Saturday, 1 March 2014

Wrong answers to an interesting question

It's not the best known of surveys, but every quarter the Reserve Bank carries out a survey of expectations across a reasonably broad cross-section of respondents (mostly financial sector types, including me, making 35 of the latest respondent group of 72, but also 19 from business, 8 from agriculture, 3 from labour groups and 7 miscellaneous). So it's a useful complement to the economists-only consensus forecasts compiled by the NZIER.

You can see the RB's latest results here. The Bank's main interest is, as you'd expect, the behaviour of inflation expectations, which are tracking as shown in the graph below. It also collects views on GDP growth and unemployment (the cycle is getting ever stronger), earnings growth (modest), bill and bond yields (expected to rise), and the NZ$/US$ and NZ$/A$ exchange rates (no great change expected).

There is one small flaw in the survey, however. The Bank asks people for their perceptions of the stance of monetary policy on a scale from very loose to very tight, and turns the answers into an index number: the latest result is shown below. As you can see, people are answering that monetary conditions are remarkably easy.

But they're not, of course, and if you've come across this survey before and took this graph at face value, you'd have been misled. As I said a wee while back, overall monetary conditions reflect the combined impact of both interest rates and the exchange rate (and arguably other factors too, such as ease of access to credit or equity). If you go back over the past few years and graph the Monetary Conditions Index, which takes both interest rates and the exchange rate into account, against the RB survey measure of what monetary conditions feel like, you get the result below (I've estimated the Mar '14 MCI at current bank bill and TWI levels).

The reality, in short, is that overall monetary conditions, far from being unusually easy (as assessed by the survey) are in fact heading for levels that are quite stringent by historical standards (going by the MCI).

What's happening, unfortunately, is that respondents are actually supplying their estimate of whether interest rates are unusually low or unusually high.

Maybe the RB is able to make some other use of the answers, but they're not good answers to the question the Bank was actually asking.

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