Thursday 19 August 2010


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?


  1. What I cant follow is how much inflation is actually deflation. Given wages are pretty much static when my rates go up yet again I have less money to spray around, when my ACC levies go up same result.
    It annoys me immeasurably that my interest rates have to go up because I have less money to spend because of increased costs that I have no hope of passing on.
    Why wont Bollard take into account the deflationary impact of regulatory increases in prices rather than given us a double whammy.

  2. Rates going up is more a change in relative prices than inflation per se - things provided by local councils have become more expensive as compared to other things. This may be due to something like Baumol's cost disease (less productivity increase in the service sector, but they still have to compete for workers, so cost relative to productivity goes up when coupled with monopoly provision).

    That said, the MPS note did specifically point at local body rates as something that has been out of whack. Of course, don't expect Auckland's to drop anytime soon...they've an amalgamation to pay for. And Christchurch gets to choose between two bad options. And Dunedin has a stadium to pay for....

  3. Hi Eric,

    I'm with David on this one.

    On the production side, Manufacturing sales are falling, down 7% form last year (table 1, next link). Labour returns from manufacturing, salaries and Wages, are falling, with large decreases in the capital equipment producing industries (table 19: Service industries look to be fairing a bit better from the GDP figures.

    Partial pictures on business profit, like Balance of Payments, balance on investment income, are half of last years values (Table 8, and perspectives on investment activity, like from the Overseas Trade by Broad Economic Group ( at the lowest values in 4 years.

    With retail trade in the large manufacturing areas of Wlg & Chch declining, while Auckland and agriculture areas like Waikato are significantly up (table 11,, on top of other measures of production, investment and profit, this is looking like a very regionally patchy recovery with significant business under-investment and declining profitability in some areas.

    The deflation David is worried about I think is real when you look indicators of economic activity, cut by region and what's been happening across the industries.

  4. I'd buy generalized deflation IF CPI expectations were roughly zero plus GST plus effects of emissions trading. But they're a lot more than that. iPredict has Dec 2010 as 54% likely to top 4.2% inflation (annual increase); 75% likely to top 4.2 in March quarter 2011; 87% likely in June 2011. I don't quite know how you get deflation with CPI numbers like that.

  5. It depends on how you're measuring price change and who's consumption you're looking at.

    The CPI captures large components of the things which the Household sector spend their cash on. Most of the major items of consumption spending are capture but not all of them. It doesn't capture the price effects of some large gobs of expenditure on goods and services consumed by the household sector, like owner-occupied imputed rent from housing capital assets, amounts spent on education or on health (drop "GDP Sources and Methods" into Stats NZs search bar). A better measure of the full price change occurring within the household sector is the Private Final Consumption Expenditure implicit price deflator in the National Accounts (tables 5.1-5.3 in

    For the year ending March 2010, annual household price inflation was 1.9%, which on a seasonally quarterly basis (table 5.2), did actually become negative at the aggregate level (suggesting there were some LARGE declines which offset the increases in some household consumption items).

    Then take a look at what's happening with prices for capital goods and what's happening with prices in capital items - there prices have been falling for quite a few quarters. A good thing if you're trying to invest in productive capital, but pretty horried if you're selling productive capital items.

    Across the economy as a whole (table 5.2), March 2010 was the first quarter for the previous four that experienced any of the price inflation which the Reserve Bank or commentators could be yahooing about. The previous three quarters had been showing nothing about except falling overall prices measured on a quarterly basis.

  6. @James - I think that's a ways away from the initial concern: regulatory price increases having wealth effects that threaten deflation.

  7. Yeah, fair enough :) You got me on a Friday afternoon :D