Hi Andrew, thanks for another thoughtful comment.

If I was to summarise what I took for your comment it would be as follows: Essentially you are saying that there has been a persistent trend in relative prices and that if we look past that trend the true underlying rate of inflation has been too high, especially given the effective “inflation taxes” inherent in our tax system.

I see exactly where you are coming from, and there are two points I would like to raise in line with this:

1) In essence we should measure the comovement in prices that is independent of prior relative price shocks and treat that as the inflation measure – with that in hand we have a clearer idea of whether the Bank is indeed meeting its mandate.
2) The inherent bias in taxation is more an institutional issue than an issue with the implementation of monetary policy. In essence since the tax system is set up how it is, and since the inflation target is set where it is, we face this cost. To solve it, we need to change either the inflation target or the tax system – rather than anything with the implementation of monetary policy by the Bank.

Suppose you are right and the central bank has relatively little influence over relative prices in th emedium or long run. (I have not seen evidence countering this proposition .) Then a central bank charged with maintaining low inflation (or, to be precise, to ensure the general level of prices is stable) should have little interest in relative prices except to the extent that relative price movements destabilise price expectations. In a world where non-tradeable prices persistently increase relative to tradeable prices because of faster productivity growth in the latter sectors, the central bank should try to make sure both sets of prices in terms of money are increasing at a lower rate. To make this concrete, and to quote an example from a 2007 paper in the Reserve Bank Bulletin (which showed that relative price movements in Australia and New Zealand across disaggregated sectors are highly correlated in the medium term, with sectors with prices that increased relatively rapidly in NZ also increasing relatively rapidly in Australia and vice versa) , between 1990 and 2005 non tradeable prices in NZ increased by 63% (3.3% pa)while tradeable prices increased by 16% (0.8%). Since relative price movements in Australia were very similar, it should be concluded that the Reserve Bank should not be trying to reduce the rate of price increase in the non-tradeable sector compared to the tradeable sector. Rather it should be trying to ensure that both sets of prices in terms of money increased less rapidly: say by +20% and – 27% respectively over the period.

I would contend that a problem in NZ is that the central bank allows the rate of increase of both tradeable and non-tradeable prices to be too high, particularly because of the way the tax system penalises some classes of assets in an inflationary environment more than others. If the tax system is not indexed for inflation (which it isn’t) allowing both tradeable and non-tradeable prices to persistently increase in terms of money is to create distortions that favour excessive borrowing and that penalise people who prefer to lend than purchase assets. Having a central bank deliver outcomes that persistently favour borrowing over lending is as curious public policy as would be having a bank that worries excessively over prices in the non-tradeable sectors.

andrew