Kiwiblog

This is the alternative. They honestly seem to believe that you can enrich a country by just printing more money. I thought this lunacy died out with Social Credit.

The only Western countries doing QE are those which have the official cash rate near zero and have run out of other options. No sensible country is advocating printing money in the circumstances NZ is in.

There is a difference between a last resort and a preferred option. As an analogy if someone is dying from blood loss through a severed limb then a tourniquet is your last resort to stop them dying. But if they have just cut their leg open a bit, you don’t apply a tourniquet as your first response because the impact of doing so is very nasty.

In monetary terms, the nasty impact is prices go up and up.

You can see the Twitter debate here.

Be scared, be very scared. Most Green policies will just be inefficient and waste money but not necessarily be hugely harmful. This one is different.

Brian Fallow writes in the NZ Herald:

Listening to a procession of manufacturers say their piece to the parliamentary inquiry into manufacturing this week, two things were clear.

One is that the high dollar is causing real and lasting damage to their sector.

The other is that the idea that an overvalued exchange rate is the fault of the monetary policy framework has hardened into dogma.

Cast off outdated neoliberal doctrine. Change the Reserve Bank’s mandate. Then New Zealand manufacturers will have a fighting chance. That was the message.

It echoes statements like this from Labour leader David Shearer last Sunday: “We’ll make changes to monetary policy so that our job-creating businesses aren’t undermined by our exchange rate.”

It is glib. It glosses over difficult questions about what changes they have in mind, and what the costs, risks, trade-offs and spillover effects would be

All correct.

And it misdiagnoses the problem, which is that the rather enfeebled state of much of the other 99.8 per cent of the world economy has led to policies abroad which are unhelpful from New Zealand’s point of view and which we can only hope succeed.

This is in fact the major point.  The US and Europe are poked (for now) and their dollars are weaker. Politicians preaching how we can rectify this are dreaming. If we want proof that this is about the weakness of the US$ and the Euro, not a strong NZ$ – look at this graph from ANZ:

As you can see we are in fact historically quite low against the Australian dollar.

If the object of the exercise is to ensure that in the future the Reserve Bank runs monetary policy looser than it otherwise would, consider this: higher inflation would lower real wages, and real incomes more broadly, in the hope of protecting jobs in the favoured sector. Should the union movement support that?

Lower interest rates would increase the risk of a housing bubble that, this time, bursts messily all over us. Ask the Irish tradesmen flocking to Christchurch how much fun that is.

If it succeeds in making New Zealand exports cheaper to foreign buyers – a pretty big if – it will also make New Zealand assets cheaper to foreign buyers. That should give economic nationalists in New Zealand First and the Greens pause.

So nice to have someone print this out.

Stats NZ have published the latest CPI and inflation remains at 0.9%. The graph above shows what inflation has been since WWII. It is due to inflation that we are no longer competitive as an exporter unless the dollar is lower.

And inflation since 1990, showing the tail end of the 4th Labour Government, and those since.

Inflation over each three year term has been:

• 1991 – 1993 3.7%
• 1994 – 1996 8.5%
• 1997 – 1999 1.7%
• 2000 – 2002 8.7%
• 2003 – 2005 7.6%
• 2006 – 2008 9.5%
• 2009 – 2011 8.0% (includes GST increase)
• 2012 0.9% (for one year)

Printing money to fuel inflation is like a sugar fix. It gives you a temporary rush, but makes you sicker in the long term.

Stuff reported:

Food prices fell for a fourth month straight in December, led by a drop in non-alcoholic beverages which offset higher meat, poultry and fish prices.

The Food Price Index fell 0.2 per cent in the month, according to Statistics New Zealand following a 0.8 per cent decline in November. The current level of 1243 marks the lowest point on the index in almost two years.

I’ve calculated annual food price inflation since the series began in 1960, below.

So in one year, food prices increased 25%. I guess there was lots of money being printed that year.

