Gareth Morgan, Director of Gareth Morgan Investments
The Reserve Bank has raised its outlook on inflation. Thank goodness for that. Their projection that it was headed for zero was running thin to put it mildly. But despite this revision the Bank's forecasts haven't inspired the Governor to ratify tighter monetary conditions. Indeed he argued that the market should relax conditions. It has not responded convincingly. Bond rates have risen, the bill rate hasn't sustained any drop, and the currency has faded. The fading currency is just as plausibly a response to worries about the current account or foreign investor concern about the ability of the Reserve Bank to deliver on its inflation pronouncements, as it is any monetary condition "easing" in response to Dr Brash.
The only thing standing in the way of a boom-bust cycle in New Zealand at present is the market wisdom that this economy threatens an unsustainable upswing, with property price inflation and household spending thriving while exporters struggle and firms generally return inadequate profits. Let that mix brew for too long and the subsequent inflation will inspire a vicious reaction from financial markets – with or without the local central bank's help. That the bond market sold off as soon as Dr Brash made his plea for easier monetary conditions, suggests Reserve Bank credibility in meeting its targets has expired.
It is curious that the Reserve Bank which only a few months ago was quite relaxed to set monetary conditions at a level which would in their own view, deliver zero inflation, is now arguing for monetary conditions that will bring inflation in significantly higher. The Bank's indifference between these inflation projections, against a backdrop of repeated failure to anticipate inflation as high as it's been, cannot enhance Reserve Bank credibility. More importantly, it threatens a sharp reaction from the Bank once it realises it once again has missed the inflation boat. Belated, sharp adjustments to monetary conditions are just the tonic for recession.
The integrity of the Reserve Bank's forecasting process is not in question. The apolitical nature of its monetary policy might be. By its own admission the credibility of monetary policy is based on past performance. Little wonder then that the financial market received with disbelief the Bank's recent arguement for an easing of monetary conditions.
The data is there for all to see. This economy is recovering – not across the board but importantly in the sectors that have driven much of the inflation over recent years. Logical then that the expectation should be that inflation will be going up again soon – say over the second half of 1997. Given the lags involved with monetary policy then a tightening of conditions now should be the policy reaction. But not so. The nature of the recovery and the damage it is wringing on some sectors – namely some, though not all exports – appears to have spooked the Reserve Bank Governor. Accordingly monetary policy is again being compromised.
Such a political reaction from the Bank- and that's all it can be described as- is quite out of order. It is not the job of the monetary authority to "save" certain sectors – and as we are seeing, attempts to do so just invites the wrath of financial markets. An appropriate response would instead be for the Bank to tighten now but to keep on urging the government to play its role by addressing the institutional and regulatory protection that is fostering inflationary pressure from those parts of the economy responsible. Putting the blame where it lies is the key. Rather than advocacy of capital gains tax on property, an attack on the regulatory sources of price inflation from all the sheltered sectors – from medical practitioners to local authority policies which drive urban property prices skyward.
The Bank has in the past cited these influences. It is time to turn up the heat on politicians who require enlightenment. Rather we appear to be witnessing a political decision from Reserve Bank Governor Brash that to do so would threaten the Reserve Bank Act itself. Patently, the incentive for the Governor to deliver on his pledge of inflation around 1½% is not strong enough. Even the precedent of seven consecutive quarters of inflation above the permitted zone has not persuaded Governor Brash to adopt a policy stance consistent with his anti-inflationary rhetoric. Taken together with a Bank Board that simply will not censure the Bank executive for policy failure, there can be little wonder that the market is choosing to ignore Reserve Bank directives. Better to trust the market's view on inflation, than that of proven failures. All very well, but a central bank which loses the market's confidence is a policy inefficiency New Zealand doesn't need.
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