What’s behind the 50-point cut?
So the Reserve Bank surprised (almost) everyone by cutting the OCR by 50 basis points (there was one analyst who picked it – I can’t seem to find out who it was though). Lets discuss why they cut by 50 points and then move on from there.
The Bank appeared to cut on the basis of three over-riding issues:
- Downward revision to domestic growth,
- Huge downward revision to world growth,
- Concern that a smaller cut would not loosen financial conditions.
Given there forecasts and assumptions a 50-basis point cut was a good call – if the “equilibrium” interest rate has fallen why not just cut rates straight away to get there. However, in the current environment I believe that a 50-basis point cut was not right – as I don’t believe their forecasts (I had the same problem with the forecasts in June a lot of the reasoning is the same as then).
Another kicker for me is what they think will happen to inflation expectations.
Update: A detailed post by Eric Crampton over at Anti-Dismal.
This time around they did not say that inflation expectations were anchored, which looks about right – I’m glad to see they said so. Furthermore they admitted that “high inflation expectations” would keep inflation up, even if “excess capacity” developed (a factor I think they are also exaggerating in their forecasts).
However, even after stating this they have slashed rates – they are admitting inflation expectations aren’t anchored and then they are cutting rates! Have they forgotten that the whole point of using monetary policy is to anchor inflation expectations – if they are failing in that role, they are failing altogether. Dr Bollard even said as much recently – so why has he deviated again?
There way of solving this difficulty is to assume inflation expectations will fall – without any positive action from the RBNZ. Inflation expectations can only be tamed when a credible Reserve Bank acts to keep price growth down – with none of this occurring, and no movement by the Bank to restrain price growth, I fail to see how inflation expectations will once again become anchored.
Trying to anchor expectations when they come loose is like trying to put the bonnet of your car down while you are driving. You can either stop and put it down before carrying on, try to do both at the same time (which takes longer and slows you down), or just ignore it and keep the bonnet in your face (which should make you drive more slowly) – as a result, there are real costs associated with getting expectations anchored.
Once your bonnet is down, you are home free for the whole drive (except for possibly the odd stop to make sure it hasn’t come loose 😉 ) – we’ve let the bonnet loose, lets just get it down and lets get on with running our economy at full speed!
Dr Crampton’s call is starting to make a lot of sense – no matter how uncomfortable I am admitting it 😀
“Dr Crampton’s call is starting to make a lot of sense – no matter how uncomfortable I am admitting it”
Eric has expanded on his views on Inflation targeting and the medium term and I think he has a point. I would love to know what the medium term is? Does the RB have any notion of what it means? And if it doesn’t can inflation be outside the band forever? I’m being to think it can be!!!
“Eric has expanded on his views on Inflation targeting and the medium term and I think he has a point”
Linked 🙂
“And if it doesn’t can inflation be outside the band forever? I’m being to think it can be!!!”
Effectively yes – remember a slump in import prices could drive CPI growth back into the target band, but this isn’t the same as controlling inflation 🙂
“Effectively yes – remember a slump in import prices could drive CPI growth back into the target band, but this isn’t the same as controlling inflation”
That’s called good luck rather than good management.
“That’s called good luck rather than good management.”
Indeed, but it also does not imply that the inflation problem disappears – as it is both a change in the price level (not growth) and could be construed as a relative price change.
However, I was just putting that forward as it is conceivable that CPI growth could head inside the target for one quarter – but that does not mean that the inflation problem is over 🙂