If we look at post 1990 only:

So three big spikes post 1990. One was in 2001, another in 2008 and the third in 2011. The latter one being impacted by the GST increase.

If you look at food inflation over each three year approx electoral term, the cumulative annual increases were:

• 1991 – 1993: -0.1% (go Ruth)
• 1994 – 1996: 4.3%
• 1997 – 1999: 4.2%
• 2000 – 2002: 11.1%
• 2003 – 2005: 2.7%
• 2006 – 2008: 18.4%
• 2009 – 2011: 6.6%

Annual food inflation in 2012 is -0.9% so far. Useful to recall this when you see stories about the rising cost of food!

Stuff reports:

Kiwis who did it tough in 2012 will find no comfort over the next year as financial anxiety rises with the climbing cost of living.

A survey by The Dominion Post paints a gloomy picture for many households: two-thirds of respondents said the cost of living is becoming too high.

And that bleakly held view is backed by various experts, who confirm that prices are likely to climb further over the next 12 months.

The survey polled more than 600 readers and found rates, petrol, food and house prices all among the most pressing financial woes. Taxes, medical and dental expenses, and the exchange rate were also prime concerns.

A reader survey, while interesting, is not a scientific random poll. And nowhere in the article do they mention what the actual inflation rate is, or that interest rates are at a record low. Here’s what Stats NZ found:

• Annual inflation at 0.8%, the lowest it has been since 1999.
• Food is 0.9% cheaper than a year ago
• Clothing and footwear is 1.0% cheaper

I’m also fascinated by the fact the exchange rate was listed as a worry for prices, as the higher the exchange rate, the cheaper most things cost (a high rate is bad for exporters but good for consumers generally).

If you are going to do a story based on perceptions, it would be good to actually include some facts in the story – even ones that don’t agree with the perceptions.

The Herald reports:

Tradable inflation, which covers items open to foreign competition, was unchanged in the quarter, due to falling prices for second-hand cars, petrol and dairy products. On an annual basis, tradable inflation shrank 1.2 per cent.

Non-tradable inflation rose 0.5 per cent in the quarter at an annual pace of 2.3 per cent, mainly due to higher local authority rates.

Rates can not keep increasing as an unsustainable rate.

Transport prices fell 1.1 per cent in the quarter, with the price of petrol down 1 per cent, second-hand car prices down 2.8 per cent and domestic air fares falling 7.8 per cent. Fresh milk prices fell 3.8 per cent in the quarter, while telecommunication services prices declined 1.8 per cent.

Food prices rose 1.1 per cent in the September quarter, led by more expensive produce, while grocery food prices fell 1.6 per cent.

Dwelling insurance prices surged 17 per cent in the quarter, and are up 43 per cent on an annual basis as insurers pass on rising reinsurance costs in the wake of a series of earthquakes that levelled Christchurch, the country’s second-biggest city.

Yeah my building insurance costs have doubled, and our building is well above code.

What I find most interesting is the household energy costs. Do you recall earlier this year stories proclaiming massive increases in electricity prices, and the like. I was somewhat critical of those stories as they never gave any hard data as to what the actual increases were.

Well for the quarter, household energy costs increased a mere 0.3%. For the year a 3.9% increase. This compares to annual near 8% increases from 2002 to 2008.

Marc Krieger of Krieger Capital blogs:

In any event, quantitative easing ultimately benefits the rich. For example, the Bank of England commissioned a study in which it said that 40% of the gains of its quantitative easing programme went to the top 5% of British households. The reason is simple. The rich own shares, property, and precious metals, whose values rise or remain constant when the central banks flood the world with money conjured out of thin air. Conversely, working people and savers rarely own financial assets whilst simultaneously having their real wages drop during an inflationary period. Dr Norman’s tacit support of even lower interest rates penalises retirees who depend on interest income to live. In essence, Dr Norman wants the Reserve Bank to continue the very imbalances that helped produce the Global Financial Crisis by punishing those prudent enough to save and rewarding the spendthrifts.

