respective reserve banks. The ARB excludes the price of oil from it's calculation of inflation. Hence the OCR in Australia has remained stable since March 2005. The NZRB includes the price of oil in it's inflation calculation and our OCR has gone where?

I don't know enough about these matters to understand the underlying reasons for this major difference but it is clear that we are going downhill and Australia is prospering. It is incomprehensible that when the economy starts to decline you assist it by increasing the cost of investment in growth.

No wonder the Aussies laugh at us and talk about our Reserve Bank with raised eyebrows and shaking heads.

Who sets the rules? The Gummint or the Reserve Bank? It was all very well to remove the Reserve Bank from the depradations of Muldoonist style politicians but it seems to me there is another side to the story. The Reserve Bank is not subject to being elected out of office when it screws up the economy.
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Posted by Adolf Fiinkensein | 11/02/2005 12:16:00 PM


Blogger Gooner said...

Parliament sets the rules via the Reserve Bank Act. My view is that the band (1-3%) is too narrow. Now that I know of the oil situation it might not be too narrow if oil is removed from the benchmark CPI index which is where Bollard and Co look for underlying inflation. Don't know how to remove it from that index. Must be part of some Act. Interesting to note also that the incoming (nominee) Chairman of the Fed Reserve to replace Greenspan likes our inflation indexing for as a way of controlling monetary policy. Maybe he should look across the Tazzy.

11/02/2005 01:25:00 PM  
Blogger darren said...

Yes, the fluctuating price of oil should be removed from the index.
But what has help increase interest rates is the recent rampant growth in government spending.
I am sure Liar-bour would be laying the boot into Brash had he been elected PM and Bollard had put up interest rates.
Liar-bour government spending = higher interest rates

11/02/2005 02:13:00 PM  
Blogger fm said...

I mentioned this analysis a few days ago, but it's worth linking to, and repeating, again:

Before the current government watered down the RBNZ’s inflation targeting regime, the current rate of inflation might have already seen the RBNZ Board meet to decide whether to recommend dismissal of the Governor to the Minister, although the contribution to inflation from higher oil prices would fall under the caveats to the Policy Targets Agreement. This is now much harder to do, because the inflation target has been re-defined in such a way as to accommodate a much wider range of outcomes. By the Bank’s own admission, there is little scope for inflation to return to the target range before 2007.

11/02/2005 03:38:00 PM  
Blogger Ashley Clarkson said...

Yes, it's a bit odd to count the fluctuations in the price of petrol in the basket of goods that the CPI is measured by, as any increase in the price of oil will push up the prices in other goods which are measured by CPI. After all, increase in wages isn't counted (from memory) but rather accounted for through the price increases in goods which are measured.

11/02/2005 03:53:00 PM  
Blogger t selwyn said...

I have a suspicion that fascist countries (esp. Nazi Germany) kept their wheels on for so long because they controlled the information and therefore could influence spending, investment etc. and other economic decisions through manipulating and monopolising information. So too countries can avoid reality in the short-term and influence market players by changing the details. I am very interested that Australia's CPI does not include oil. Then again we have "headline" inflation and other little tweaks that we use to avoid reality eg. interest rates are not part of CPI (from what I understand).

The government bends the rules (info) to suit themselves - like Bollard is contractually responsible for keeping 1-3% but he has breached that by 0.4% and says he is likely to for another year at least. If I was on the RBNZ board I would have to fire him because he's failed. I sympathise that interest rate OCR as a tool is a totally inadequate and damaging mechanism - but restricting credit to the trading banks in particular would reduce inflation and I think Bollard has full authority over that.

Perception and calculations of future outcomes in crucial to markets and the economic decisions they make, so the scenario for a long-term positive outcome would be to get both the exchange rate and interest rates down asap. How? - Fire Bollard. State that inflation will be at 4-4.5% at the end of next year and put the OCR down to 6.5%. That would freak the living daylights out of the forex market and the billion or so a week in NZ$ bonds being sold into Europe and Japan would end immediately sending the currency down to where almost every single economist, banker, exporter, politician and business operator thinks it should be. It will take at least 6 months for the lower exchange rate to alter the current account deficit. There will be an inflationary spike as oil prices and imports that were locked in under the presumption of a higher NZ$ take their toll.

During this time regulations constraining the housing market should be implemented to structurally reduce inflation and cause investment flows away from speculative static property and into productive capacity. A low interest rate would help this too. If we have relatively high levels of immigration as we do now then any measure of constraint will be futile because of the basic supply/demand equation so that will have to be looked at too ie. reducing immigration. I prefer a citizens-only freehold regime to achieve the result.

On top of all that (and there's a good letter to the editor in today's NZ Herald about this) start a compulsory super scheme whereby the RBNZ can influence the contributiuon % to fight inflation (as Singapore has done effectively). Govt. over-spending on non-infrastructural assets is a perennial problem also.

