July 08 OCR decision: Rates cut to 8.0%

So the Reserve Bank cut interest rates to 8.0%.

The only new information that has come out since June is a higher inflation outcome as a result of larger than expected increases in petrol and food prices. Furthermore recent increases in funding costs have helped to convince the Bank to cut.

Even ignoring inflation, it appears that the Reserve Bank values the livelihood of those who have mortgages above people who are struggling to pay their food and fuel bills (which will go up, as a lower exchange rate will increase the New Zealand price of both).

Good Bloomberg piece here.

More discussion to come later (the additional discussion has now appeared).

  • I’m surprised. I’d have guessed no more than 1/3 chance they’d have made the cut. Now, do I revise my expectation about the extent to which the Bank fails to care about inflation, my expectation about the real economic data, or both?

  • “Now, do I revise my expectation about the extent to which the Bank fails to care about inflation”

    I ignored inflation above because I think it is obvious that the back doesn’t care about inflation anymore.

  • Well, it could be that they’ve moved from not caring about it at all to positively preferring it.

  • Isn’t it something special that we are seeing rate cuts at the same time as inflation is expected to hit 5%.

    The current RBNZ has all the markings of time-inconsistency that comes with discretionary policy – it will make a good case study in how not to perform monetary policy in about 10 years.

  • Steve

    it is a time inconsistency problem, but the reasons for the inconsistency I see as this;

    The reason for the current high prices is the booming worldwide economy over the past few years. This boom has ended yet we are still suffering from increasing costs. increasing interest rates at this stage would do little positive about this because it is the effect of the past few years. by lowering rates it keeps the economy moving. the negative outcomes of keeping interest rates high are worse for the economy. If I am wrong can you clarify? i’m not a macroeconomist.

    I also have a feeling that there has been some sort of govt discussion to take the focus off solely being on inflation. Similar to overseas jurisdictions where monetary policy is based on many factors, not just inflation. while in NZ officially it is only inflation, the govt/RB probably has a wider view of its responsibilities.

    Who says inflation is expected to hit 5%? I would have thought that inflation expectations are starting to curb, but the economy is looking fragile, so lowering rates makes sense… no?

  • adamsmith1922

    I have this awful feeling that this was not the right move. Many will now expect cost pressures to ease when they will not. Further for manufacturers who use imported materials costs will now go up, thus increasing the incentives to relocate production off shore.

    Fuel costs will rise further, thus forcing prices up. In turn this will stoke wage demands.

    I would not be surprised, if there is a change of government and perhaps even if no change, to see some labour action post election.

    I am perhaps too pessimistic, but see the hovering spectre of a lengthy recession and perhaps stagflation?

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  • I’m no economist, but to me this looks like consistent (but wrong) behaviour.

    The Reserve Bank was woefully slow to raise interest rates during 2004 to 2005 and has now eased far too quickly. Is there some other agenda beyond fighting inflation that us non-economists are unaware of?

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  • Hi all,

    Hello Steve,

    “increasing interest rates at this stage would do little positive about this because it is the effect of the past few years”

    The higher interest rates are not meant to account for recent increases in food and fuel prices – they are meant to keep inflation expectations anchored. As a result, we have to ask the question, are inflation expectations (the amount people are going to add to their price to account for inflation) anchored?

    “I also have a feeling that there has been some sort of govt discussion to take the focus off solely being on inflation”

    The Bank does not have a sole inflation mandate – it is just its primary mandate. Ultimately, the Bank is supposed to control inflationary pressures now in order to promote long-term growth. The ability to do this is debatable, however this does not mean we should give the Reserve Bank a wider mandate and only one tool – if you have to achieve many things with only one tool it is usually very different (especially when the tool pushes them in opposite directions).

    “Who says inflation is expected to hit 5%? I would have thought that inflation expectations are starting to curb, but the economy is looking fragile, so lowering rates makes sense… no?”

    Everyone is saying inflation will hit 5% now, even the Bank. I said it first though 😉

    Inflation expectations are not starting to curb, annual price growth has been so persistently high that it has lead to higher trend inflation expectations – that is the issue ultimately.

    Hi Adam,

    “I am perhaps too pessimistic, but see the hovering spectre of a lengthy recession and perhaps stagflation?”

    I find it hard to see a depression in New Zealand – our terms of trade is at its highest point since 1974. A drought and oil price shock caused a recession, no doubt, but if economic activity starts to pick up in December (given the strong income growth that comes from higher commodity prices) you can bet your bottom dollar that the economy will recover. However, inflation will reappear.

    The Bank is worried that domestic demand is going to contract VERY quickly and remain VERY low for a protracted period of time. It is possible – but its not the situation I would put money on.

    “The Reserve Bank was woefully slow to raise interest rates during 2004 to 2005 and has now eased far too quickly. Is there some other agenda beyond fighting inflation that us non-economists are unaware of?”

    I’m not sure, maybe they do have other motives 🙂

    I agree that they raised too slowly and that they have eased too early – however, a lot of other economists agree with them. I think many economists believe that “now is different” in regards to inflation – given that labour market institutions are a lot more flexible. However, I’m not so sure that this is the case, given that the rising skills of labour have effectively increased their bargaining position, making it easier for inflation expectations to translation into inflation.

    We will see I guess.

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