• rmacculloch

How can a Blog (and Sharon) make better inflation forecasts than 250 RBNZ staffers?

Yesterday inflation rose to a little under 5%, a ten year high. We've long been forecasting sharply increasing inflation & interest rates. It wasn't rocket science, but somehow eluded the 250 staff at the Reserve Bank of NZ, as well as the Monetary Policy Committee (MPC). We commented back in April how the Bank seemed blithely unaware of the inflationary pressures erupting in the country. To the extent some such pressures were acknowledged, the Bank simply said they were "near-term", "temporary", sweet nothings. The MPC stated at that time how "medium-term inflation .. would likely remain below its remit targets [of 1-3%] in the absence of prolonged monetary stimulus". It described how, "Inflation expectations remain at or below the 2 percent target midpoint".

We took the opposite view and commented in April, "Our prediction is that the cost of living is on the way up in NZ and interest rates will be going up sooner rather than later". Then shortly afterward in May we wrote, "Amusingly (if that's the right word?) the RBNZ's Monetary Policy Committee seems to be the only group in the country which doesn't think prices are on the rise". Why? Since in May the ANZ's Business Outlook survey showed inflationary pressures were soaring. "Reported costs are through the roof", said ANZ chief economist Sharon Zollner.

So we asked our Blog readers at that time, "Take your bets: the RBNZ vs Sharon Zollner? Our money's on Sharon". Turns out we bet on the right horse. Yes the RBNZ reversed course only months later, raised the OCR and inflation lies way beyond its 1-3% mandated range. By the way, the Governor is looking like breaching his contract. Since the Policy Targets Agreement (PTA) states his primary aim is to achieve price stability, as defined by an inflation target of 1 to 3 percent and mid-point of 2 percent. As the RBNZ itself states, "In effect, the PTA represents a contract between the Minister of Finance & the Governor, and forms a central element of the Bank's mandate & accountability".

That's what you get for having a Central Bank where most of the Senior Leadership Team haven't studied economics. And of the few who have, it has been so low level as to make well-informed judgements barely possible. Here's where the RBNZ stuffed up: it misread the virus shock as being a negative demand-side shock, instead of a supply-side one. Yet demand has held up strongly in NZ the past 18 months. Whereas supply-side (cost) pressures are huge, especially given Auckland has had one of the longest lockdowns in the world.