So this is what the pro-inflation policies of the left will bring – gains for the top 5% and losses for poorer working people. Are these not the same people who go on about income inequality?

Former Reserve Bank Chief Economist David Mayes writes in the Herald:

Printing money is usually a last resort that seriously troubled countries use to stave off collapse, and not some mysterious trick that other nations have conjured up to achieve quick riches.

I never though a so called serious political party would advocate it, since Social Credit were killed off.

New Zealand has definitely not run out of opportunities to use conventional monetary and fiscal policy if it feels the economy faces a lack of demand. So why move to the unconventional now?

Quantitative easing is used when short-run nominal interest rates have been lowered to zero and it is still necessary to expand the economy.

And our cash rate is 2.5%

Quantitative easing is used when short-run nominal interest rates have been lowered to zero and it is still necessary to expand the economy. If the central bank then buys longer dated bonds or other financial securities (including commercial paper or mortgages from the private sector), it may continue stimulating the economy.

Evidence from a symposium being published by The Economic Journal suggests that this is achieving a little in the United Kingdom, the United States and the Euro area.

The problem is that it only works well if people fear major inflation and rush out to buy before prices rise. Once growth re-establishes again, the central bank sells all assets and mops up the extra money before inflation gets out of hand. That of course explains why it doesn’t really work. If inflation is going to be headed off, then why buy now? Hence the weak effect.

Thus quantitative easing needs to be on a massive scale if it is to work.

And this is what worries me. The Greens proposed printing $8 billion of money to stimulate the economy. Now what would they and Labour do, if that doesn’t work? Would they say it was a silly idea, or would they say the problem is they did not print enough money? They’ll then be printing another $10b, another $20b etc.

The Greens claim their printing money proposal (which Labour supports, so long as the RB decides to do it, not the Govt) is to benefit exporters.

Well the group that represents more exporters in NZ than any other, Federated Farmers, have said they think the proposal is lunacy.

3 News reports:

The country’s biggest export sector is strongly opposed to the Green Party’s suggestion that the Government should print money to bring down the value of the dollar.

The agricultural sector sells most of its products overseas and Federated Farmers says printing money, known as quantitative easing, would be “incredibly bad” for New Zealand. …

The Government has rejected the idea and Federated Farmers president Bruce Wills says it would “set off an inflationary bomb that risks returning New Zealand to the dark days of double-digit interest rates”.

Mr Wills says quantitative easing should be a “break glass in case of fire” policy option.

“New Zealand is nowhere near such desperate measures because our official cash rate is 2.5 percent versus 0.5 percent in the United Kingdom, 0.25 percent in the United States and 0.10 percent in Japan.”

This is what is so bizarre about the Greens policy. Those countries which are doing QE are not doing it because they want to. They are doing it as a last resort as they can not lower their cash rate any lower.

The Greens would have New Zealand as pretty much the only developed country in the world to print money and cause inflation, as a preference rather than a last resort.

The Dom Post editorial:

New Zealand should have learned from bitter experience that it cannot shield itself from the vagaries of the international market. Labour and National tried that in the 1970s and early 1980s and ran up debts that took a generation to repay.

New Zealand is a small trading nation a long way from its markets. The only way for it to survive and prosper is to be flexible, adaptable and resilient. If the balance of economic power in the world is shifting, there is no use pretending it is not.

The decline in the value of the US dollar and the euro is a reflection of the decline in the relative worth of the American and European economies.

The attempts by American and some European policy-makers to reboot their economies by printing money are acts of political desperation.

It makes no sense for a country which has weathered the global financial crisis better than most of its Western counterparts to emulate their risky tactics. Printing money – or quantitative easing as it is technically known – fuels inflation, devalues assets and reduces purchasing power. Once started it is difficult to stop, as Germans discovered in the 1920s when wheelbarrows replaced wallets as the most efficient means of carting cash.

The Greens plan will see shares in Mitre 10 and Xerox increase!

