MPs from across Parliament have begun to question the very foundations of the Reserve Bank’s monetary policy and the way the Bank manages it.
In return, the Bank had all but admitted it was becoming powerless to drive the key indicators in the economy in the direction it wanted.
The criticism came as the Bank lowered the official Cash rate to its lowest point of two percent since the Bank began inflation targeting in 1990.
But the immediate response on the foreign exchange market was for the dollar to surge to a 12 month high against the US dollar.
So it wasn’t surprising that the performance of the Governor, Graeme Wheeler, attracted criticism at the Finance and Expenditure Select Committee which held a special meeting yesterday afternoon to consider the Bank’s announcements earlier in the day.
National’s Andrew Bailey noted that the Bank in its June Monetary Policy Statement had said the Bank in previous Monetary Policy Statements had said the TWI was too high.
“Today we have seen a rapid escalation of the dollar,” he said.
“So what I’m trying to understand is why are we getting this disconnect between what you are saying and doing and how the markets are reacting.
“Everyone in this room knows a high dollar is not helping the economy so these are really crucial communication issues because for some reason the markets are interpreting it differently.”
Mr Wheeler could only say that the Bank had cut the Official Cash Rate six times since June last year in the hope that it would drive the dollar down.
“Now having cut six times, the TWI is still about one and a half per cent higher than it was in June (last year) before we started cutting.
“So our ability to make an interest rate decision and assume that portfolios are going to give us the outcome we want is not guaranteed.
“Not at all.”
The best Mr Wheeler could offer to suggest that things could have been much worse if the Bank had not cut at all.
At the core of the Bank’s mission at present is a desire to ensure that inflation does not become disinflation where prices would start to drop.
That could easily trigger a recession.
But one of the issues the Bank has to confront is that there are two types of inflation New Zealand which are aggregated together to form the consumer price index.
On the one hand is “non-tradable” inflation which is inflation of goods and services which are not subject to international competition.
And on the other is tradable inflation which is the rise in prices of goods that are exposed to international competition.
These are complex and arcane classification.
For example, domestic air travel is non-tradable, but international air travel is tradable.
Most notably, most housing costs are non-tradable while most household running costs like groceries and clothing are tradable.
The Bank says that the problem is that the strong dollar is weighing on the tradable inflation by keeping prices of imports down.
Tradable inflation has been negative since 2012 and is dragging the so-called “headline” inflation down.
In its Monetary Policy statement released yesterday, the Bank said: “Low tradables inflation appears likely to continue for some time. This unusual persistence in tradables inflation has contributed to low headline CPI inflation, which is in turn seeping into inflation expectations, and presents an ongoing challenge for monetary policy.”
Paradoxically, low-interest rates are stimulating domestic economic activity, and the Bank says as a consequence, there will be an increase in non-tradable inflation.
The problem, as Wheeler explained, is that the Bank has nop influence “whatsoever” over offshore inflation and only very limited influence on the exchange rate.
This led to the Greens’ Julie-Anne Genter asking him whether there was a case for the inflation target to distinguish between tradable and non-tradable inflation.
Wheeler replied that if you looked at inflation targets that other central banks adopted they didn’t distinguish between tradable and non-tradable inflation.
“It is certainly true that our influence is primary without question on non-tradable inflation.
“That’s been tracking roughly between one and a half and two and a half per cent.”
But he said it was true that there was awful lot of the consumer price index that the Bank could not directly control.
And if the bank can’t control an “awful lot” of the cpi, then it is limited in its ability to carry out its core role of meeting the inflation target set out in the Policy Targets Agreement between the Bank and the Finance Minister.
Labour’s Grant Robertson, however, was unimpressed.
“At the front of the document you give us every single time you come here is the Policy Target Agreement,” he said.
“That doesn’t distinguish between tradable and non-tradable inflation.
“It sets a target for you which you won’t reach for seven years.
“Is not time to have another look at both policy targets and overall monetary policy?”
Wheeler said that if you looked around the world, there were around 30 central banks that used inflation targeting and that he didn’t think there was one of them that had moved away from inflation targeting.
“If you look att he targets that they have set yo use the Federal Reserve has a target of two percent; the Bank of Japan, two percent; European Central Bank, just below two per cent; the Bank of England, two percent.
“So no one has changed either away from inflation targeting or from the inflation targets that they have set.
“there isn’t a better framework out there.
“One can argue about where the target should be, but I don’t think there is a good case for moving away from inflation targeting.”
And Wheeler got support from the Finance Minister, Bill English, who as he entered Parliament for the afternoon session said that inflation targeting was relevant.
“And around the rest of the world, they certainly regard inflation targeting as relevant.”
One month of free, no-obligation access to POLITIK plus the daily POLITIKToday email. CLICK HERE