Thursday, 11 August 2016

Interesting detail from today's Monetary Policy Statement

There is some really interesting material in today's Monetary Policy Statement (pdf file).

On the downside, there's an analysis of world dairy production, which shows (in the graph below) a strong and probably ongoing surge in world dairy supply. We can't see the demand curve as easily, but it may not be strong enough to absorb this new supply: as the MPS said, "While demand for dairy products is expected to be supported in the long term by growth in emerging markets, high global production is likely to weigh on prices in the medium term. These factors have led the Bank to revise down its medium-term assumption for whole milk powder prices". I'm no expert on dairying, but unless there is some quick and large fall in the NZ$, I'd say the already high levels of financial stress on our dairy farmers are going to be stronger, for longer. Not good at all.

Housing is top of mind for a lot of people at the moment. Here's a fascinating graph: look at that black line in the graph showing house price inflation ex Auckland and ex Canterbury. Basically it shows that quite a few people have been saying, "My house in Pakuranga is worth $1.5 million? Sold, it's yours, I'm off to Nelson", and quite a few other people have been saying, "Here come those jafas. Jack the price up".

Is it all going to fall over anytime soon? No, says the RBNZ. It has house prices still rising, at a national level, over the next few years, though rising at a far slower rate. We'll see.

If I parted company with the RBNZ over any of its analysis, it's over net migration and our output gap. On migration, the RBNZ has net migration dropping away quite a lot, and reasonably quickly. They could be right, but I'm more inclined to believe any drop-off will be more modest than that. There seems to be a political anti-immigration head of steam building up which might curtail inflows, but if that doesn't eventuate, our relative cyclical positioning in the global economy seems to me to be more consistent with net immigration holding up more than the Bank is picking.

The output gap - is there lots of spare capacity (a "negative" output gap, and so little domestic inflation), or very little (a "positive" gap, with stronger inflationary pressure) - is a key variable. Measuring it is inherently iffy, but the RBNZ's best guess is that the economy is currently roughly at capacity: the output gap is neither strongly positive nor strongly negative. As the graph below shows, the Bank believes the output gap will turn increasingly positive in the next couple of years, helping to push prices up.

I'm not quite there myself. On a very basic calculation, if the labour force keeps growing at its current 1.7%, and business investment grows by 6% (the Bank's forecast), the economy has the potential to grow by around 3.1% (two-thirds weight on labour, one-third on capital), plus throw in some modest overall productivity gain, and you get to 3.3% or 3.4% growth in the country's output capacity. If the economy actually grows at around the same rate - which is the Bank's forecast - then the output gap doesn't change at all, and domestic price pressures don't build up like the Bank expects. Its job of getting inflation back to 2% will be harder than it thinks it is.

But we knew that.

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