Jawboning

While folks in the US worry that there might not be enough inflation, the RBNZ here has started jawboning against letting inflation expectations get too high.



We have a GST increase coming through in October combined with the Emissions Trading Scheme starting to affect prices.

The Agreement defines the Bank’s price stability target in terms of the Consumers Price Index. However, it also instructs us to focus on the medium-term trend in inflation, and lists changes in indirect taxes and significant government policy that directly affect prices as specific reasons why inflation might vary around its medium-term trend.

As such, monetary policy will not attempt to offset the immediate direct inflation impact of the coming policy changes.

Given the staggered nature of the indirect tax increases and the progressive introduction of various sectors to the Emissions Trading Scheme, there is an additional risk that the coming spike in inflation causes consumers and businesses to reassess their expectation of medium-term inflation.

The degree to which monetary policy can “look through” temporary inflation spikes depends crucially on the extent to which New Zealander’s inflation expectations are impacted by such spikes. [emphasis added] Of late, inflation expectations have risen from the lows seen at the trough of the recession but they remain contained. Two-year-ahead inflation expectations initially lifted late last year, when there was some talk of the housing market gaining significant momentum again and the economy had clearly moved out of recession.

Subsequent to that we saw excise taxes rise, the ETS-related charges become more definite and the announced rise in GST. All of these are likely to have played some part in inflation expectations staying up, even as the housing market has eased off and the pace of the recovery has remained moderate.

However, the Reserve Bank does not expect the forthcoming price spike to have a lasting impact on inflation expectations. (In support of this, the just-released AON survey shows that longer-term inflation expectations have not moved as a result of the impending GST increase.)

...
But there are also examples of persistent price increases in sectors that have not suffered persistent cost increases, and these have an inflationary effect. The diagram shows the impact of excise tax increases on alcohol and tobacco industries, and that the energy and local authority sectors have recorded persistently high price pressures.

Given the fragility of the recovery it is important that firms base their pricing decisions on low underlying inflation, and not the forthcoming temporary spike.

Monetary policy would need to respond if inflation expectations and prices were ratcheted up significantly. The result would be higher interest rates and a dampening of the economic recovery. We are hopeful this will not need to be the case, so that monetary policy can play as full a part as possible in supporting economic growth. [emphasis added]

I've also worried that the staggered introduction of the ETS may cause revised expectations. So it's reassuring to see that RBNZ is keeping an eye on things.

I did like this line:

Inflation has been well contained recently, with consumer prices increasing 1.8 percent in the 12 months to the June quarter this year. This marks five consecutive quarters where annual consumer price inflation has been at or close to the mid-point of the Reserve Bank’s 1 to 3 percent inflation target.

Dry wit?