Why is there this clamour for a rise in interest rates? Just what are we trying to achieve?

I truly don’t get it. Many financial market commentators appear to be saying that because the New Zealand economy is a rock star, we need to now endure an increase in interest rates.

I won’t argue here whether or not our rock star status is justified – I’ll leave that for another post (although I am at a loss as to why one would want to be in the same company as Miley Cyrus).

But, I do want to address this clamour for an interest rate rise. The clamour has intensified as some production, employment, spending, price and confidence indicators have gathered positive momentum over the past 6 months. Indeed the clamour grew to a cacophony this week with the latest CPI inflation figure ‘soaring’ to the giddy heights of 1.6% per annum. Because many financial market commentators were surprised by this number it, apparently, underpinned the argument for urgent action by the Reserve Bank.

All I ask is, why? Just what is the problem? And how will an increase in New Zealand’s interest rates address that problem?

I infer from the clamour that the problem could be one of heightened inflation. But, the 1.6% is well within the 1% to 3% specified in the Policy Targets Agreements (PTA), and further, quite close to the 2% midpoint focus also specified in the PTA. Again, what is the problem?

I infer that some have issues with rising house prices, and perhaps that is the problem? But, we’ve been down that track before. Raising interest rates will only make us seem to be even more of a rock star, attracting largesse to the country to further fuel property market speculation. Increasing interest rates does little to address that ‘problem’ – indeed, it will exacerbate it.

I infer that due to our rip-roaring economy some suggest there is a risk of heightened future inflation. In particular, construction materials and labour costs are set to soar. So, is the problem our rip-roaring economy and, so, we need to slow down its growth rate?

Are you serious? I confess to being flabbergasted. Are we truly suggesting that to solve this ‘problem’ we should slowdown the re-build of Christchurch? Surely not.

Or, that we should slowdown the construction of new houses? This may cure the ‘problem’ illness, but the patient may expire as a result.

Or, that we should slowdown the infrastructure spend on UFB rollout? Or, that we should slowdown the renewal of plant, machinery and equipment that is taking place? Again, surely not?

I must confess to an unsettling feeling of déjà vu. I argue (again) that an increase in interest rates will hike our exchange rate even further. This will penalise our income earners (i.e. exporters), and reward our spenders with even cheaper imports (i.e. consumers). More specifically, one of our core problems remains our policy prescription that ‘buys’ low inflation at the expense of the productive, income-earning tradable sector. Indeed, while the CPI of 1.6% is well within the 1% to 3% range, inflation in the tradable sector is -0.3%, while that in the non-tradable sector is at 2.9%. And this discrepancy has been around for a while.

And what will the widely heralded increase in interest rates do for this problem? It will further underpin the rock star status of the Kiwi$. Hence, we will continue to achieve our inflation target by suppressing even more the income-earning tradable sector, and further rewarding consumers.

As I said at the start, I just don’t get it. But, I confess, I am but a mere economist and am not well versed in the sophistications of the financial markets.

Comments (6)

by Tim Watkin on January 28, 2014
Tim Watkin

My confession is that I hadn't looked at it that way... it seems to be a default position that as economic indicators start to improve you increase interest rates to keep some kind of balanced ship... whatever that means. Is it just nervousness that rates have stayed at historic lows for so long and that in some sense the powers-that-be want them back nearer historic norms to feel, well, normal? Because we hardly seem likely to face some 7 percent growth, Chinese-like over-heating issues.

My only other thought is that rates try to respond to where the economy's going to be in a year or two, don't they? Does the Reserve Bank think that in 18 months we'll need those higher rates? Or is there something in how we compare to other western economies, that we don't want to be seen as keeping rates low?

by Charles Finny on January 28, 2014
Charles Finny


Our Twitter exchange refers.