It is interesting that Labour has not ruled out printing money also – just that they don’t want their fingerprints on it. The summary is:

• Greens will force the Reserve Bank to print more money, driving up prices for all NZers
• Labour will amend the RBA, to encourage the Reserve Bank to print more money, driving up prices for all NZers

Also a great comment by Alex Tarrant on Twitter:

BREAKING: Fuji Xerox approaches Green Party in early bid for printer procurement contract…

Heh. Also Victoria tweeted:

Brb, just getting a wheelbarrow to carry my notes to buy a loaf of bread!

Matt Nolan at TVHE blogs a very useful analysis of what the Greens have proposed (and Labour are semi-supporting):

 Russel Norman is completely misrepresenting QE by saying that the recent crisis is “evidence it isn’t inflationary”.  QE was put in place to fight the fact that policy was too tight overseas, and they were trying to fight deflation – in essence the fact that inflation stayed near the “target band” in these countries is evidence that QE is indeed inflationary as you would expect … just in the way they were intending.

Exactly. QE can be considered if you face deflation, and your official cash rate is as low as it can go. We are within our target band at 1% (which is what I think we should be aiming for) and the cash rate is 2.5%.

Remember how often Greens and Labour complain about increased costs such as electricity and food? Well this is a policy to increase their costs even more for families finding it hards to make ends meet.

Now you may believe we should fund the rebuild with a one-off tax – that’s fine, in that case get the government to put a tax in place directly (or to directly cut spending from other place).  However, taxation by stealth of this sort is likely to be worse in multiple ways:

1. We have betrayed RBNZ independence for virtually no reason … understandably a sneak tax by the RBNZ would make people less likely to believe them in the future about holding to their inflation mandate.  As a result, we run into the time-consistency issue in monetary policy again, and it will become more painful for economy when the RBNZ tries to commit to its inflation mandate again.
2. We have a relatively rough redistribution of resources due to this.  By putting in our sneak tax through QE, we transfer resources to those with assets, those doing the rebuild, and those who can easily adjust prices/wages – while hurting those on fixed income, and those who have saved.  It is an inflation tax – pure and simple – and as a result, it will initially transfer resources from those who can’t protect themselves (generally the poor) to those who can (generally the rich).  If we introduce the tax through fiscal policy instead we can sort out these distributional issues a little better.
3. A country that is willing to introduce QE as a clear fiscal transfer – when there is no monetary policy reason – will destroy its credibility with international lenders.  People will scoff at this, but such a policy will increase the level of “inflation insurance” lenders ask for – increasing the cost of credit in New Zealand.

That is a very good way to put it – the Greens have proposed an inflation tax – one that will hit fixed income households the hardest!

The Greens, and Ganesh Nana, are wrong in stating that the RBNZ has failed.  Distinctly and totally wrong.  Things like this:

”No system of monetary policy is perfect and New Zealand cannot remain the last devotee to a failed monetary theory while the rest of the world moves on,” Norman said.

Paint a complete and utter misrepresentation about the lessons from the Global Financial Crisis.  Our flexible inflation targeting framework saved us from a massive crisis at home – while the rest of the world fell apart.

Matt’s conclusions:

1. We don’t need QE in NZ, as we have enough monetary stimulus (and if not we can cut interest rates further).
2. What is being suggested isn’t even QE – its the monetization of government debt, effectively a inflation tax to pay for the rebuild in Canterbury.
3. It is unlikely that such a tax is the “best” way of raising the revenue to rebuild Christchurch – which should be the primary question.

Say no to the Green’s inflation tax.

Oh you must watch the video also, H/T Whale.

John Clarke as hilarious as always. He is also factually correct in this case.

I thought this madness died with Social Credit, but Greens (and Labour may not be far behind) have said that they want the NZ Reserve Bank to effectively start printing money. They think that NZ printing more money is a good way to increase the relative value of the US dollar. We might as well start burning our savings.

