Careful reading statements – the July 12 OCR
Over at NBR, Rob Hosking suggests that the RBNZ is saying a couple of things following today’s statement – a couple of things I believe they are not saying. Implicitly these are:
- Relative to June, the Bank wants a lower average official cash rate in the coming years (so a lower track, and potentially a cut to the OCR).
- The Bank feels that the “neutral” interest rate is lower (as this is how a level of the OCR goes from stimulatory to not stimulatory).
The reason for this view is the change to the last line of the statement between June and July – it has gone from having “stimulatory” in it to not having stimulatory in it. This is true, but I feel it is being taken out of context – note that in April stimulatory was also missing. Furthermore, the rest of the statement is banging on about how the Bank’s view is unchanged since June … a pretty clear signal that their view is unchanged.
In order to flesh out the argument Hosking states:
It suggests the OCR is going to remain lower for longer, especially when put alongside economic forecasts in the previous statement which said New Zealand’s capacity for economic growth is now lower than previously because of high debt levels and the need to rebuild from recent shocks, both economic and geological.
It is true that the RBNZ “lowered potential”. However, lowering potential implies that the Bank needs to do less to stimulate the economy – not more. All other things equal, lowering potential growth output, or shrinking the output gap, suggests that rate will be HIGHER going forward – not lower.
Although I appreciate that it is difficult to read these statements, and that Hosking is right to try to read into slight changes in wording by the Bank – I feel that the interpretation he has given to today’s statement goes a little too far. In truth, the Bank has reiterated what they said in June – rates are staying at current levels for a while, unless Europe goes bang.
I agree that whether ‘stimulatory’ is in or out of the statement doesn’t suggest much, but doesn’t lower potential mean that the neutral interest rate is also lower? So, interest rates might track higher in future, but that the current rate, while stimulatory, be less stimulatory than it was when potential was higher?
The eqm interest rate depends on time preference and growth in future income – this is true. And when the June statement was made we definitely had the case where the current level of the OCR was less stimulatory, and that the issue of “insufficient demand” in the economy was less severe. I could have definitely phrased that better! I should have said potential output instead of potential growth.
Whatever the actual case about interest rates, isn’t the more interesting and worrying story that potential output is lower? Everyone focussing on where interest rates go – that some will be relatively better off and some relatively worse off – seems secondary to the point that we’re all worse off with lower potential.
Indeed – shocks that lower our livelihood aren’t good.
However, “potential” in the long-run sense and “potential” in the way the RBNZ is using it are also a bit different – given that part of the reason for this drop in potential may be put down to temporary extrenal factors.
I will admit I am currently unconvinced about their narrative regarding potential – and the only reason that narrative in itself exists is so that we can discuss sort-run movements in monetary policy.
Long-run movements are more an issue for description, and potentially policy discussion by Treasury.
In essence, we focus on interest rates and not potential because we control interest rates, we can use the short-run trade-off between unemployment and inflation. We do not control, or have no real lever over, potential in the economy … outside of the equity-efficiency trade-offs that exist in structural policy.