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September 1, 2008 7:00pm by David Farrar

Inflation Expectations

Matt Nolan at TVHE has some nasty grpahs of inflation expectations. This convinces me the Reserve Bank lowered rates too soon.

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Comment18

NZ Politics
inflation
Matt Nolan
The Visible Hand in Economics

Comments (18)

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getstaffed

I still recall a political commentator observing in the early 80’s that the NZ public had been so conditioned to detest inflation that incoming aircraft would soon be sprayed for inflationary expectation (if you’re old enough to remember early 80’s politica and/or regular on-arrival aircraft cabin spraying then this will make sense…).

On this topic.. the line of reasoning about inflation, or why we should avoid it, was that we needed lower inflations that our export trading partners so as to become more competitive, and that low inflation gives rise to cost/price certainty which in turn encourages business investment in income generating activities. I’d be keen to hear from anyone more knowledgeable on this stuff… are there ANY circumstances where higher inflation is ok?
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September 1, 2008 7:11pm
Glutaemus Maximus

There are NO conditions where Inflation is OK for a Country. Or Trading Block.

Companies with weak management are happy with it until they go pop. Why is Because it makes any Inventory easier to sell from period to period. Until the sales dry up.

Japan also suffered with Negative Inflation.

Consensus says that inflation (true) at 1-3% behind GDP growth is a good thing.
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September 1, 2008 7:47pm
Anthony

I’m not surprised at this. My usual lunch place has raised it prices three time in the last 12 months. They keep saying how food prices have gone up. I am tempted to say to them that most of the cost of making a sandwich is labour and overheads.

I am now buying lunch more often at another place that hasn’t raised its prices at all.
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September 1, 2008 8:23pm
Monty

The Reserve Bank lowered interest rates early because of pressure from the Minister of Finance – like all Labour appointments he was only selected for the job on the condition that he would be a poodle to the Labour Government. Another Problem for National to fix when they take the reins of power in a few weeks.
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September 1, 2008 8:23pm
wreck1080

I’ve been saying for some time that interest rates should be going up, not down.

Lets just say, inflation is worse than higher interest rates. You can escape higher interest rates generally by not borrowing or selling current debt .

But, noone escapes inflation!

I do support variable gst for inflation control though.
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September 1, 2008 9:33pm
Glutaemus Maximus

GST should be zeroed for all Fresh Fruit, Fresh Vegetables, Fresh Meat, and other wholesome food, if they are produced in NZ/AUS.

Plus any other basic food stuffs like flour, bread, milk, cheese etc.

Processed food should still carry the normal rate

It should also be Zero for Children’s clothes.

RUC should be scrapped, and Duty on Diesel increased a tad.

Would love to see this in NATIONAL Policy.

An inflation buster?
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September 1, 2008 9:50pm
Bullitt

Ive been lurking for awhile but this topic touches on a couple of issues I follow pretty closely so time to contribute.

GM pretty much everyone proposing to have selective zero rating of certain items has never had to deal with implementing the GST Act. New Zealand is internationally regarded for having one of the simplest GST/VAT systems in the world and its still particularly complicated around the limited zero rating we do have (Exports, Financial Services, Fine Minerals etc). The compliance costs of removing certain items would be huge, particulary for retailers of said items. The small decrease it cost of those items would be more than compensated for by the increase in costs of running every business.

As for the OCR I agree it was lowered far too early. There is absolutely no benefit to the economy from inflation, the only short term benefit can be achieved by unexpected inflation. Therefore in the medium to long term the only way inflation can help the economy is if it is increasing at an increasing rate. Obviously this brings with it far more problems than it solves. I still dont understand why RBNZ lowered the OCR. The Reserve Bank Act was brought in for precisely this reason, they only have one target which is to keep inflation within 1-3%, they do not need to be concerned with the rest of the economy. Inflation is and will continue to be above the band for a long time therefore they should not be cutting the rate.
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September 1, 2008 11:27pm
OECD rank 22 kiwi

Not long now until second quarter GDP figures are released. What’s that, a second quarter of negative growth? That means recession time. New Zealand will be the first industrial country to lead the way into recession but it doesn’t look like the other industrialised countries after joining New Zealand’s example.
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September 1, 2008 11:30pm
freedom101