Make no mistake, what they are calling for is the value of everyone’s savings to be reduce, as inflation takes off. You know all how they say wages are too low for low income workers? Well they want the cost of food, goods and services like electricity to increase faster than they have been.

There are basically two sorts of countries that print money. Those that are bankrupt, and those whose economies are so stalled that the central bank cash rate is as low as it can go.  In the US it is 0.25%. NZ is at 2.5% so a fair way away from that.

Russel Norman claimed:

Secondly, when you look overseas at the use of quantitative easing – because all of our major— most of our major trading partners are using it

This is simply wrong. The US and the the Eurozone and Japan have done it (and sort of the UK)  - again because they are almost bankrupt or their central rate can not be lowered anymore. But they are not our major trading partners.

Our exports for the year to June 2012 came to $46.7b. Exports to the Eurozone were $2.9b, UK $1.4b, Japan $3.4b and US $4.1b. That is a mere $11.8b out of $46.7b – under one quarter. Australia is almost a bigger export market than those four combined.

And let me tell you if we started printing money, and Australia was not, watch the outpour to Australia get far far worse.

Some policies put forward are just silly, or ineffective, or wasteful. Some are very very bad and dangerous. This is one of them. The idea of printing money to grow the economy has never worked long-term. It gives you a short-term sugar rush at best. It puts up the price of pretty much all goods and services as inflation grows.

It is actually to our advantage long-term that the US and Eurozone are printing money. Proposing to follow them voluntarily is the worst thing NZ could do.

The latest inflation figures show up for me how silly Labour’s election policies were. Do you remember how they campaigned on removing GST off fruit and vegetables, because people can’t afford them?

Well in the last year the average cost of fruit and vegetables has dropped 6.6%.

Overall food prices have increased just 0.6% in the last year. That is good for especially low income families, as food makes up a larger proportion of their budget.

Clothing costs increased only 0.1% over 12 months also.

Also do you recall all the stories about massive increases in electricity prices? Well over 12 months the average cost is up 1.8% only.

Inflation overall for the year was 1.6%. Still a bit higher than I would like it. I believe 1% is the appropriate level to aim for (mid-point of 0% to 2% range) but the Reserve Bank will be happy with 1.6% and interest rates should remain low for a while yet.

The day after Phil Goff announces he is campaigning on the cost of living, Stats NZ announces the lowest annual inflation rate since March 2004.

Bill English has done this handy table comparing the last two years, to the previous two years. National needs to do more stuff like this:

Price and wage changes over comparable periods

Incredible that food prices went up 15% over the last two years of Labour’s term. Now this is not their fault, but it shows how meaningless their no GST policy on fruit and veges is – the price movements from season to season are far greater than the GST. For example vegetables went up 21% in Labour’s last two years and have dropped 6% since Sep 2008.

And most damning, a NZer on the average wage had a 1% drop in their real after tax wages from Dec 2006 to Sep 2008, while under the most recent seven quarters that worker would be 9% better off. And that is before the 1 October tax changes which will make then even better than 9%.

Just been looking at an old press release from Bill English. It compares the nine years from Sep 90 to Sep 99, the same period from Sep 99 to Sep 08 and the 21 months since then to June 10.

The average weekly earnings went up 27% in the 90s, 37% under Labour and 7% since Sep 00. The average increase per year is 3.0%, 4.1% and 4.0%.

But if you take account of tax paid, to look at what someone on the average earnings/wage gets to take home, then the increases are 33%, 33% and 11% – or annualized it is 3.7%, 3.7% and 6.3%.

Finally thought you want to look at the purchasing power – has someone earning at the average (mean) had their purchasing power increase during each of those periods, and by how much. Now inflation during each period was 16%, 29% and 2% Annualised this is 1.7%, 3.2% and 1.2%. This is worth remembering when Labour talks about cost of living.

So what was the increase in real after tax average earnings. They were 15.5% from Sep 90 to Sep 99, 3.0% from Sep 99 to Sep 08 and since Sep 08 8.7%. On an annualized basis, real wages went up 1.7% a year under National, then only 0.3% a year up until Sep 08, and a massive 5.0% a year since Sep 08.

