RBNZ overshooting once again

New Zealand was the first central bank to introduce inflation targeting, so you would think they'd have got the hang of it by now. But no - even with Don Brash safely relegated to the Opposition benches, the Reserve Bank of New Zealand still manages to get it wrong. Today they raised the Official Cash Rate by another 25 basis points to 7.0%, the highest in the OECD (aside from Mexico). In today's statement Governor Bollard explained the rate hike thus:

...medium term inflation risks remain strong. Persistently buoyant housing activity and related consumption, higher oil prices and the risk of flow-through into inflation expectations, and a more expansionary fiscal policy are all of concern. While there has been a noticeable slowing in economic activity, and a particular weakening in the export sector, we have seen ongoing momentum in domestic demand and persistently tight capacity constraints. Hence, we remain concerned that inflation pressures are not abating sufficiently to achieve our medium term target, prompting us to raise the OCR today.

Bollard noted "the continuing strength of household spending, supported by a relentless housing market and rapid growth in mortgage lending", along with "a worsening current account deficit, now 8 per cent of GDP." For those hoping for some respite, he warned of "the prospect of further tightening" and added:

Certainly, we see no prospect of an easing in the foreseeable future if inflation is to be kept within the 1 per cent to 3 per cent target range on average over the medium term.

True, annual inflation is 3.4%, breaching the central bank's target band of 1%-3%. But the pick-up in inflation in large part reflects higher oil prices. The pace of economic growth has already slowed significantly, down from over 4% to around 2.5%, with June quarter private consumption growth the slowest in three years. Softer domestic demand will help ease medium-term inflation pressures.

The RBNZ look like they are once again going to overshoot by raising rates more aggressively than they need to - just as inflation is peaking and the economy heads into sub-trend growth. Stephen Kirchner at Institutional Economics agrees, writing that RBNZ Governor Bollard Has Lost the Plot:

Raising the official cash rate will only attract further capital inflow, already very strong, putting further upward pressure on the exchange rate and making the current account deficit even worse.  This is exactly the policy mistake the RBA made in the late 1980s, when it sought to target the current account deficit with tighter monetary policy, resulting in a recession in the early 1990s.  Both Governor Bollard and the Finance Minister have been trying to talk the NZD lower, yet monetary policy has been driving it higher.  This can only cause credibility problems for the Bank.

Comments

[Stormy]

Some random thoughts

Credit tightening to curb inflation seems like a no-win proposition these days.

“Raising the official cash rate will only attract further capital inflow, already very strong, putting further upward pressure on the exchange rate and making the current account deficit even worse.”

All that money floating around...higher interest rates will attract it like honey does flies. It seems as if we have created a monster with our economic policies. Oil is inflationary; trade polices are deflationary. All those profits and nowhere to go; they are certainly not going into investment. And they certainly are not being used to raise the general standard of living…anywhere, except for CEO’s and the financial community. The banking system is running out of silver bullets.

Watch the fire sales this holiday season. Retailers are being advised to start the season early, because as winter hits…keeping warm will be a priority. Get the money now.

China and the third world have learned to play the great game of monopoly…or so they seem to think: Use tax breaks and cheap labor to leapfrog into industrialization and waive environmental regulations.

Western companies and governments leapt at the Chinese bait. Foolishly, Western governments cut both taxes and interest rates in the hopes of spurring growth at home. What they got is not what they expected, although they should have known better. They simply turned their societies into consuming machines. Tax breaks and lower interest rates in the West did not spur investment and new technologies. Yes, goods became cheaper…compare the prices of computers in the late 1990’s with those now. (Although now these prices are slowly rising again: inflationary oil is winning the battle with deflationary cheap labor.)

What did the West do while this economic boom reverberated through round the world? Did it build a 21st century infrastructure? Did it invest in those technologies that would guarantee safe passage through peak oil and global warming? No. Instead it fashioned every credit instrument conceivable to keep the party going. And this extended line of credit will be its undoing. Deflation and extended credit—what a heady cocktail for any economic party.

And what will China’s reward be in all this? A new 21st powerhouse by 2050? Think again. It came to the party too late. It cannot ride on the coattails of the U.S. and the western consumer. There is not enough credit or oil left; the Western consumer will be tapped out. Take away his safety net and raise the price of energy and everything, everything will go into simply staying alive. Very shortly, China will not be able to use the West as one giant ATM machine.

And what will China be holding when all this is done? Industrial pollution as far as the eye can see—even now from outer space Chinese pollution is a giant brown blur over the that part of the world. China is trying to pass through the industrial age when it should have simply by-passed it.