Let’s not forget that it was one of Winnie’s bottom lines to amend the RB’s inflation target. Since Labour came to office they have relaxed the target twice, from a clear target to a waffly one, with a higher band. What’s happening to inflation expectations is entirely predictable.
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September 2, 2008 5:15am
Viking2

Put up the interest rates just when the Aussies are goin down and our third quarter GDP is going to be a crash, unemployment on a big rise, Costs going sky high. Yeh what a great thing to do. Kill off what is left of business, destroy peoples lives, encourage more to join the exodus to Aussie. What’s with you guys. You all consult you computer screens to much. Get off your lazyboy and get out and talk to people in the real economy.
In the BOP the Winz ques are back and getting longer, business has ground to a halt in the last two months and people are leaving in droves.
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September 2, 2008 7:19am
Kiwi Trader

The RBNZ’s job is simple, control inflation.

Thats it.

It is not supposed to try to control growth, unemployment or any other indicator. It can’t, and monterary policy is distorted when it trys to.

As it is doing now.

I have blogged on this at length, but the reality is that the RBNZ is simply not doing it’s job.

I agree with Monty, it will be pressure from Cullen, with another cut lined up for next week, going into the election.

I also agree with Bullitt, the RBNZ’s moves do not make economic sense…Bollard should be sacked, but as he is doing Cullens bidding it makes sense if you look at it politically, not economically.

Economically, the RBNZ is simply not doing it’s job and is sending all the wrong signals by cutting interest rates.

Anyway the RBA is due to cut today, using the “going for growth” argument as well, so let’s wait to hear their weasel words as well.

The best central bank in the world is the European Central Bank….. now they have their eye on the only ball that matters…inflation…..because that is their job, their only job.
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September 2, 2008 8:08am
philu

and how about that nzeir report..saying that ‘the bad news’is all over.’.

..and that happy days are here again..(!)

..even the tv one business-dude had a problem keeping a straight face while reading that whopper..

..and was compelled to demur/mumble a rebuttal..

..that should see any future predictions from nzeir kicked to the curb..

phil(whoar.co.nz)
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September 2, 2008 8:32am
Kimble

“GST should be zeroed for all Fresh Fruit, Fresh Vegetables, Fresh Meat, and other wholesome food, if they are produced in NZ/AUS. Plus any other basic food stuffs like flour, bread, milk, cheese etc. Processed food should still carry the normal rate. It should also be Zero for Children’s clothes. RUC should be scrapped, and Duty on Diesel increased a tad. Would love to see this in NATIONAL Policy. An inflation buster?”

No, it definitely is not. It lowers the price level for some goods, but does nothing to fight inflation or, more importantly, inflation expectations.

Anything you gain by making things “cheaper” you lose in the complexity of the system. Cheese is processed food. Are childrens clothes still childrens clothes if adults can wear them? Increasing a duty on diesel flows right throughout the economic system and would result in higher prices paid by consumers for almost everything.

If this is ever National policy I would not vote for them.
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September 2, 2008 10:52am
Kimble

Dont talk about things you dont understand, phule.

At the very top of that list is economics.
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September 2, 2008 10:56am
Viking2

Yeh like the RB can control the negotiations between the oil producers and its customers and it can control the negotiations between the three big Iron ore producers in the world and its suppliers and by inference the customers of those steel producers. (Steel in NZ up by over 85% and more to come and I don’t need to remind you of the price of petrol)
Stop acting like control freak socialists and open your eyes to the world. We are so damm insignificant that it don’t matter and when those that do, decide to sneeze we freeze. We need a bit more lateral thinking instead of dogma.
So it makes good sense to destroy NZ businesses and their families by giving a guaranteed minimum price to the banks for the money they swoop up through carry trades. Like to consider what would happen to those trades if the rates had gone down 2% last year. The banks would have frozen them out because they didn’t have the margin. They would have been much more judicious in their selling of funds.
The guaranteed minimum interest margin/price for the banks is a scandal worse than Muldoons MMP for sheep farmers.
A policy that is 25 years out of date for little old NZ. As bad is that English has a slavish adherence to that self same policy, ah but of course he grew up on one of them there sheep farms.
Start thinking people.
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September 2, 2008 1:32pm
PhilBest

Look, we’re stuffed on fiscal policy, we just don’t have any room to move. Why? Because real estate prices have been allowed to “bubble”. That has sucked investment money away from productive sectors, and caused big increases in indebtedness secured only against on-paper inflated values of real estate, not against real, solid, productive assetts. Not only has the indebtedness got out of whack with the ability of people to actually service that debt out of their incomes, but the “security” for that indebtedness is based on valuations that are out of whack with liquidity, i.e. spare cash. The assumption that total property values are worth “X” is invalid if there is no ability for “X” to be stumped up by all potential purchasers of the total property. We are going to have a painful adjustment.