This table above shows the difference. I’ll update it after we get the Dec 10 figures which will include the latest tax cuts, but also the GST impact.

The moral of the story is wage growth by itself is not enough. You also need low inflation and tax cuts to offset fiscal drag.

Bill English’s office has put out a comparison of real (CPI adjusted) net (after tax) wage growth for a full-time worker on the average (mean) wage.

The Australian data only goes back to 1994, so the first time period compared is Sep 1994 to Sep 1999 – the final quarter before Labour took office.

During those five years the real net income for a FT worker on the average wage rose 13.2% in New Zealand and 6.2% in Australia.

Then over the next nine years from September 1999 to September 2008, the increase in New Zealand was 3.0% and in Australia it was 19.3%. Yep six times greater in Australia. They had high wages, low inflation and tax cuts. We had no tax cuts, higher inflation and lower wage increases.

From Since September 2008, to June 2010, the increase in New Zealand has been 8.7% vs 4.8% in Australia.

If one translates this to average annual increases, then the comparison would be:

• Sep 94 – Sep 99 – 2.6% NZ vs 1.2% Aust
• Sep 99 – Sep 08 – 0.3% NZ vs 2.1% Aust
• Sep 08 – Jun 10 – 5.0% NZ vs 2.7% Aust

Now the time periods used are slightly cheery picked, in that the latest period includes both the April 2009 tax cuts and the October 2008 tax cuts – so they do not correspond exactly to Government terms. But on the other hand Labour did the Oct 2008 tax cuts most grudgingly, because of the election, and probably would ave cancelled them if they had retained office.

The stat that stands out to me is that during those nine years from Sep 99 to Sep 08, the average after tax income only grew 0.3% a year. Fiscal drag mean someone on the average wage paid more and more tax as their salary increased.

Vernon Small critically looks at Labour’s claims on inflation:

Labour’s Phil Goff and his inner circle had settled on attacking over the forecast spike in inflation, figuring there was a ready market for suggestions the tax cuts would be swallowed by rising prices.

But the case Labour has tried to make risks backfiring, because frankly, the evidence looks a bit fishy.

I had planned to write along these lines, but glad Vernon has done it for me.

The Treasury forecasts that inflation will surge to 5.9 per cent next year before falling back and staying at 2.4 per cent for three years; well within the Reserve Bank’s 1 per cent to 3 per cent band. It also notes that “underlying” inflation would remain relatively subdued and have a limited impact on interest rates

Next year’s spike includes 2 per cent from the rise in GST, which is compensated for by tax cuts and increases in superannuation, benefits and support for others on state-supported incomes.

More than compensated for.

It also includes a contribution of 0.5 per cent from the rise in tobacco excise (that Labour enthusiastically supported in Parliament)

Which will only affect smokers, and for those whom quit smoking will save them money.

and another 0.4 per cent from the fuel and power prices associated with the Emissions Trading Scheme, which Labour would implement with bells on, pushing inflation much higher. (In any case, the inflationary impact of the ETS was already included in the December half-yearly update.)

Now this is crucial. Quite a few people are unhappy at the impact of the modified ETS scheme, which adds 0.4% on 1 July to overall costs through higher petrol and power charges, but what Labour have not mentioned is their unmodified ETS would add 0.8% to inflation. They had passed a law which would have doubled the price increase due to the ETS.

Take those and the impact of GST away, and underlying inflation next year would be about 3 per cent, close to the top of the Reserve Bank’s 1 to 3 per cent band, but not so unusual.

The other thing Labour has not mentioned is they have constantly called for more government spending. This would mean a higher deficit and more borrowing, which would be inflationary. So their crocodile tears over inflation are less than convincing – their stated policy is to spend more, and to have an ETS which doubles the impact on power and fuel prices at 1 July.

