Wednesday, 24 April 2013

Today's OCR

As expected, the RBNZ left the Official Cash Rate (OCR) on hold today, at 2.5%. Whether it should have, though, is debatable. As the Bank noted, the NZ$ was already overvalued, and has recently become even more overvalued after Japan's government embarked on a massive monetary easing. This has led to a lower yen and a higher Kiwi dollar - the Kiwi is up from around 65 yen six months ago, to around 84 yen today. Logically, Japan's easing ought to have led the RBNZ to ease policy here: if local monetary policy was set correctly before the yen's rise, then it is too tight now at this new, higher level of the Kiwi dollar. And it was arguably already too tight in the first place, as the chart below shows.

It resurrects the old Monetary Conditions Index - for people who may have forgotten, this is the measure that the Bank used to steer by, and that combines both interest rates and the exchange rate into a single measure of the overall bite of monetary policy. Today's index is at a level appropriate to a boomtime economy, one generating the sorts of inflationary pressures that were around in the robust economy of the mid 1990s and again in the pre-GFC years of 2005-07. But we're manifestly not in a boomtime economy: growth's modest, and inflation low. Policy looks on the over-tight side.

This suggests some possibilities. One is that the Bank doesn't appreciate or believe that monetary policy is too tight - unlikely. Another is that it knows policy is too tight, but it's not able in current market conditions (notably ultra-easy monetary policy in many of the major OECD countries) to move the NZ OCR/NZ$ mix to where it would like it to be - possible. Most likely, though, is that the Bank doesn't mind too much, and that it is placing considerable weight on the pressures in the housing market. It has been, and was again, upfront about these pressures - "House price inflation is high in some regions, despite prices already already being elevated. The Bank does not want to see financial or price stability compromised by housing demand getting to far ahead of supply" - but my take on the whole thing is that house prices are looming ever larger as the Bank's greatest policy concern.


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