EXCERPTS:

Bernard Hickey; “We’re in Stage One of the Five Stages of Real Estate Grief”

http://www.stuff.co.nz/blogs/showmethemoney/2008/07/22/were-in-stage-1-of-the-5-stages-of-real-estate-grief/

“There are apparently five stages of grief, according to the Kubler-Ross model. The first stage is denial, then there’s anger, bargaining, depression and then acceptance.

I think New Zealanders have yet to really understand the catastrophic financial event that is happening to the housing market as we sleep and eat and take out the rubbish every day. To be fair, it’s not as easy to see as in a stock market, but house prices are quietly cratering around us, and yet many are still in denial. I think the nation is still in stage 1 and about to progress to stage 2.

In decades to come, 2008 will be seen as the ground zero of a market collapse in the same way that 1987 is seen as the year New Zealanders fell out of love with the stock market permanently. By some measures, the stock market’s value is still below where it was in 1987. I think the same thing is happening right now in the property market……..

“….I have been predicting that nominal house prices will fall 30% from their November 2007 level over the next couple of years and that it could take at least until 2018 before nominal prices get back to the peak levels we saw in November last year. The median house price will drop from around $350,000 to around $250,000 with this forecast…….

“….the signs aren’t screaming in your face, but they are there. They will become crystal clear over the next 12-18 months.

Firstly, housing is vastly unaffordable at current prices. The Wizard Home Loan affordability measure (which I help compile at interest.co.nz) shows that it currently takes 78.5% of a single median take-home pay to service the mortgage payments on an 80% loan to value mortgage for the median house. Some would say no one expects the median-income-earning first-home buyer to buy the median house on a single income. Yet that’s what we could afford to do up until late 2002, when it took just over 40% of take-home pay to service the mortgage.

How is anyone (let alone someone on a lower than median income) expected to have a family and service the mortgage on a house? The answer is no one and it will stay that way until somehow the affordability ratio gets closer to 40% again.

First-home buyers withdrew from the market midway through last year because they ran out of financial oxygen at these prices. Property investors pulled out at about the same time because they realised the property speculation game was about up and interest rates had made life too difficult even for those people deliberately running the losses needed to reduce personal income tax bills……..

“…….Secondly, the easy finance that helped drive the boom has dried up. Banks are being much more careful about lending aggressively to investors and other buyers, partly because they also expect prices to fall and they don’t want to be on the wrong side of negative equity when prices fall.

Finance companies offering easy money to property developers have also evaporated in one of those bloody mists you see after a bomb has gone off. They have gone. Bridgecorp, Capital and Merchant, Lombard, Dominion, Dorchester Pacific and St Laurence are either in receivership or about to go into moratoriums. All have stopped lending. Even those left standing, such as Strategic and Hanover, have stopped lending to all intents and purposes.

The receivers for these companies have been forcing developers to sell apartments at cut prices or simply shutting down their developments. Losses are being crystallised……

“……The easy money from the banks is drying up too. The Reserve Bank has told them to pull their horns in and market conditions have also forced them to dial back the 80-100% home loans and the cheap deals for bulk-buying property investors.

The Reserve Bank quietly told the banks in May to prepare for a scenario where house prices fell 30%. This is not the RBNZ’s official forecast, but is the assumption it has told the banks to include in the risk models they use to calculate their capital requirements under Basle II rules. The RBNZ’s own forecast is for 13% fall in nominal house prices and a 23% fall in house prices after inflation is taken into account.

I reported earlier this month that this 30% house price fall scenario resulted in the Reserve Bank forcing the banks to include an extra $910 million of capital in their calculations for capital requirements. Our banks now have plenty of capital to meet those requirement, but only because they quietly raised a combined $2.028 billion worth of equity-type or long-term capital from New Zealand investors in a series of bond issues in March, April and May.

