The series of relative price shocks coming from successive industries falling under the ETS, the removal of the initially heavily subsidized price of carbon permits, and the likely increase in the world price of emission permits with economic recovery over time can't help but feed into both CPI shocks and expectations of CPI increases. Note that the effective purchase price of permits is currently $12.50/tonne given the government's fixed supply price and two-for-one deal; the world price is currently €15/tonne: roughly double the NZ price.
In my initial post, I worried that the RBNZ position, as characterized by Key that ETS would have no effect on inflation, meant they expected that we wouldn't see the reasonably hefty increases in permit prices post 2012 that would feed CPI expectations. Which would mean either that the permit system would be a bit of a nonsense for not effectively moving to world prices, or that RBNZ wasn't watching inflation expectations. However, as the MPS notes, they will be watching for feed through into inflation expectations; they just don't expect that to happen over the medium term. As I have a hard time telling what the RBNZ ever means by the medium term as it's nowhere defined in the Reserve Bank Act or the Policy Targets Agreement, I suppose that it's tautologically true that it won't happen over the medium term.
But Matt Nolan raises another rather important consideration:
The main thing that makes it “not just relative price shocks” is Kyoto. If we have a net liability under the Kyoto protocol this would be equivalent to a negative terms of trade shock (something I would term a negative supply shock) – so the Bank would optimally want to partially accomodate that (given their implicit quadratic loss function).Yes, if RBNZ cares about more than inflation, I can see this.
The main question has to be how an ETS impacts on inflation expectations (these would be the second round effects). The Bank must believe that the gradual nature of the ETS’s introduction, and the negative direct income effect stemming from any Kyoto liability, will be sufficient factors to prevent them having to do anything – they don’t think inflation expectations will move. If anything, the common belief that we will end up with a liability as a nation (when all the figures are finally together) implies that Bank policy should respond by EVEN LESS than it would in the face of a compensated relative price shock – as it is a negative supply shock.Unfortunately, the RBNZ series on inflation expectations doesn't go beyond end 2011.
Matt's post is good. I worry more than he does that all of this will feed into inflation expectations, but he's the one who's working with that kind of data all the time, so I ought be updating my expectations more than him.