A wager: Price growth of 15% between Dec 10 and Dec 15

In the comments of this post, Andrew Coleman and myself decided to place down a little wager on price level growth during the next five years.  The bet goes as follows:

If the CPI grows by more than 15% between its December 2010 level and its December 2015 level (excluding any changes to the GST rate), Matt pays Andrew $100 (in Dec 2010 prices)

If CPI grows by less than 15% during this period, Andrew pays Matt $100 (in Dec 2010 prices).

We put down this bet just to show that we believe our own positions enough to stake money on them.  He believes there is some probability that the Reserve Bank will allow prices to grow at more than 2.8%pa during the next five years, and that this probability is sufficiently high for him to be willing to make this bet.  On the other hand, I do not think this will happen.

Update: Eric Crampton has also joined the bet, sitting on Andrew’s side.  So it is my $200 against $100 from each of them.  Confirmation here – combined with an explanation why.  I use the same explanation if I ever bet against the All Blacks in the work pool.

  • If you’re looking to up the stakes, I’ll put another hundred with Andrew’s.

  • @Eric Crampton

    Sure, same rules?

    Also, why am I the only one that seems to believe the Bank won’t violate its mandate?

    I sort of expect this to happen: I’ll lose the bet, as the Bank ignores a lower dollar and higher fuel prices stating that they are price level shocks … or the Reserve Bank Act will get chumped 😉

  • Same rules, sure, so long as “effect of GST” ONLY means the immediate effect of that increase and not any flow-on into wage expectations and salary increases.

    I think the Bank did bend to pressure 2005-6 and did violate its mandate during that period; I don’t think they’ll be under any less pressure over the next couple of years with the Christchurch rebuild.

  • @Eric Crampton

    Yar, it is just the price level shift – not the impact on inflation.

    “I think the Bank did bend to pressure 2005-6 and did violate its mandate during that period; I don’t think they’ll be under any less pressure over the next couple of years with the Christchurch rebuild.”

    If I remember correctly, everyone was expecting a recession in 2006 – and the Bank’s policy was consistent with that. But instead we had a rebound and a massive TOT increase they couldn’t have known was going to happen – so they responded by lifting rates sharply.

    It is easy to say that they’ve violated their mandate ex-post, but ex-ante we have to ask if their forecasts had a violation, and whether they were reasonable. Given that everyone expected else also expected a recession I don’t think the blame is with the Bank per see.

    Although, I am still uncertain how I’ve ended up defending them – I am of also of the opinion that they have pushed their mandate towards the limit, which I don’t really agree with. I just think an all out violation is a big call.

    Regarding Chch I also very much agree with you – but given that I expect the building cost pressure to be persistent (and therefore more likely to feed into expectations) I would expect them to respond to it. We will see how my faith is tested in a year’s time 😉

  • How much of the GST-related CPI increase do you count as already being reflected in the December 2010 quarter results? We expect a 2% price level increase with GST. The quarter on quarter increase from Sept 2010 to Dec 2010 was 4%.

  • @Eric Crampton

    Sep-10 to Dec-10 was 2.3%, the Dec-09 to Dec-10 growth was 4%.

    IMO, most of the GST increase was in Dec-10, some was in Sep-10, some will be in Mar-10. We are treating it as all occurring in the December qpc though – so that provides the base.

    As long as the government doesn’t change GST again, we will just be comparing the Dec-10 quarter to the Dec-15 quarter.

  • You’re right – I flipped the columns. So CPI Dec 2015 target is 1307.55 for bet resolution. Excellent.

  • @Eric Crampton

    1307.55 if they don’t revise anything 😛

    We could rebase the series, then roll out a 1150 in that series if we so desire.

  • Awesome. Posted for the record over at Offsetting too. A pleasure equalizing utilities across potential world states; thanks for helping me to do so.

  • likes this

  • this is hawt!

    What happens if the PTA changes over the period?

  • @agnitio

    If the PTA changes and it violates the current mandate (with higher price growth) I lose.

    I would be hurt in two ways 😉

  • I hope I only win by a tiny margin.

