The inflation policy target has been missed regularly over the past two years, and will be missed for another year. The evidence is that the target has been moved. So by who? And will we be let in on the secret?

About this time last year, there was an overwhelming clamour from market players that New Zealand's interest rates must go up. I admitted at the time I was perplexed as to why, but presumably wiser heads prevailed. And so up went our interest rates.

And I remain perplexed.

Having increased interest rates, we will get another statement early next month from the Reserve Bank of New Zealand (RBNZ) outlining their reasons why they will not reduce New Zealand’s Official Cash Rate (OCR). So, New Zealand will continue to have amongst the highest interest rates in the developed world and, consequently, an overvalued currency.

The RBNZ statement will also reiterate that the RBNZ believes the NZ$ is overvalued, but will then promptly propose to do nothing about it.

Their reasons for not reducing the OCR will likely revolve around New Zealand registering amongst the fastest GDP growth in the developed world, rising construction cost pressures as the Christchurch rebuild accelerates and further demand pressures from soaring migration inflows.

There will also be confirmation that the inflation target will continue to be missed through this year.

Note, in September 2012 the Minister of Finance and the Governor of the RBNZ signed a Policy Targets Agreement stating

“... the policy target shall be to keep future CPI inflation outcomes between 1 per cent and 3 per cent on average over the medium term, with a focus on keeping future average inflation near the 2 per cent target midpoint”.

The annual CPI inflation outcomes over the nine quarters since September 2012 have been 0.9, 0.9, 0.7, 1.4, 1.6, 1.5, 1.6, 1.0, and 0.8.

These outcomes, I submit, are not quite “... near the 2% target midpoint".  Indeed, take the GST hike out of the picture and we get the image of highly over vigilant inflation police over the best part of the past 5 years. But that, perhaps, is a different story.

Unfortunately, it’s now going to get worse. Recently, in its January OCR review, the RB admitted that “Headline annual inflation is expected to be below the target band through 2015 ...”. Translation: not only are we currently missing the target, we will continue to miss it for the rest of the year. And, still, the RBNZ refuses to reduce the OCR.

The inflation policy target has been missed regularly in the past, and will be missed for another year. But the RB does not consider this a compelling case to reduce the OCR. One could argue that the case is even more compelling when noting that none of the nine outcomes since September 2012 can be said to be close to the stated focus of "... near the 2 per cent target midpoint".

So, if not now, what further evidence is required to shift the RBNZ's minds that the OCR should indeed come down to meet their inflation target? Note that even if we extract petrol prices from the above sequence of outcomes the numbers become 1.0, 0.9, 0.9, 1.2, 1.7, 1.6, 1.6, 1.2, and 1.0.

I can only conclude with that there hasn’t ever been a “... focus on keeping future average inflation near the 2 per cent target midpoint”.  

In other words, the goal posts have been moved.

This begs the questions – who moved them and to where have they been moved?
Clarity from the RBNZ and the Finance Minister as to what precisely is the current policy target would be opportune.

Unless, of course, one prefers to continue the charade of market players second-guessing the central bank’s moves – and allowing those players to make hay in the process?

Comments (8)

by Alan Johnstone on February 23, 2015
Alan Johnstone

I'm not an economist, but I keep a keen eye on world events.

I see that Denmark and Sweden have both moved to negative interest rates to hold down the value of their currencies and ward off deflation.

I worry that deflation is a real danger here, where the real value of debt increases, is it time to abandon our 20th century monetary policy and engage in a spot of QE to drive demand and consumption ?   


by Ganesh Nana on February 24, 2015
Ganesh Nana

Agreed wholeheartedly that deflation is a real danger.  Europe, UK, US (and China) all reporting indicators signalling signs of deflation.  Need to re-focus from late-20th century fixation on inflation fight, to needs of real economy - not sure I like QE for driving demand and consumption - prefer investment spending on building real things e.g. 21st century energy/transport infrastructure, 21st century housing, and jobs; not in finance speculation sector.

by onsos on February 24, 2015

You'll know better than me, Ganesh, but could it be that the Reserve Bank is worried about housing inflation and is factoring this into the equation? 

by Ganesh Nana on February 24, 2015
Ganesh Nana

Yes, I'm sure the RB is worried about housing inflation - and we've been down that road so many times before.  i.e. sacrificing real economic developments on the altar of housing inflation flamed by ongoing speculative behaviour.  But, if the goal posts have moved for the RB to target housing inflation then we should have been told/informed.  Housing inflation is no excuse to shift the goals posts and not inform the populace.

by Katharine Moody on February 24, 2015
Katharine Moody

.. and we've been down that road so many times before.  i.e. sacrificing real economic developments on the altar of housing inflation flamed by ongoing speculative behaviour.

Agree, except this time is a bit different - as the worrisome inflation is concentrated in Auckland-only (and more so, in parts of Auckland-only). It is very poor policy to attempt to tackle that inflation in an un-targeted way.  The worst of the worst as it fuels deflation elsewhere whilst making no difference in the target area.

by donna on February 24, 2015

Once again, thank you Ganesh for shining a light on the weirdness that is the current iteration of the Reserve Bank. I've been wondering for a while where the inflation is coming from, and it concerns me that QE cash fueling the Auckland housing market (as it is fueling housing markets elsewhere) is being mistaken for inflation. Indeed, we are making the same mistakes as we did in the 2000s and - again as you rightly point out - damaging our export sector by keeping the dollar high. I have read comment to the effect that the exchange rate is affected by factors other than interest rates. While this is true, by far the greatest influence is the official cash rate.

And thank you for daring to suggest that We The People have a right to be informed about major shifts in economic policy - however arcane - that affect us. I look forward to Graeme Wheeler clarifying this.

by Ganesh Nana on February 25, 2015
Ganesh Nana

I'd much prefer a response from the Minister - after all, the Minister is our elected representative tasked with monitoring the performance of the RB given it is the Minister's signature that is on the PTA that appears now to be being  effectively ignored.  This 'contracting out' model of monetary policy only works if there is adequate monitoring and supervision of the contract by those we elected to be in charge. Remember, we never elected the RB to be in charge.

by DeepRed on February 28, 2015

I harbour suspicions that the goalposts are being moved by those who stand to lose big from a housing bubble burst.

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