I agree with much of the above.  I believe that an increase in the OCR at this time is a very serious move.   It has to be based on confidence in the health and direction of travel for the global economy and on hard evidence of inflationary pressures growing in the domestic economy.  I just don't see enough evidence of these pressures right now beyond the housing market.  And there the pressures do seem to be easing a little.  The latest inflation stat was up a bit on expectations.  One blip does not a trend make....

I am worried about growth slipping in China and Australia, about the easing of quantitative easing in the US, and continuing deflationary pressures in Europe.  

And while we are growing quite well it seems, I see some signs that in some parts of the export economy the recovery remains a bit fragile.  Increased cost resulting from increased interest rates coupled with reduced competitiveness due to an even higher dollar value (higher interest rates at this time would make this almost inevitable) could be badly timed. 

Put it all together and I think we should be waiting until at least March before we put the OCR up.


by Tim Watkin on January 28, 2014
Tim Watkin

Thanks for your thoughts Charles. It's mostly anecdotal, but I think the Auckland housing market has cooled considerably, the Reserve Bank has done a stellar job there and so could afford to pat itself on the back and delay any increase.

If you can spare another minute or three, I'd be interested in what you think the implications are of what's going on overseas – the risk of fewer exports than we hope, or more than that? And what parts of the export economy are fragile?


by Charles Finny on January 29, 2014
Charles Finny

Have a look at the profits (losses) of some of our meat and seafood exporters and smaller wine companies....

I think that we will see modest growth in the global economy in 2014 which is good news for our exporters.  But it will not be strong growth.  China, our biggest market, is likely to grow less strongly than we have seen.  And our second most important market - Australia - looks very weak.

On the positive side Japan is doing better than we have seen for many years and we have a wonderful FTA with Taiwan which should see good growth opportunities for all sectors.

On balance I see an OK year for exporters.  But there will not be much inflation generated by them!

Yes, I hear the same anecdote about Auckland property.




by Rich on January 29, 2014

 is there something in how we compare to other western economies, that we don't want to be seen as keeping rates low?

Well, the dominance of property as an "investment" and refusal of governments to control it with fiscal measures, the limited effect of the 2008 banking collapse (it was buffered by the finance company sector) and the need to control inflation by keeping imports cheap play a part.

I do tend to think it's the carry trade (where foreign investors place their money in NZ dollar deposits so that it earns a substantial interest premium over yen or euros) acting as the tail wagging the dog. This money now finances most NZ mortgages and most mortgage payers (and all banks) would be in trouble if it tried up. So the NZD interest rate *has* to be held at a suitable premium over other currencies to compensate overseas lenders for the (substantial) currency risk.


by Josie Pagani on January 30, 2014
Josie Pagani


“The clamour (for higher interest rates) has intensified as some production, employment, spending, price and confidence indicators have gathered positive momentum over the past 6 months.”

It seems people have been predicting higher inflation globally and therefore the need for higher interest rates forever, as if post GFC economies are now overheating and need to be cooled. If only!

This isn’t true of the American economy or the New Zealand economy. Wage growth remains too low in New Zealand. Why put the brakes on the economy now? It makes no sense to tighten monetary conditions until - unless - there is evidence of too much wage inflation. In other words that the real economy is overheating. We know it isn’t even growing strongly, let alone overheating - and wages remain too low, not too high.

It’s entertaining to see what Paul Krugman calls ‘the inflationista camp’ shift its ground when calling for higher interest rates. “It’s about inflation; no, it’s about sound market functioning; no, it’s about financial stability — but always with the same bottom line: rates must rise now now now.”

High interest rates will hit exporters again, but protect owners of capital who will increase profits with the higher rates. Exporters are already doing it hard with the bloated Kiw$. Now we're going to hit them again? Higher rates will risk increasing unemployment  - for what? A natural upturn in the business cycle which is fragile at best and possibly just a blip.

Surely better to leave interest rates alone until there is real evidence of an overheated economy. Let’s see some real growth first.

Thanks for this analysis Ganesh.

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