On the other side of the ledger, as the economy improves, the Treasury expects wages to increase by 2.6 per cent next year (the year Labour chooses, because of the unflattering comparison with the 5.9 per cent inflation spike) and then rise by 3.5 per cent, 3.7 per cent and 3.9 per cent in subsequent years, while inflation is tipped to stay at 2.4 per cent.

These are just forecasts, and should be taken with the usual shaker of salt. But if you take one year into account you should be prepared to take them all.

On that basis, wages could well outstrip inflation in the next four years, and beat underlying inflation by even more.

As is generally the case.

Does Labour really want to argue that, as well as compensating for any GST rise, the Government should offset all the effects of inflation? That was above 3 per cent in 2001, 2006 and 2008 – when Labour was in power – and there was no similar call then.

Personally I would be delighted if Labour adopted a policy of giving people tax cuts every year to compensate for inflation. But somehow I don’t think they intend to.

Labour are campaigning against the GST increase (yet being careful not to promise to reverse it), saying it will hit households hard. Well Stats NZ have calculated that the impact of GST going to 15% will be a one off increase of 2.0% in the CPI.

Now let’s see how that compares to the CPI increases under the last two Government’s.

In December 1990 the CPI was 731 and in December 1999 it hit 837. That was an increase of 14.5% over nine years – an average of 1.5% a year,

From December 1999 to December 2008 the CPI went from 837 to 1072 – an increase of 28.1%, and an average of 2.8% a year.

The difference between inflation under Labour and under National is around 14% – or seven times greater than the one off 2% increase caused by a GST increase.

Now if one takes just food prices, it is even worse. The food price index increased only 9.9% under nine years of National. Under nine years of Labour it shot up a massive 37.1%.

So if you hear a Labour MP talking about the impact increased prices will have on families, remind them of the 37% increase in food prices and the 28% increase in all prices that occurred under Labour.

The Dom Post has a guest column by Stephen Kirchner from the CIS:

The idea that New Zealand can ignore inflation and grow faster through easy money and a lower exchange rate is a tempting, but short-sighted view. It ignores the fact that higher domestic prices would ultimately undermine rather than promote international competitiveness. Economic growth and export success must ultimately be built on real factors such as productivity growth, not easy money and exchange rate depreciation.

It is like cheating on an exam – only works for a while

The Reserve Bank’s primary focus on inflation recognises that monetary policy needs to be based on a single instrument and policy objective. Pursuing multiple objectives with multiple instruments, as Labour now suggests, is a recipe for incoherent policy and poor economic performance such as New Zealand experienced before its path-breaking reforms of the 1980s.

TVNZ is a good example of having multiple conflicting objectives. Either none of the objectives are achieved particularly well, or some of them are just ignored.

It would also undermine the transparency and accountability that were important objectives of the Reserve Bank of New Zealand Act. Under the current framework, the governor of the Reserve Bank is personally accountable for realising the inflation target under a policy targets agreement with the finance minister. Sustained breaches of the inflation target can result in the non-executive members of the Reserve Bank board recommending dismissal of the governor to the minister. This is no idle threat, but it would be difficult, if not impossible, to hold the governor accountable for achieving multiple objectives instead of a clearly defined inflation target.

An excellent point. More objectives will mean less accountability. The Governor will always have a get out of jail card.

Since the first PTA was entered into in 1990, the inflation target has been progressively watered down. Most notably, the inflation target has been relaxed from 0-2 per cent to 1-3 per cent and given a medium-term focus, so there is now greater tolerance of short-term breaches.

I actually believe it should go back to a 0% to 2% range. Over time even 3% inflation is too much.

Roger Kerr writes:

A gains tax on housing would not reduce inflation. Inflation is an ongoing increase in the general level of prices, not a one-off change in some prices.

The introduction of the Goods and Services tax resulted in a one-off increase in the consumer price index – it did not lead to ongoing inflation.

Similarly, a capital gains tax might reduce property prices initially but it would not affect longer-term inflation.

