Reserve Bank governor Alan Bollard dismayed some commentators early in June by signalling an easing of interest rates. At interest.co.nz, for example, managing editor Bernard Hickey wailed about the guv going “soft on inflation” and said “it’s time to question Bollard’s inflation-fighting credibility”. His reasoning: consumer price inflation has either been above, or is projected to be above, the upper limit of the bank’s target band for periods totalling almost four years between 2002 and 2011.
Hickey questioned whether Bollard could credibly say he may cut the official cash rate “just as consumer price inflation is hitting an 18 year high?” In the June Monetary Policy Statement, after all, he was forecasting sharp slowing of the economy, with little GDP growth over 2008, “but with spike in consumer price inflation to 4.7 percent in the September quarter”. Moreover, Bollard was forecasting annual consumer price inflation remaining above the one-to-three percent target band until the June quarter 2010.
But – among other threats to that outlook – he was assuming oil prices would drop back below US$100 barrel. Hence inflation could finish up higher than forecast, yet Bollard was talking about rate cut later this year.
Hickey examined the RBNZ’s forecasting record in recent years, the link between interest rates and the housing boom, and the level of non-tradeables inflation. The latter had never been below three percent during the governor’s term, “yet he is forecasting fall from 3.9 percent to 2.5 percent between December of this year and September of next year. This is worthy of scepticism.”
Hickey also took issue with the policy targets agreement signed by Bollard and Finance Minister Michael Cullen in September 2002 (it was “a significant weakening” from the 1999 agreement between Cullen and previous RB governor Don Brash). And he fretted about inflationary expectations being fuelled by the central bank’s failure to make people believe it is serious about keeping inflation within the target band.
Westpac chief economist Brendan O’Donovan was similarly disappointed by the governor’s easier stance. Sure, the RBNZ had slashed its forecasts for economic growth. But “inflation is higher throughout the forecast horizon…” When the central bank itself was forecasting inflation would average 3.4 percent over the next three years, “why should businesses and consumers take the midpoint of the inflation target as any kind of guide to what inflation is likely to be in the years ahead?” O’Donovan asked.
Let’s put the inflationary ogre in perspective.
In the 1970s and ’80s our inflation rate averaged 11.6 percent year, compared with an average for the developed world of seven percent year. basket of goods costing $100 on 1 January 1970, BERL economist Ganesh Nana has calculated, had doubled in price to $200 by 1 May 1976; doubled again to $400 by 29 August 1982; doubled again to $800 by 27 December 1988; and cost just under $894 on 1 January 1990. The climate was ripe for introducing regime of inflation targeting.
Since 1990, New Zealand’s inflation rate has averaged two percent year. The cost of $100 basket of goods on 1 January 1990 by 1 May this year had risen to $147. The developed world’s average inflation rate over that period was about 2.3 percent year.
Double-digit inflation meant we would never get serious employment growth, because it distorted resource allocation. Now that inflation is around three-to-four percent, the effort to get it down further does the same thing: if interest rates are too high, investment in machinery, equipment and long-term infrastructure is discouraged; too-high exchange rate discourages exporting and investment in exporting.
Another set of forecasts in the monetary policy statement was worthy of critical comment. It showed employment growth (1.7 percent in 2006/07) becoming -0.2 percent (a contraction) in 2007/08. Further contractions are forecast over the next two years (-0.2 percent in 2008/09 and -0.4 percent in 2009/10). Zero growth is forecast in 2010/11.
The unemployment rate is forecast to grow from 3.6 percent in 2007/08 to six percent in 2010/11.
Four years without employment growth, after two decades of inflation targeting, five years or so of robust economic growth, and year or so of booming commodity prices, should be raising questions too. Above all, isn’t it time to question whether one-to-three percent inflation (or whatever the target) should be the only target set for economic policy? And when we achieve relatively low inflation, should the interest rate clamps be kept in place to keep the ogre in leg-irons, even if the economy is hobbled as consequence, development is discouraged and job prospects disappear? Is low inflation the goal? Or something grander?
Bob Edlin is leading economic commentator and NZ Management’s regular economics columnist.
