BNZ on the inflation menace and the Reserve Bank

From the BNZ Strategist dated 14 August 2008

"Unrelated to the cycle but of significant importance to New Zealand’s medium term prognosis is the approach that the Reserve Bank of New Zealand takes to containing inflation. Recently inflation has burst through the top end of the Bank’s target band. The RBNZ can be excused for much of this as the major driver has been a global supply shock, the first round impacts of which the Bank has no influence over.

What concerns us more, though, is what the Reserve Bank is doing in terms of its inflation target. We can’t help but feel that the RBNZ has gone soft on inflation. There no longer appears to be any great desire to get annual inflation back to the mid point of the target band. Rather, anything under 3.0% seems to do.

We might well be wrong in jumping to this conclusion but this increasingly appears to be the accepted view of folk in financial markets.

There is a large body of research that says if you are to be an effective central bank

(a) inflation expectations need to be anchored and

(b) there needs to be a clearly identified and understood target.

We would contend that there is increasing uncertainty about both. It should thus be of no surprise that inflation expectations seem increasingly to be headed for 3.0%. While, so far, this is an adaptive response to rising headline inflation, there is a real danger that they get stuck there which will ensure that the central bank’s job gets harder and that the neutral nominal interest rate will be higher than would otherwise have been the case.

If this is so, start getting used to higher interest rates, on average, for longer than has been the case. And for the populace as a whole remember that the higher is inflation, the harder the hit to those on fixed incomes and the less well off. " Unquote

Exactly my point, see earlier post on inflation - KT