Congratulations to Martin Luk (Governor), Amanda Ngo, Jake McConnell, Shaan Keesha and Amay Aggarwal who won the Reserve Bank of New Zealand Monetary Policy Competition. The team made a 10 minute presentation on their OCR decision to three RBNZ economists Jed Armstrong and Hayden Skilling, and Assistant Governor John McDermott. They then had a 20 minute question and answer session in which they showed great teamwork in answering some very searching questions. There were 5 other schools in the national final.
A short animated video by the Reserve Bank which shows how the economy works. It also outlines the role of the Reserve Bank of New Zealand. Good for an introductory lesson.
I have mentioned the resource curse in previous posts especially those countries with natural resources. Below is an extract from a previous post.
Africa may have enormous natural reserves of oil, but so far most Africans haven’t felt the benefit. In Nigeria, for instance, what’s seen as a failure to spread the country’s oil wealth to the country’s poorest people has led to violent unrest. However, this economic paradox known as the resource curse has been paramount in Africa’s inability to benefit from oil. This refers to the fact that once countries start to export oil their exchange rate – sometimes know as a petrocurrency – appreciates making other exports uncompetitive and imports cheaper. At the same time there is a gravitation towards the petroleum industry which drains other sectors of the economy, including agriculture and traditional industries, as well as increasing its reliance on imports.
For New Zealand it seems to be working in reverse. New Zealand’s biggest export earner is dairy and with prices dropping by 23% since last year and the outlook of continued monetary easing from the RBNZ the dollar has dropped from US$0.77 on 27th April to US$0.67 today – a level not seen since 2010.
However, going against what the resource curse suggests, the weaker exchange rate will provide extra revenue for exports like the tourism industry which has been enjoying high numbers especially from Asia. Furthermore, there have been suggestions that it could surpass the dairy industry as the biggest earner of export receipts. There are further benefits for domestic companies competing against imports as the weaker dollar makes competing overseas goods more expensive relative to those produced in New Zealand.
In 2014, 9 of the 34 members of the OECD experienced deflation whilst 3 others had zero inflation. Over the whole area consumer prices rose by only 1.7% mainly due to the fall in oil prices.
However in the Euro area inflation was only 0.4% over the year which is worrying especially as the European Central Bank (ECB) targets an annual rate of 2%. With interest rates at the ECB at 0.05% there is little scope for any stimulatory activity to increase inflation. Furthermore they are also charging banks deposits on money in the bank through a negative rate of 0.2%. Although lower oil prices will benefits businesses and consumers alike it maybe paradoxical if people expect lower inflation as cheaper energy pushes the headline rate into negative territory. So, the ECB has taken a leaf out of the US Fed’s book and decided on a form of quantitative easing by purchasing covered bonds and asset-backed securities.
Mario Draghi, President of the ECB, has not ruled out using additional measures “should it become necessary to further address risks of too prolonged a period of low inflation”.
Although Japan has an annual rate of inflation of 2.9% this has been largely due to an increase in the retail sales tax – if you exclude it from the calculation the inflation rate would be 0.9%. The Japanese Central Bank has a target of 2% inflation. As with the ECB interest rates in Japan are very low – 0.1% – so this leaves no scope for any stimulatory cuts. They are hoping that a further stimulus package of ¥3.5 trillion (NZ$ 37.41billion) on 27th December will boost the economy.
In New Zealand the annual inflation rate in September was 1% – the Reserve Bank Act 1989 stipulates a band of 1-3% while targeting future inflation at 2%. Unlike their counterparts at the ECB and the Bank of Japan they do have scope for stimulatory cuts as the official cash rate is currently 3.5%.
Brian Gaynor in the NZ Herald wrote a piece on the amount of debt in the New Zealand economy and the fact that the Reserve Bank needs some fresh ideas to stem the increasing trend. With the OCR increasing this week to 3.5% the disposable income of the floating mortgage holder will reduce and ultimately impact on their ability to spend – floating mortgages represent 33% of all mortgages in dollar terms. Although higher rates help those that have money in the bank however a lot of this is from overseas investors so interest payments leave the economy. Furthermore the elderly tend to have savings in banks but they are not seen as significant spenders. The higher interest rates also attract ‘hot money’ as NZ’s rates are higher than most other industrialised countries.
The amount of debt in the economy is a major concern especially when you consider how much is mortgage debt – see below. Also the fact that debt as % GDP is now 88.5% and 145% of disposable income – this is putting pressure on inflation not forgetting that people are living very much beyond their means.
The RBNZ is concerned with this debt and introduced restrictions on high loan-to-value residential mortgage lending. They see that there is too much emphasis on housing which is being fuelled by greater access to debt. One only has to look at the Irish property to see how things can wrong – house prices dropped 50% between 2007 and 2012.
With the recent increase in the OCR by 25 basis points to 3% interest rates are now heading to towards a neutral rate – one that is neither contractionary or expansionary. The macroeconomic indicators reflect the following:
* Annual inflation at 1.5% is not that far from the mid- point of the RBNZ target band, especially considering the temporary effect that an appreciating currency has on headline inflation. See graph below from BNZ.
* The economy has limited spare capacity – capacity utilisation is close to long term average and firms are having more difficulty than normal in finding labour.
* Economic growth is above trend and looks set to push further above trend this year.
These economic indicators suggest that the economy is in reasonable shape and will be able to avoid a severe correction over the nest couple of years.
From the BNZ Economy Watch.
In the Post-GFC environment, heightened bank funding costs have driven a wedge between the OCR and borrowing costs. The key contributor has been RBNZ regulation requiring banks to source more secure forms of funding. Some relief in costs was experienced last year as some expensive funding from the GFC rolled off, and some reduced competition in the domestic deposit market was experienced. At the margin there is potential for a little further decline in funding costs. However, greater stability is now expected. Therefore more of the rise the underlying OCR will ultimately be felt by borrowers.
Although the Ides of March refer to the 15th March, the next Monetary Policy Statement from the Reserve Bank Governor is on the 13th March and most commentators believe that this will be the first of many hikes that will see the OCR hit 4.5% by late 2015. There was a belief that RBNZ Governor Graeme Wheeler would start hiking last week but central banks don’t like giving exact dates. But the Christchurch rebuild and the increase in Auckland house prices will warrant higher costs of borrowing
Central Banks have often used the term ‘the neutral rate’ which refers to a rate of interest that neither stimulates the economy nor restrains economic growth. This rate is often defined as the rate which is consistent with full employment, trend growth, and stable prices – an economy where neither expansionary nor contractionary measures need to be implemented. In most economies post GFC the neutral rate of interest fell as they have required lower rates to try and encourage growth. The graph from the BNZ below shows that the neutral rate in NZ has dropped form 6% to 4.5%.
The BNZ Markets Outlook reported an annualised increase in net immigration by 33,000 the highest since 2003. The boost mainly comes from the fall in migrant departures. This will impact on aggregate demand and the RBNZ have talked in monetary policy statements about increases in potential growth (like the housing market) and the impact it will have on a tightening of monetary policy later next year – remember also the Christchurch rebuild.
New Zealand households have gone through a period of deleveraging since the GFC in 2007 in which borrowing against the house has dropped significantly. Consequently household savings has gone up. However the increase in household debt from 2000 to 2007 was rapid and is forecast to increase further especially with house price inflation on the rise. But this house inflation doesn’t correlate to the economic conditions of the country and RBNZ Governor can be justified in saying that house prices are over-valued. Graph below from the BNZ Economy Watch.