Back in the early part of 2020 when we were learning about Covid-19, lockdowns, and border closures, the Reserve Bank made a comment which media didn’t pick up on. When taking the decision to remove LVRs, cut the official cash rate to 0.25%,then extend lines of credit to banks and print money, they said they had adopted a “least regrets” policy.
They said that they would deliberately take the risk of easing monetary policy too much and for too long, over-stimulating the economy, and boosting inflation too much. They noted that they would have fewer regrets about over-stimulating things then having to play policy tightening catch-up than not easing enough and contributing to a deflationary and destruction downward spiral in the economy.
Mission accomplished! They did over-stimulate the economy, they did push inflation to7.3%, and since October 2021 when they took the cash rate from 0.25% to 0.5%,they have been fighting against the inflation they helped cause.
This eventually led them to adopt a new “least regrets” policy in February 2022. From their Monetary Policy Statement that month:
“…the Committee applied their least regrets framework, noting that the most significant risk to be avoided at present was longer term inflation expectations rising above the target and becoming embedded in future price setting.”
So, after that review they switched from only raising the cash rate 0.25% at a time to boosting it 0.5% with a 0.75% boost in November 2022. They decided to take the risk of crunching the economy too much and risking inflation below 1% as that was better than risking inflation settling above 3%.
We can’t as yet say mission accomplished again – not with inflation still at 4.7% and twice the long-term average proportion of businesses saying they plan raising their selling prices. But we do have evidence in hand that the economy is being decidedly crunched.
Already the Reserve Bank caused a recession at the turn of 2022 into 2023, and now there is a good chance they have done so again for the latter part of last year.
We have just learnt that rather than rising by about 0.5% in the December quarter as many had expected, the volume of retail spending in New Zealand during the December quarter fell by 1.7%. In fact, on a per capita basis spending volumes were almost 7% lower than a year earlier.
The retail sector has been smashed and sales have fallen for eight quarters in a row. We can also see that business capital spending levels are falling, and house construction is declining rapidly with companies exiting the sector(often involuntarily) in growing numbers.
The new government is tightening fiscal policy, consumer confidence and spending plans remain well below average, and growth prospects in our major export destination – China – look poor.
The underlying fundamentals argue strongly for an immediate easing of monetary policy. But as noted above, inflation is still much too high at 4.7% and businesses are still saying they’re going to strongly raise their selling prices.
Until the Reserve Bank sees solid evidence that businesses will capitulate to the economic weakness and cease raising their prices so much, there will not be any easing of the current 5.5% official cash rate.
But the tidal bore of pressures against inflation is likely to eventually become so strong that even the Reserve Bank will have to admit that they are too aggressively pursuing their least regrets policy of crunching the economy. Rate cuts for the second half of this year are likely – about one year ahead of the Reserve Bank’s plan for cuts – but whether that means near July or near December is impossible to say until we get a lot more information on the economy.
Tony Alexander is an independent economist and produces a free weekly publication with a housing focus called “Tony’s View”, available for signup at www.tonyalexander.nz
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