OCR review preview – June 2008

Well we have had an action packed quarter haven’t we – bad employment numbers, bad retail numbers, bad inflation numbers, and tax cuts.

Of course I’ve stated that all these things imply more inflation, but its not what I think thats important – its what the Reserve Bank thinks that matters. On June 5th we get to here what there outlook for economic activity really is – and as a result we will get an idea about how their view of future monetary policy easing has changed (from September 2009 as a starting point in March).

So what is going to happen? The Reserve Bank will heavily reduce their growth forecasts (I’m guessing 0.9% growth over the March 2009 year – with a technical recession over the first half of 2008). A weaker labour market outlook and a downturn in global growth forecasts will be major factors behind this shift – along with a sharper housing market correction. The delay of the ETS will lighten up inflation forecasts while additional fiscal stimulus will lift it again – fundamentally inflation will cross 4% in September, but head under 3% by June.

It is possible they may state that fiscal policy changes (ETS and tax cuts) cancel out – especially given that most of the tax cuts appear out in 2010 – and approximately 50% of consumers are supposed to act in a manner that is “liquidity constrained” (so will not borrow on the tax cuts which are coming).

With inflation expectations elevated and the dollar threatening to bolt with three months of potential rate cuts the Reserve Bank will probably implicitly time rate cuts from March 2009 in the MPS – however with some (real) risk of cuts occurring earlier.

Personally, I think inflation pressures are far more endemic – but I believe that the Bank believes that the risks to growth are too strong to ignore. If this is the way things go down I would expect a short rally in the dollar – before the realisation that the RBNZ was just treading water sets in, dragging the dollar back to where it started.

5 replies
  1. Eric Crampton
    Eric Crampton says:

    Why is RBNZ even worrying about risks to growth? That isn’t their mandate. I’ve re-read the 2007 Policy Targets Agreement. There’s a bit of blather about the government’s objective to provide full employment, but the only RBNZ link in that section is that price stability contributes to the goal.

    We had five quarters beginning September 2005 where CPI exceeded the RBNZ target band. During that period, inflation was entirely driven by non-tradeables. This time round, it’s going to be harder ’cause import prices are helping to fuel CPI rather than attenuating the effects of domestic pressures. How many bouts like this beyond the targets threshold before the RBNZ loses credibility?

  2. Matt Nolan
    Matt Nolan says:

    Hi Eric,

    I am very much in the same camp as you here – growth is not, and shouldn’t be part of their mandate.

    However, when looking at what the Reserve Bank will do rather than what they should do it becomes obvious that the Bank places some weight on growth and “stabilisation” (a term I find a bit funny to use in the face of shocks to AS).

    The funny thing is, non-tradable inflation is still over 3% – in fact its currently rising at a faster rate than tradable inflation. I have a bad feeling about New Zealand’s (and the worlds) inflation outlook.

  3. Eric Crampton
    Eric Crampton says:

    I’d checked the numbers before posting; I’d been guessing that tradeables were up considerably compared to non-tradeables. I was surprised to see non-tradeable to still be above tradeable, though both are above 3.

    You’re dead right that RBNZ has ignored its statutory mandate; it instead seems to be in collusion with the government to subvert its mandate. If the RBNZ wants to get credibility back as an inflation-fighter, it has to get rid of Bollard. I hope he’s quick to the chopping block if there’s a change in government.

  4. Matt Nolan
    Matt Nolan says:

    “If the RBNZ wants to get credibility back as an inflation-fighter, it has to get rid of Bollard”

    I have great respect for Dr Bollard as an economist – however I do realise that he can be a touch dovish.

    I think that ultimately the credibility of the RBNZ depends more on its institutional structure than who is leading it. If Dr Bollard was told that his sole mandate was inflation – and judged solely in that regard I think he would act very differently. After all, it is all about the incentive stipulated in his contract!

  5. Eric Crampton
    Eric Crampton says:

    Doesn’t credibility somewhat depend on perception that the guy in charge isn’t likely to make informal arrangements with Parliament that persistent breaches of the policy target agreement will not be punished? Institutions are really important, but absent having some kind of automatic rule that x quarters constitutes breach and brings punishment, you’ve got to have a guy who hates inflation at the top.

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