Thursday, 10 March 2016

Surprise! Surprise!

You've seen that the Reserve Bank has unexpectedly cut interest rates by 0.25% and has at least one more 0.25% cut in the pipeline.

For me, the most striking thing in the Monetary Policy Statement was this graph.

No matter how you slice it, it's now apparent that core inflation is, at best, systematically in the bottom half of the RBNZ's target 1-3% band, or, arguably, dropping out the bottom. And the trend, if anything, is that core inflation is still falling.

There are some who will argue that this is, in part, the RBNZ's own doing, with its interest rate increases in 2014 which (with hindsight) proved too tight a setting of monetary policy and hence subdued inflation more than desirably. Personally, I'm rather more inclined to another explanation, which is that our economy (and others) have changed in some still not fully understood way, so that the amount of inflation you get for any given degree of strength in the economy is less than it used to be (a "flattening of the Phillips curve", in the jargon).

Bernard Hickey of asked Governor Wheeler a very good question at the post-Statement press conference, along the general lines that perhaps there have been structural changes in the global economy - technology? better supply chains? - that have made pursuit of 2% inflation targets a waste of space (I'm paraphrasing).

The Governor agreed that there had certainly been changes along those lines that could well be depressing inflation. But he said that no central bank had yet decided to flag away inflation targetting, and no central bank had lowered its target inflation rate. He also said that the traditional "output gap" analysis - if the economy is going gangbusters (a positive output gap) you'd expect higher inflation - is still very useful, and that the Bank isn't abandoning the traditional framework.

We'll see. For now, though, I'm rather attracted to the idea that inflation in the developed world has moved structurally lower. Throw in the additional fact that most of the major developed economies have their monetary policies set on super-easy, and you can readily get to the point of believing that there's actually no sensible setting of local monetary policy that will get inflation back up to 2%. In that light I'm not surprised that the Bank has now pushed  inflation being back at 2% out to March 2018.


  1. The failure of Japan's monetary policy over the last decade to move the inflation dial is a challenge to my neo-classical world view. I'm not very happy when the facts do not confirm to my biases.

    Still; of major concern is, given the low rates and the level of govt debt racked up perhaps ion response to cheap debt, is what happens if the structural bias changes to an high interest rate world. We can;t print out way out of trouble and the cost of default will be ugly; future governments will be burdened with the high cost of repayment without the easy out previously available of inflation.

    (I think Bernard Hickey is more associated with these days)

  2. Yes, Japan's worth thinking about, esp re the role of expectations. We lived there early 80s, even then you expected overall price stability with some prices actually falling, and it's gripped as an idea much more forcefully since then. Wheeler mentioned (in response to Bernard) that demography may be one of the structural low-inflation forces, and Japan is certainly one of the greying-fastest countries. Can't say I see the causal links terribly clearly, myself!

  3. Old people have capital and no labour. I'd expect asset prices to fall and services reliant on scarce labour to rise. Not sure that's what's happened.

  4. Old people have capital and no labour. I'd expect asset prices to fall and services reliant on scarce labour to rise. Not sure that's what's happened.