  • @Eric Crampton

    You’ll be glad to know that you will win the bet if most private sector forecasters are correct – I’m thinking that’s part of the reason I went against it 😉

  • prices grow, wages decrease, one hell of a economy

  • Michael Reddell

    Seems to me that whatever this bet is, it is not on whether or not the RB delivers on its mandate. For a start, 15% increase over 5 years is 2.8% inflation per annum (ie within the 1-3% band, and recall that the midpoint is nowhere mentioned in the PTA). Second, of course, the current PTA has only 18 months more to run; no doubt less if there were to be a change of government. Third, of course, it is quite possible for the one-off price increases the Bank is charged with looking through to be skewed one way or the other on average over a relatively short period like five years.

  • “Seems to me that whatever this bet is, it is not on whether or not the RB delivers on its mandate.”

    I agree I could easily use and say that the Bank still delivered on its mandate – given that the current mandate really just requires that they forecast they are going to stay within the band.

    However, ex-ante the only bet you can make about the mandate MUST assume that ex-post they will stay within the mandate – the reason the sums of money are so low is due to the risks that, even though they follow their mandate (or don’t) there are other corresponding price shocks.

    Also, you call 5 years a small period of time – but their mandate is over the medium term (which could be viewed as 5-10 years). As a result, I think the horizon is fair enough.

    One thing I find VERY difficult about this time horizon is that they say “our target is over a number of years” and yet “the past is irrelevant” – there is something uncomfortable about this IMO, even though both elements can be justified in of themselves.

  • raf

    I’m with you on this one Matt. Happy to join the bet.

  • @raf

    Good man, was worried no-one else believed the mandate would hold 😛

  • Miguel Sanchez

    Michael is quite right – this is not a bet on a breach of the mandate, not even ex ante. And he would know, better than any of us 😉

  • @Miguel Sanchez

    Yar, as I said in my follow up comment I agree – as long as the Bank forecasts that it will stay in the band it is following its mandate.

    I would ALSO note that nowhere in the post itself did I say this was even a bet about the mandate, just a bet on price level growth. In second comment where I said that was too loose, I agree. Note, that I have been saying that I think the Bank has never violated its stated mandate – both here and in the previous post where this got set. As a result, I am in agreement.

    However, this raises a much bigger issue – if the mandate isn’t testable just how credible can it be? The reason I stated that ex-ante this was the only objective bet we could make is because ex-ante its the only objective bet we can make – if the Bank wants inflation expectations anchored within the band, a bet regarding whether they are (ex-ante) expected to remain within their mandate must assume that price level growth will average a level within the band.

    IMO, the solution is to come up with a “true” measure of inflation that abstracts from relative price changes – and ensure that this stays at an appropriate level. I would also state that, given this, we would then need to decide BETWEEN an inflation band or a medium term inflation (point) target.

  • andrew coleman

    Hi Matt,
    I’m willing to raise my portion of the bet to 16% over 5 years, which exceeds 3% per annum – just as inflation exceeded 3% pa in the five years to December 2007.

    But that is only part of the point. In the long term it probably doesn’t matter too much whether inflation in NZ is 15% rather than 16% every five years. What is surprising is that we are so willing to allow for the pretence that a 15.9 percent change in the price level every five years could be interpreted as being consistent with the Reserve Bank achieving its primary function. According to section 8 of the Reserve Bank Act…” The primary function of the Bank is to formulate and implement monetary policy to the economic objective of achieving and maintaining stability in the general level of prices.” and section 9 ….”The minister shall, before appointing, or reappointing, any persons for Governor, fix, in agreement with that person, policy targets for the carrying out by the Bank of its primary function during that person’s term of office, or next term of office, as Governor.”

    New Zealand has a minister and a governor who think that so long as the CPI doesn’t increase by more than 15.9 percent every five years, the situation is consistent with the objective of stability in the general level of prices. We have a central bank that has imposed some of the highest real interest rates in the world, and the most steeply inverted yield curve in the world, for the best part of a decade without being able to consistently reduce the inflation rate below 2 percent (so perhaps it is know-how, not willingness). We have a governor and Bank who has presided over a 24.9% increase in the CPI in 8 years. For all I know, we have governor who wears a grey suit because he thinks it’s a close approximation to black. To my mind, somehow, this is not a situation where we should be confident that true stability in the general level of prices is going to be achieved in the next five years; and I am not particularly confident that the Reserve Bank will prevent the CPI from rising by 16 percent. I wish I were.