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How the RBNZ misjudged the situation in 2020-21

Much attention has recently been given to NZ's high inflation rate, which now lies around 6%. Our Central Bank never saw it coming. How come?

The RBNZ got confused about the nature of the shock caused by the pandemic, probably because so few competent economists work there now. The shock lowered demand, mainly for services, which largely rely on face-to-face interactions, especially during the lockdowns, which was deflationary. However much of that demand quickly bounced back. Demand can be hard to forecast, since it relies a lot on consumer psychology.

However, the shock has also had a large supply-side component, which was inflationary. Border controls have choked off the ability of our employers to hire from abroad, even from our pool of ex-pats, creating skill shortages and putting upward pressure on wages. Supply chain problems and delays are widespread. We all knew these effects would be particularly pronounced in NZ since entry to the country has been subject to some of the most stringent restrictions in the world. As such, they should've been built into official forecasts.

By overestimating the deflationary demand-side effects and hugely under-estimating the inflationary supply side effects, monetary policy has ended up wildly out of kilter.


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