Gareth Morgan, Director of Gareth Morgan Investments
“Inflation is dead” has been the catchcry for some time, but that did not stop most forecasters being caught out by a lower than expected inflation figure for the September 1991 quarter. It was the second time within a year that had occurred – last December’s result also surprised by not showing the oil shock-induced effects expected. These undershoots are testament to the strength of the deflation gripping the economy. The Reserve Bank has been caught out, too, this year by the sharpness of the inflation fall and sought to make amends last month by easing policy. It hasn’t been helped by its own creation, the “Housing Adjusted Price Index” (HAP!). This baby was to be a lily white inflation measure through being scrubbed clean of house prices and mortgage interest rates. Disconcerting, then, is the HAP! outcome for the latest quarter: up 1.1%, compared with the rise in the Department of Statistics’s competing measure, the Consumer Price Index, of just 0.4%.
Sad to say, HAP! is also besmirched. It, too, incorporates indirect taxes and government administered prices which play havoc with the inflation rate. And its treatment of housing costs, its supposed strength, is suspect. Rents are substituted for home ownership costs, but these must be imputed for the 74% of homes owner-occupied by measuring rents on the remaining 26% of the housing stock. That is a risk-fraught leap based on faith in the representativeness of the rentals measured. The landlords of the sample of rental homes include government departments, SOEs private firms and charitable bodies which have often set rents at sub-market levels for employees. Fringe benefit tax and tougher times have seen these rents adjusted to market levels, a process still continuing and which produces astronomically high percentage increases within the measured sample, high enough to distort the total rental measure. This factor and the inclusion of tax effects make HAP! of little practical value.
Better, we would assert, to leave housing costs out of an underlying inflation measure altogether. We estimate such a true inflation rate, excluding housing, to have been under 2% over the last twelve months. If that is so, the Reserve Bank is to be congratulated for achieving its mandated target 2 years and 3 months early. That done, it behoves it to reconsider the appropriate level for short term interest rates. In the USA the Fed is targeting cash rates at 5% coming out of a mild recession with inflation stubborn at 4%. Would there be a real danger of reignited inflation in this country if our cash rate was set at a corresponding rate relative to inflation of 3% ? Two quarters of inflation undershoot in a year suggest this literal comparison is not as outrageous as it appears.