The negative equity disaster heading our way…

The banks had to do this because they had a combined $30.574 billion worth of mortgages where the loan to value ratio was 80% or greater as at March 31. That’s about a quarter of all mortgages. If prices were to fall 30% then about 268,000 loans will be in negative equity, given the average loan size is about $114,000 according to RBNZ figures.

Think about it. A quarter of a million property investors face negative equity………

“New Zealand’s property investors and owners are about to be dropkicked into a lost decade where they face paying off monster debts without the benefits of realistic rents or capital gains.”

AND:

Don BRASH; “The Implications of Present Restrictions on the Availability of Residential Land” presented before
the Select Committee Hearing on Affordable Housing.

http://www.rmastudies.org.nz/documents/Don%20Brash%20speech%20may08.pdf

“We all know that over the last few years the price of houses has risen enormously in almost all developed countries.
We all know that in New Zealand house prices in our main urban areas are now among the most unaffordable in the world, relative to household incomes.
And we’ve all heard the multitude of reasons produced to explain this situation: greatly reduced interest rates (so that borrowers can afford to borrow more than previously); low levels of unemployment (so that people feel more comfortable taking on large amounts of debt); financial deregulation (so that banks have been driven to compete for borrowers more aggressively than before); tax laws which favour investment in residential property; and, in some countries, high levels of net inwards migration.

And there’s no doubt that all of those factors have, to varying degrees, added to the demand for houses.
But an increase in demand for houses will only cause an increase in the price of houses if there’s no commensurate increase in the supply of houses.
Of course, in the short term it’s not easy to increase the supply of houses. So if, for example, there’s a sudden surge in net inwards migration, it wouldn’t be in the least surprising to see the price of houses increase until developers and builders are able to respond to the increased demand by sub-dividing more land and building more houses.

And it’s also true that a downwards adjustment in the level of interest rates will tend to lead to an increase in the price of all assets.
Similarly, more aggressive lending behaviour by banks brought about by financial deregulation will lead to an increase in the price of many assets.
But none of these factors seems adequate to explain what’s happened in many developed countries in recent years.

We could reasonably expect that, after a year or two, developers and builders would respond to an increase in demand for housing arising from a surge in net inwards migration by increasing the supply, with a tendency for house prices to return to their previous level.
We could expect to see a step increase in the level of house prices as a result of lower interest rates and more aggressive lending behaviour by banks, not steady increases, year after year, to the point where houses have become severely unaffordable in a great many urban areas.
Something else has been going on to produce these very large increases…….

“……clearly the first implication of restricting the availability of residential land:
doing that greatly reduces the affordability of housing, with all the consequential effects
in terms of a decline in the proportion of families who can own their own homes, with
that effect almost certainly having a disproportionately large impact on low income New
Zealanders, many of them Maori or Pacific Islanders.

But I’ve come to believe that restricting the availability of land for residential
development has consequences which go far beyond its effect on the number of people
who can own their own homes. The rapid increase in the price of houses has almost
certainly had far-reaching economic consequences as well…….

“….We know that as house prices have increased strongly over the last 20 years, and
especially over the last decade, New Zealanders have felt very much wealthier and have
changed from being modestly frugal to being, on average, net dis-savers – indeed,
probably the champion dis-savers in the world!

We know that this has perpetuated a situation where, as a country, we are heavily
dependent on the savings of others, with that dependence having become markedly
greater in the last few years.

In September last year, the New Zealand banking system had made loans totaling $273
billion to New Zealand-based borrowers, but had deposits totaling only $175 billion from
New Zealand-based depositors, leaving a funding gap to be borrowed from overseas of
$98 billion.
3
So much for the argument that New Zealand interest rates are in some sense
“too high”!

Or put it another way: between 1990 and 2007, deposits from New Zealand households
grew at an average rate of 7% per annum, while home loans made by the banking system
grew at 14% per annum over the same period. The difference was, to a large extent,
financed by borrowing the savings of foreigners.

We have supported our living standards by borrowing from foreigners to the point where
we are, relative to the size of our economy, more heavily indebted to foreign residents
than any other country in the world. Once upon a time, the New Zealand government
borrowed overseas to fund its spending. Now, the New Zealand government has no
foreign debt expressed in foreign currency, and very little foreign debt even denominated
in New Zealand dollars. The overwhelming bulk of the obligations owed by New
Zealanders to foreign residents is owed by the private sector, and a great deal of that is
owed by ordinary New Zealanders, through the banking system, to fund a bubble in
house prices and a level of consumer spending which we have not earned. This has been
facilitated by the restriction on the availability of residential land.

