ECONOMICS: Putting Inflation in Perspective

Article excerpt

Byline: Bob Edlin

Reserve Bank governor Alan Bollard dismayed some commentators early in June by signalling an easing of interest rates. At, for example, managing editor Bernard Hickey wailed about the guv going "soft on inflation" and said "it's time to question Bollard's inflation-fighting credibility". His reasoning: consumer price inflation has either been above, or is projected to be above, the upper limit of the bank's target band for periods totalling almost four years between 2002 and 2011.

Hickey questioned whether Bollard could credibly say he may cut the official cash rate "just as consumer price inflation is hitting an 18 year high?" In the June Monetary Policy Statement, after all, he was forecasting a sharp slowing of the economy, with little GDP growth over 2008, "but with a spike in consumer price inflation to 4.7 percent in the September quarter". Moreover, Bollard was forecasting annual consumer price inflation remaining above the one-to-three percent target band until the June quarter 2010.

But -- among other threats to that outlook -- he was assuming oil prices would drop back below US$100 a barrel. Hence inflation could finish up higher than forecast, yet Bollard was talking about a rate cut later this year.

Hickey examined the RBNZ's forecasting record in recent years, the link between interest rates and the housing boom, and the level of non-tradeables inflation. The latter had never been below three percent during the governor's term, "yet he is forecasting a fall from 3.9 percent to 2.5 percent between December of this year and September of next year. This is worthy of scepticism."

Hickey also took issue with the policy targets agreement signed by Bollard and Finance Minister Michael Cullen in Sept ember 2002 (it was "a significant weakening" from the 1999 agreement between Cullen and previous RB governor Don Brash). And he fretted about inflationary expectations being fuelled by the central bank's failure to make people believe it is serious about keeping inflation within the target band.

Westpac chief economist Brendan O'Donovan was similarly disappointed by the governor's easier stance. Sure, the RBNZ had slashed its forecasts for economic growth. But "inflation is higher throughout the forecast horizona" When the central bank itself was forecasting inflation would average 3.4 percent over the next three years, "why should businesses and consumers take the midpoint of the inflation target as any kind of guide to what inflation is likely to be in the years ahead? …