Saturday, 1 February 2014

How tight is tight?

Everyone is primed for higher interest rates: some folks thought the Reserve Bank would even start the process last week, but in any event there's a near-universal consensus that the next Monetary Policy Statement (March 13) will see the first hike in the Official Cash Rate.

Over at The Visible Hand In Economics, the question's been asked, ''Should we hit inflation hard and fast?', if you'd like to contribute to the discussion. My own view is that we've got some potential inflation problems emerging - non-tradable, domestically generated inflation is 2.9% already, and rising -  but even so I'd be concerned about a sharp and quick rise in interest rates, mainly because I'm not sure everyone realises how much monetary policy has effectively tightened already, through the mechanism of the higher Kiwi dollar.

Here's that old measure of overall monetary policy, the Monetary Conditions Index, updated to the present.

It combines the 90 day bank bill rate and the trade-weighted index of the Kiwi dollar into an overall measure of the bite of monetary policy. I know, it's not perfect, but it's a better view of the policy setting than you'd get by looking at interest rates alone. And what it shows is that we're already near the kind of monetary policy tightness that was appropriate towards the end of the strong economic cycles of the mid 1990s and mid 2000s. So in my view it would be easy to overtighten by mistake - especially, as seems likely, if rises in the OCR translate into an even stronger Kiwi dollar.


  1. Indeedy, and of course there is defacto tightening from LVR restrictions and the change in the yield curve in recent months.

    Sometimes we get a bit tied up in discussing monetary policy solely through the point-in-time OCR. It is a good sound bite, but can be misleading. I am as guilty of this as anyone of course :)

  2. Yes - it would be nice some day to come up with an expanded version of the MCI that took in things like the LVR rules and any separate effect of longer maturity rates. I seem to remember the RB reckoned the LVR rules were worth 0.3% of OCR tightening, so as you say it's a material de facto tightening