Radical, perhaps - impossible for a beige Labour Government to even contemplate - but the necessary sorts of things we should be discussing for our long-term.

11/02/2005 04:57:00 PM  
Blogger Kimble said...

(By reducing credit do you possibly mean increasing the required reserves?)

Bollard doesnt "control" inflation, just as the government doesnt "control" the economy. Though by what you have written, you obviously dont think this is true. Apparantly it is the governments role to control the housing market, to control overseas investment, to micromanage the reserve bank. I dont think you will find too many people here in favour of a broadening of the role and influence of government, such as you propose.

As for your perfect prescription for our economic future, what a load of interventionist nonsense. I mean, how did you manage to stick these two sentences together, "During this time regulations constraining the housing market should be implemented to structurally reduce inflation and cause investment flows away from speculative static property and into productive capacity. A low interest rate would help this too." Do you think the over investment in housing over the last few year MIGHT have something to do with a relatively low interest rate?

What are you going to do about intra country movements (which account for a significant portion of the increase in housing demand in the main centre (Auckland))? Ban movement? Subsidise rural housing? Require people to apply for and be granted a special governmental dispensation to sell their house?

But this part is liquid brilliance, "State that inflation will be at 4-4.5% at the end of next year and put the OCR down to 6.5%." I mean, just TELL people what inflation WILL BE!!! Fantastic! Let them all know what the future will hold! They will be able to incorporate that into their economic decisions, in which case, why dont they just do that right now to remove the uncertainty "of future outcomes in crucial to markets" which affect "the economic decisions they make"?

What would also help with peoples perceptions is a collapse of our dollar! So by all means, spook the forex traders. Nothing means success like a country with a governmentally induced, plummeting exchange rate!

Besides remember back when the OCR was 6.5%? Those heady days of March 2005, when will they ever return?!

If you want to depreciate the currency though, you are on the right track. Increase inflation to 4.5% (one day you will have to show us the magic lever in Bollards office that sets this inflation level), simulatneously increase the demand for imported goods from countries with lower inflation and increase the cost of our exports in currency adjusted terms, the higher supply and lower demand for the NZD will devalue it! Pssst, it might work even better if you turn the inflation-amp up to 11.

11/02/2005 06:45:00 PM  
Blogger t selwyn said...

Kimble: breathe through your nose, mate - I'm a recovering libertarian.

1. Increase reserves to cut credit: correct.
2. I used the word "control" about the Nazis and fascist states only.
3. I use these words about us: "Bollard is contractually responsible" and "regulations constraining" - any action in the economy, like the existence of our currency for example is a measure of control (being the ability to create an effect) but I do not endorse "micromanagement" either. I don't want the government to stick it's nose in any more than it has to (although you could argue about whether the compulsory super is too far).
4. "Do you think the over investment in housing over the last few year MIGHT have something to do with a relatively low interest rate?" - It has more to do with immigration than the interest rate as I explained. But let me make it clear: Immigration down = less demand for housing = house price down = house financing down = more money for other investments.
5. "Intra-country movement" is not the main reason prices in Auckland are sky high - it is immigration. And on this point I note that I heard recently that there is no official statistics for foreigners owning property here! They don't keep it because it would make our balance of payments look even worse (ie. more correct) I suspect. That is what I'm talking about by hiding "details".
6. "just TELL people what inflation WILL BE!!! Fantastic! Let them all know what the future will hold!" - Well, that's better than lying isn't it? The only other method (apart from OCR) the RBNZ wants to use is strongly worded statements to the market about intentions and future movements. That's what they do all the time. You're being too pedantic: "state" = "state the expectation of". By stating the expectation of the RBNZ is 4-4.5% inflation this will definitely have an affect. Telling people that inflation won't get over 4% is keeping him his job at the moment but not affecting the exchange rate or lending by banks. If, IF, if it was followed through with my other prescriptions then it should work, should, SHOULD have the outcomes described (ie, low interest rates, lower exchange rate)... and cheaper housing.
7. It isn't enough just to telegraph it with turgid words at a business conference but to do it in more than words by firing Bollard (for example).
8. " Nothing means success like a country with a governmentally induced, plummeting exchange rate!" - Sometimes reality is a cold shower. Either the RBNZ can attempt to "manage" it as best they can by setting the agenda (as I suggest) or they can let it go and whinge and whine and have what the Treasury has warned of: a sudden and market-led depreciation beyond the bank's "control". Which is worse? Which is a worse look? Argentina pretended that it's peso was worth US$1 and ended up confiscating everyone's bank account when they couldn't handle the lie - we are NOT in that situation, esp. because our dollar floats freely (as it should) - but that is a situation where they let too much underlying tension build. And what is that "people's perception" - NZ is cheap for a holiday and their products are not over-valued anymore.
9. Inflation is a worry - I'm only suggesting acknowledging that in order to lower it long-term we are going to have to move it out, ie. to maybe 4.5%, in the medium term - I'm seeing it going that way anyway but there is no plan to get it back down except through squeezing the productive sector and causing a recession. When you analyse each component of what I've said individually the cases are marginal, but together I think they are a good mix. I may be wrong and that we would have a recession regardless.

