Why do policy makers care about this graph so much right now? (ht Roger Kerr)

Specifically, my question to people is simply this three parter:

1. Does this graph show an issue,
2. If so, what is it?
3. And if so, are their any changes that could improve matters?

Some small thoughts of my own beneath the fold.

What do we know here:

1. The amount produced in the non-tradable sector has increased more than the amount produced in the tradable good sectors.
2. Non-tradable good prices have gone up more than tradable good prices (from the CPI)
3. Domestic productivity growth has been weak relative to international productivity growth
4. Our real exchange rate has risen
5. Our terms of trade has risen
6. Export prices have risen
7. Import prices have risen

These are all undeniable facts.  However, when we come to a policy conclusion from it, we need to say “hey, given judgments about what is best and how resources are allocated through the choices of individuals, is this type of outcome appropriate/the best possible”.  Even better than that is when someone explains why there may be an issue – for example Kerr mentioned the fact that high government spending could well have pushed up the real exchange rate.

I don’t disagree with this point – in fact earlier on I wrote about the fact that the equity-efficiency trade-off (and broader costs of policy) were often ignored by Labour in the past, and how this was illustrated in part by the productivity performance of NZ.  However, I would beware focusing solely on government spending, or EVEN the current deficit, as the sole reasons for the lift in our real exchange rate – beware those bearing silver bullets.

A key set of points for me is that:

1. Our terms of trade has structurally increased
2. Changes to policy throughout Asia have lead to massive productivity growth among our neighbours – something we as importers benefit from
3. There was a tax bias towards housing, and potentially other investment vehicles, through the tax system following the introduction of the top tax rate – a matter that has been largely dealt with.

All three of these issue will have pushed up our real exchange rate, and if we assume the third one has now been dealt with, there is no policy recommendation required here.

Now my question to people is simply this three parter:

1. Does this graph show an issue,
2. If so, what is it?
3. And if so, are their any changes that could improve matters?

Any answer if valid, don’t be shy – I would definitely appreciate any thoughts.  I realise I am putting this up before a weekend though, so doubt I will hear back sadly