The rapid escalation in house prices fuelled by restrictions on the availability of
residential land has also had an impact on the conduct of monetary policy. As the
Reserve Bank noted in its submission to the Finance and Expenditure Committee of
Parliament last year, rising house prices don’t in themselves cause inflation. But the
Bank noted that once house prices start rising, whether because of increased net
immigration or for some other reason, restrictions on the availability of residential land
create a momentum for further increases in prices, which require tighter monetary policy
to contain. So all borrowers end up paying a price in the form of higher interest rates,
and all exporters and their staff pay a price to the extent that the exchange rate is pushed
to levels well above what the fundamentals justify…….

“……Pushing up the price of housing through restricting the supply of residential land almost
certainly has another effect on economic growth. Not only has this encouraged New
Zealanders to spend more than they earn, financing the gap by borrowing from
foreigners, it has almost certainly encouraged more of the total available savings to be
channeled into housing, with less going into more directly productive assets. While
home loans from the banking system grew at 14% annually between 1990 and 2007, as
I’ve noted, other loans to New Zealand borrowers – mainly New Zealand businesses and
farms – grew by just 6% annually.

In the United States, the increase in house prices to the point where in many major urban
markets they have become severely unaffordable encouraged some grossly imprudent
lending practices, with banks and other lenders willing to lend on the flimsiest of security
and poor loan-servicing capacity because of a naïve belief that they would be saved from
loss by a continuing escalation of house prices above the rate at which incomes are
growing. The unwinding of this situation is having a serious impact on the economic
growth of the United States, and potentially of the whole world.

It is often argued that the restrictions which local governments have placed on the
development of land for housing have at least reduced the total area of New Zealand
devoted to urban development (as if this were some kind of desirable outcome in itself).
But assuming that 80% of our population is in some sense “urbanized”, and assuming an
average urban population density of 1900 per square kilometre (which is the density in
Christchurch – both Auckland and Wellington figures are higher), only 0.7% of our total
land area is urbanized at the present time. If New Zealand’s population grows by 50,000
a year, and we housed all these additional people in fringe housing around our urban
areas at the population density of Christchurch (requiring roughly 26 square kilometres,
or one hundredth of 1 per cent of our total land area, each year), we couldn’t urbanize a
further half per cent of our total land area over the next 50 years if we tried!

And does the refusal of local governments to zone more land for residential purposes on
the outskirts of our major cities actually reduce the land devoted to housing anyway?
Probably not – it may just increase the amount of commuting which people have to do.
Instead of being able to live on the outskirts of our larger cities, they may be forced into
satellite towns some miles beyond the artificial boundaries of our cities – in Rolleston
and West Melton in Canterbury, in Pukekohe and Warkworth in Auckland.

But let’s suppose the tight restrictions which local and regional governments have
imposed have actually managed to reduce the land devoted to housing in New Zealand.
Let’s suppose that without tight restrictions the area of New Zealand devoted to urban
development would already be 1% of our land area. Yes, it is possible we may have
needed to invest a little more in transport and other infrastructure.

But I haven’t the slightest doubt that that infrastructure could’ve been financed without
difficulty if we’d charged appropriately for those services. And the consequences of that
alternative policy would’ve been vastly less damaging – for the ability of young New
Zealanders to buy their first home, for New Zealand’s dependence on the savings of
foreign residents, for the interest rates paid by all borrowers, for exporters, and for our
standard of living – than what we’ve experienced.

The policy of tightly restricting the availability of residential land, a policy followed by
most of the main regional and urban local governments in New Zealand, has been an
unmitigated disaster from almost every standpoint.”

AND:

Owen McShane; “Why Are Australians Richer Than Us”

http://www.rmastudies.org.nz/index.php/issues/44-housing-costs/124-why-are-australians-richer-than-us

(Excerpt)

“Australian GDP per capita is now A$47,181. That’s about 40% higher than New Zealand’s A$33,682, at present market exchange rates. Even Tasmanians, their “Clean and Green” poor cousins, at only $35,253, are richer than New Zealanders. Western Australians, are the richest at $58,688, which makes them about 75% better off than New Zealanders.

