Matt Nolan

RBNZ liquidity measures: What do they mean?

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This post is more of an open discussion post. I want to know what YOU think about the new Reserve Bank liquidity measures.

We know that BNZ, Goldman Sacs, the Press, and fellow bloggers such as the Hive and Mish believe that this (and yesterdays financial market review) illustrates a significant change in stance by the Bank. However the Bank itself believes that this illustrates no change in stance, but is simply mean’t to keep our monetary policy practice in-line with other countries – in the words of CPW, they wish to sit at the big boys table.

My knowledge of such things is decidedly limited – however, I’ll tell you what I think they mean, then you can correct me 😉

The main changes according to the Bank are:

  1. Extension of the range of securities eligible for acceptance in the Reserve Bank’s domestic liquidity operations to include: NZ-registered NZ dollar AAA rated securities, including Residential Mortgage-backed securities, and AA rated NZ government sector debt – including Government agencies, SOEs and Local Authorities.
  2. The discount margin applied in the Bank’s Overnight Reverse Repo Facility will be 50 basis points for all eligible securities.
  3. A graduated ‘haircut’ regime will replace the existing limit structure for all securities eligible for domestic liquidity operations.
  4. Extension of Overnight Reverse Repo Facility from 1 day to a maximum of 30 days.

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Matt Nolan

Why does the target rate matter?

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WIth inflation heading far outside the Reserve Bank’s target band both Kiwiblog and Kiwiblogblog have had a little to say about inflation targeting.

David Farrar at Kiwiblog states that inflation outside the range is bad, and in fact our relevant target band should be 0-2%. He also states that we can act like the target is truly the point at the middle of the band – ergo we currently have a target of 2% (in the 1%-3% band). David then finishes by saying that current interest rates will have to stay high – something that will be a concern to people.

Wat Tyler (a good historical reference of a left wing blog may I add) disagrees with this way of looking at the target, states that interest rates were higher in the 90’s and so should not be such a concern, and says that a little breakout from the inflation target doesn’t matter – as long as we keep inflation in single digits.

Both sides have points – lets try to dig a little deeper and figure out what my opinion is 😉

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Matt Nolan

Externalities and Fed monetary policy

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An interesting article by Sebastian Mallaby discussed the contrary monetary policy strategies of the US Federal Reserve (cut rates to avoid a recession) and the European Central bank (keep rates elevated to avoid inflation). (h.t. Greg Mankiw)

In the article, Mallaby alludes to the view that the US Federal Reserve might feel that it is the greater protector of the world economy – this takes for granted the positive externalities to the rest of the world from the Fed cutting rates. These are:

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Matt Nolan

Emissions trading scheme and inflation

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Inflation is an important issue for everyone in New Zealand at the moment, with rising food and oil prices driving our annual inflation rate has fallen outside the Reserve Bank’s target band (hitting 3.2%pa in December). The fact that inflationary pressures are elevated will make it difficult for monetary policy to respond to any slide in real economic activity – a definite concern for New Zealand.

At the same time there has been a lot of talk about how the emissions trading scheme will impact on inflation. Both the Reserve Bank and Westpac are telling us that it will lead to a higher rate of inflation, and commentators seem to have accepted that it will – but how does this work?

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Matt Nolan

Inflation psychology

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‘Inflation psychology’ was the topic of a recent inflation update by Stephen Cecchetti (h.t. Freakonomics blog). In it he mentions that people seem to have selective memories regarding price changes – namely people are likely to remember price increases more than price falls.

I once mentioned such a potential bias when I commented on Kiwiblogblog, it is a bias that I definitely hold, and I suspect other people do too. For example, did you know that the nominal New Zealand price of petrol is only starting to reach the level recorded in July 2006 now? People often remember the big increase in petrol prices in mid-2006 and late 2007, but they seem to forget about the significant fall in prices that occurred between these periods.

The question then is, what does this bias imply for inflation?

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Matt Nolan

Torres and inflation expectations

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I am a Liverpool supporter (the football club), I’m proud to admit it 🙂 . While I was reading an interview with Fernando Torres today, I ran into this gem of a line when discussing Benitez’s rotation policy:

“It is normal to rest. We players never want to, but if the manager says so, you have to. If everybody accepts that is the way forward, the atmosphere doesn’t suffer.”

This reminds me of inflation expectations. If the Reserve Bank (the manager) says that it is commited to making inflation zero (for arguments sake), then individual agents accept that the Bank will do whatever it takes to achieve that target (hiking interest rates), and inflation expectations shift to zero. If this is the case, there is no need for a costly adjustment to the new equilibrium (atmosphere), as inflation expectations drive the true rate of inflation.

Ok, the two arguments are a bit different, but I still think that Torres would make a great economist 😉