But what do you think should be done? Or is it OK as is?

11/03/2005 01:30:00 AM  
Blogger Colonel Tux said...

There are only two choices really.

Free market or not. Removing Oil for the CPI would mean that reported inflation is lower than actual inflation - leading people to make invalid decisions.

11/03/2005 09:38:00 AM  
Blogger Adolf Fiinkensein said...

For me, the central issue is the wisdom or otherwise of taking dire action in an attempt to control something over which we have no control and in the process doing serious damage to the living standards of ordinary people, whose living standards already are next to parlous. I really don't care about how inflation is measured. I do care about rising interest rates and a rising currency which between them hurt many many peole grievously and do nothionh, but nothing to reduce inflation caused by demand for housing and rising high prices. It is equally stupid for the RB or the Gummint to crow about falling inflation and reduce interest rates when oil prices drop, as inevitably they will.

Even an alcoholic grader driver from Hokitika can see that.

11/03/2005 09:55:00 AM  
Blogger Colonel Tux said...

Hi Adolf,

I agree that the interest rate rise does hurt. But the fact remains that it ONLY hurts those who spent money that wasn't theirs (i.e. borrowing) and helps those who constrained their consumption and saved money instead. Since our saving rates is so low, foreigners are funding the borrowing (attractive because of the high interest rates), the only thing that can reverse the pain is to constrain our financial behaviour.

11/03/2005 11:19:00 AM  
Blogger Kimble said...

There is no such thing as actual inflation, there are only estimates. You can tweak inflation by adding and removing certain things but you will never get something accurate. What IS important is that you dont change the rules for inclusion too often or too substantially (you have to from time to time, of course). The only problem I have with the inclusion of oil in the inflation stats is that CPI is supposed to be the CONSUMER price index. Now if it is motor oil that is being included then I have no problem at all.

Just one point Tim, is housing investment 'crowding out' investment in general? If people dont buy a house will they take out mortgages to invest in infrastructure bonds instead? For a lot of people house-buying is a purchase rather than a deliberate investment. If they dont buy the house, will they invest? Will they spend or will they save? If inflation is high then they are more likely to spend. Also, if inflation is high then the required return from investments will need to be high as well, simply to protect capital.

11/03/2005 11:42:00 AM  
Blogger Antarctic Lemur said...

An interest rate rise affects future borrowers across the entire economy regardless of their previous behaviour.

And if a borrower under the previous interest rate regime has progressed to great enough wealth then they will profit again from an interest rate rise, so long as they forgo their own borrowing activities.

The real problem is an organisation or group of organisations are consuming more wealth than any efficiency or innovation gains by itself or other organisations are creating.

My candidates for said organisations: Oil producing nations and associated distribution companies, NZ Government agencies, Telecom.

11/03/2005 11:45:00 AM  
Blogger t selwyn said...

Kimble: "Is housing investment 'crowding out' investment in general?" - I think that housing (ownership that is - not renting) will always be (and should always be) a householder's priority, so the demand will always be strong. People are more likely to plough money into their house first - rather than their business. I can't see any of that changing. I'll just mention again what a strong factor I regard immigration as being in this matter.

You ask: would people then invest in bonds etc. for infrastructure... and I think you are right - they probably wouldn't - like most poor people they will buy plasma screens etc. and consumer crap that is expensive and will be obsolete in 3 years leading to huge demand and an general increase in prices which is why I suggest a form of compulsory super contribution which will direct investment, store funds credibly for individuals to use later (incl. house deposit?) and be a new and effective tool in limiting inflation. All of which is totally anti-libertarian of course but where Roger Douglas was taking us back in '75 with his scheme from what I understand. It's not nice to say the vast majority of people in the country couldn't save to save themselves but that is what the all the data suggests.

11/03/2005 02:52:00 PM  
Blogger Kimble said...

I dont think compulsory super would affect inflation too much. It may reduce aggregate demand (though I dont think it would) but what do you think will happen when people find that their disposable incomes shrink? They will seek a pay rise of course. If the compulsory super comes from the employer instead (leaving wages the same) all you are doing is increasing the costs of labour, which is again inflationary.

11/03/2005 03:30:00 PM  
Blogger t selwyn said...

The reason I say the super would reduce inflation is from the evidence from Singapore regarding their CPF but I can't find the bloody page: I remember it said that when inflation was crazy in 1983 they boosted the contribution to 30%?.

11/04/2005 01:40:00 AM  

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