Why are Australians so much better off?

We are fed many excuses – but most don’t stack up.

However, there is much to learn from the marked difference in the way our two countries responded to recent reports on housing affordability. For ten years, private analysts in America, Canada, the UK, Ireland, Australia and New Zealand, have been blaming unaffordable housing on over-regulated land supply. Last month, CHRANZ, one of our own government agencies, finally released a report which clearly laid the blame for Auckland’s inflated land prices on its Regional Growth Strategy, the Metropolitan Urban Limit (MUL), and widespread excessive compliance costs for consents.

The first of three annual Demographia surveys, which showed Australian and New Zealand housing markets to be among the most unaffordable in the world, was first published in January 2005.

The major Australian newspapers immediately featured front-page stories outlining the severity of the problem and demanding action to release land supplies, and continue to do so. The Urban Development Institute of Australia, the Property Council of Australia and its Residential Development Council, the Housing Industry Association, and the Institute of Public Affairs all acknowledged the problem and promoted increased land supply.

The Federal and State Governments soon prepared bills forcing councils to release large areas of land for residential development. They are still squabbling about the specific cures, but have all recognized the problem and the cause.

New Zealand responded by shoving its head firmly into the sand. The early Demographia findings were given no major media space or air-time at all. The third survey, published earlier this year, generated more attention because many commentators were making the connection between inflated land prices, high interest rates, the high dollar and its impact on our exporters.

NZ property organizations have remained remarkably quiet.

The recent CHRANZ report confirms our seriously unaffordable housing and recommends freeing up the land supply and reducing compliance costs.

No one wants to know. Unlike the Australians, our “experts” avoid the issue and recommend solutions remarkable only for their foolishness…….

“Coffee……

…..When a Government Agency confirms young people are priced out of the housing market our Government-owned and chartered TV One news programme declares that young Aucklanders spend too much money on their coffee and so have only themselves to blame…..

It’s those Immigrants.

Immigration is a hot favourite with the ignorant.

But how come these immigrants have not forced up the price of cars, washing machines, and flat screen TVs? Simple. We increase the supply.

Cheap Money.

How does anyone say this with a straight face? First they blame the banks for lending cheap money. Then they complain that our interest rates are “the highest in the developed world” and, by driving the Kiwi dollar through the roof, are destroying our export sector.

We Need a Capital Gains Tax.

There is no capital gains tax on housing in America, and mortgage interest is tax-deductible. Many of their markets are severely unaffordable – like Auckland. But many are affordable – like Houston. The difference is the unaffordable markets have MULs and savage constraints on land supply.

Auckland’s Huge Size and Rapid Growth is the Problem.

Auckland is a middling-sized city with slow growth. Houston is five times as big and growing much faster. But Houston’s affordability index is only three, which means a household on an income of $50,000 can buy a house for $150,000 – and keep buying coffee.

Force Developers to Build Affordable Housing.

If we force developers to build say 15% of their housing at a 20% discount, then the rest of the houses must be sold at a higher price to fund the subsidy.

Shared Equity Schemes.

Shared equity schemes foster the belief that all housing markets continue to increase in value for ever. This is hardly the time to foster such a belief. When the bubble bursts will the Government demand its share of the equity losses?

We Need “Lots” of Special Schemes.

These special schemes only help the few who win the lottery……

Housing Speculators are to Blame.

Given that we have a strangled land supply, the speculators provide a valuable service to the growing rental market. Address the root cause – not the symptom.

Landbankers are to Blame

Housing Minister Carter blames land-bankers for sitting on land until prices go through the roof. He should sell up his three residential properties – they are in prime locations and should realize plenty – and buy some bare land. If he enquires about the costs of development and chances of success, he, too, will sit on the land until the regulators are brought to heel.

More Intensification

Auckland is already three times as dense as most North American cities of comparable size and age. We have been building town-houses and infill-housing since the sixties when the codes were written to enable them……”
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September 2, 2008 1:43pm
PhilBest

So, there U go, “philu”, me old economics expert, analyse THAT.
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September 2, 2008 1:49pm
PhilBest

And maybe, just maybe, the people who write the economic histories in a few decades might accept the above analysis as the correct one?
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September 2, 2008 1:51pm

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Links

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Dan Moskovitz

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