Watch the curve: Thoughts for the RBNZ September MPS

Tomorrow its more than likely the RBNZ will leave the official cash rate unchanged.  Following that a lot of people are going to say one of the following:

  1. Bah, the world is in crisis they should slash rates
  2. Bah, inflation expectations are elevated and CPI growth is high, they should be increasing rates

Or who knows, some people will probably say both.

Anyway, even if they leave the official cash rate unchanged this does not mean they would have done nothing – in truth even when they leave the OCR unchanged they may loosen monetary policy due to the seizing up in global financial markets.  They do this by changing their forecast for where the official cash rate will go:

Source (RBNZ)

As you can see above, the RBNZ tightened its stance between March and June by saying the the 90 day bill rate/OCR is expected to be higher during the next three years.  Essentially they were saying “we now expect underlying inflationary pressures to be higher, and to respond with higher interest rates” – by doing this,  society in turn will respond by setting prices now (and planning expenditure in a way) that are consistent with the Bank’s inflation target.

Now, the RBNZ is going to lower its rate track from June – the real question is “how does the Bank’s rate track compare to the markets rate track” and “how will the change in the Bank’s rate track lead to a change in the markets rate track”.  THIS, is how we can tell whether the RBNZ is loosening or tightening policy from WHERE IT IS NOW.  And we will have to wait until tomorrow to see exactly what happens here 😉

My key point is to say “don’t let people tell you the RBNZ didn’t do anything and it should have” – the RBNZ will have done something, we just have to ask why, and to figure out whether we believe whether their underlying view of the world (which determines how they set their forecast for interest rates) is truly consistent with everything going on – which I’m sure it will be.

But I heard they need to forecast higher interest rates in the future to stimulate the economy

I’ve heard this argument 2 ways:

  1. Higher interest rates in the future mean a growing economy – telling the economy it won’t grow is stopping it.
  2. Higher interest rates in the future promote borrowing now, which will lead to a faster economic recovery.

The first argument stems from the price level/NGDP targeting crew.  Essentially they are saying that we should be pushing ourselves to a higher “price level” in the medium term then we are currently shooting at – this requires higher inflation further out, which implies that nominal interest rates will be higher (and in this shorter horizon that real interest rates will be lower, and real activity higher).  It comes WITH the implication that inflation will be above the band, something that looks very favourable when we look at the US (where they are likely in a liquidity trap) – but not so favourable for a country like NZ.

With the second argument you’ll notice that in many ways, it contradicts the first.  The higher “nominal” interest rate in that case was a sign that inflation was at a higher level, and that real interest rates were lower.  In this case, the goal seems to be to make spending in the future less attractive – in order to get people to bring forward activity.  However, this doesn’t make sense to me in the current context.

We expect activity to be below its “natural level” for the next 2-3 years, a higher real interest rate would just ensure that activity at that point is further below its natural level.  Higher future interest rates might see marginally higher activity in the next couple of quarters in this context – but in essence we will be extending the period of economic weakness relative to what the RBNZ is currently doing.