True, and any increase in GST would be a one off bump.

Moreover, if such a tax on housing were applied only to realised gains as is likely, house prices could even rise. This is because of the lock-in effect, with owners holding on to homes to defer the tax on gains. Anything that reduces supply is likely to lead to an increase, not a decrease, in price.

One could do it on unrealised gains, but that would be pretty draconian.

Evidence confirms what theory suggests: the inflation performance of countries with a capital gains tax doesn’t differ systematically from countries that don’t.

Australia, the US and Britain, which tax capital gains, have all had large and volatile house price movements this decade.

I always like a look at empirical evidence.

A second mistaken assumption is that investment in rental housing enjoys tax privileges.

As the deputy commissioner of Inland Revenue, Robin Oliver, told a select committee in 2007: “Rules about expenses for deducting costs such as interest, upkeep and maintenance, as well as paying tax on income, are the same for investments in shares or anything else. In fact under the housing case … there are tighter rules regarding what is a capital gain.”

People are misled into thinking that rental housing is tax-preferred since highly geared rental property may record tax losses. This is because the full economic income (including the change in the market value of the assets) earned on rental property is not taxed.

However, this is a quite general feature of the taxation of real assets, including plant and equipment and farms.

A real issue though is whether it is sensible to allow property owners to claim 3% depreciation on their property annually, when the empirical evidence is that almost no residential property depreciates in value – in fact it appreciates.

Paul Walker has blogged Zimbabwe’s new annual inflation rate.

It is 10.2 quadrillion precent. That is 10.2 million billion or 10,200,000,000,000,000%.

That makes me feel better about NZ hitting 5.1%. But only slightly.

The Reserve Bank has dropped the Official Cash Rate by 100 basis points, as many had predicted.

This is the biggest ever single movement – previous moves had been as high as 50 basis points but never a 75 or a 100 before.

The Governor says:

“With weaker short-term growth and sharply lower oil prices we now expect that annual CPI inflation will return to the target band of 1 to 3 percent around the middle of 2009. However, we still have concerns that domestically generated inflation (particularly in labour costs, local body rates, electricity prices and construction costs) is remaining stubbornly high.

The domestic inflation is what causes the risk of stagflation.

“Consistent with the Policy Targets Agreement, the Bank’s focus will remain on medium-term inflation. Should the outlook for inflation evolve as projected we would expect to lower the OCR further. However, the timing and extent of OCR reductions over the coming months will depend on evidence of actual reductions in domestic cost pressures as well as how the global financial developments play out.”

I can think of some domestic costs that could be reduced!

Labour is making a habit of leaving office with economic problems for the new Government.

Stats NZ reveals that inflation for the year to September 2008 was 5.1% – its highest level since June 1990. Major contributors:

• Household Energy 7.5%
• Hospital Services 7.1%
• Private Transport 21.5%
• primary and secondary eduction 5.7%

The monthly food price index also came out today – and it is also at an 18 year high of 10.8%. Major contributors:

• Vegetables 22.3%
• Mutton/Lamb 17.3%
• Bread 16.5%
• Pasta 18.2%
• Cheese 42.3%

All fairly common items, to say the least.

The Reserve Bank has dropped the cash rate a full 50 basis points from 8.00% to 7.50%.

Reserve Bank Governor Alan Bollard said: “The New Zealand economy is experiencing a marked slowdown, led primarily by the household sector. The outlook for the global economy has deteriorated further in the wake of continued financial market turmoil. In addition, the New Zealand business sector is coming under pressure from both rising costs and falling demand. While domestic activity is likely to pick up late this year as a result of personal tax cuts, increased government spending and rising rural incomes, we expect a prolonged period of household sector adjustment and below-average growth.

I almost feel sorry for Bill English, if he becomes Minister of Finance in a few weeks.

I also remain concerned that inflation will remain too high for years to come.

Matt Nolan at TVHE has some nasty grpahs of inflation expectations. This convinces me the Reserve Bank lowered rates too soon.