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Have Central Bankers’ got it wrong?

October 30, 2017 Leave a comment

Below is very good video from the FT – here are the main points:

  • Central Banks – by lowering interest rates they could make savings less attractive and spending more attractive
  • After GFC low interest rate and asset purchases increased lending and avoided a global depression.
  • Now the world economy is not behaving as the central bankers’ said it would
  • Their theory was that with lose credit (lower interest rates) the economy would grow and inflation would rise.
  • Inflation is stagnant (unlike the 1960’s – see graph below) and this is worrying as a little inflation is required to lubricate the economy. It allows prices to fall in real terms.
  • The missing inflation may mean that the bankers’ theories are wrong.
  • Cheap money may have encouraged high asset prices and debt levels but it may undermine the economy without doing much for growth.

Inflation Unemployment.png

Black Monday – 30 years on

October 20, 2017 Leave a comment

Black Monday refers to Monday, October 19, 1987, when stock markets  around the world crashed, shedding a huge value in a very short time. In New Zealand and Australia it is sometimes referred to Black Tuesday because of the different time zone. By the end of October stock markets around the world fell significantly:

  • Canada – 22.5%
  • USA – 22.68%
  • UK – 26.45%
  • Spain – 31%
  • Australia – 41.8%
  • Hong Kong – 45.5%
  • New Zealand – 60%

Unlike other countries the effect of the crisis was compounded by the Reserve Bank of New Zealand’s inaction to lower interest rates and therefore reduce the value of the NZ dollar. This is in contrast to the USA, Germany and Japan whose banks loosened monetary policy to prevent a recession. Below is a video from the FT looking back at the events 30 years ago. Also a useful graph to put the crash in perspective – the two circled ares are the dot.com crash and the GFC.

Black Monday in context

 

Types of Macroeconomic Policies

August 30, 2017 Leave a comment

Just been doing some revision with my CIE AS class and discovered this diagram on macro policies. Mind maps like this are very useful ways of revising topics.

Fiscal policy can be distinguished from monetary policy, in that fiscal policy deals with taxation and government spending and is often administered by an executive under laws of a legislature, whereas monetary policy deals with the money supply, lending rates and interest rates and is often administered by a central bank.

Supply-side policies are mainly micro-economic policies aimed at making markets and industries operate more efficiently and contribute to a faster underlying-rate of growth of real national output

Macro Policies.png

Reserve Bank of Australia – Neutral Rate

August 20, 2017 Leave a comment

An article in the Sydney Morning Herald last month looked the Reserve Bank of Australia (RBA) and the neutral interest rate. For almost a year the RBA has kept Australia’s official interest rate at 1.5% and uses this instrument to control the overnight cash rate to try to manage the economic activity of an economy. EG.

Expansionary = Lower interest rates = encourages borrowing and spending
Contractionary = Higher interest rates = slows the economy down with less spending

How do we know that 1.5% is either expansionary or contractionary? Central banks indicate what they believe is the neutral rate of interest – this is a rate which is defined as neither expansionary or contractionary. In Australia the neutral is estimated to have fallen from 5% to 3.5% since the GFC. RBA deputy governor, Dr Guy Debelle, explains that the neutral rate aligns the amount of nation’s saving with the amount of investment, but does so at a level consistent with full employment and stable inflation. In Australia this equates to 5% unemployment and 2-3% inflation.

Aus - Neutral rate

The level of a country’s neutral interest rate will change with changes in the factors that influence saving and investment.

More saving will tend to lower interest rates
More investment will tend to increase interest rates

Debelle indicates that you can group these factors into 3 main categories:

1.The economy’s ‘potential’ growth rate – the fastest it can grow without impacting inflation.
2. The degree of ‘risk’ felt by households and firms. How confident do they feel about investing. Since the GFC people are more inclined to save.
3. International factors – with the free movement of capital worldwide global interest rates will influence domestic interest rates.

“We don’t have the independence to set the neutral rate, which is significantly influenced by global forces. But we do have independence as to where we set our policy rate relative to the neutral rate.” Dr Guy Debelle

QE unwind? Yeah right

August 18, 2017 Leave a comment

Another very informative clip from the FT. Some of the salient points include:

  • Since the global financial crisis the Bank of England, US Fed, Bank of Japan and European Central Bank have bought assets and printed US$12 trillion.
  • Can interest rates return to what has been normal in the past – say 5% instead of close to 0%.
  • US Fed plans to shrink its balance sheet later this year – monthly reduction US$6bn in its assets. But this is a very small amount when you consider that the Fed holds US$4.5 trillion
  • But this is not happening elsewhere. Bank of Japan and European Central Bank are still printing money and buying assets. With Brexit the Bank of England faces huge uncertainties regarding their balance sheets.
  • Interest rates will remain low partly due to: ageing population, low productivity growth and a savings glut. This has reduced the attractiveness of capital spending.

DW Documentary – “The Money Deluge”

July 11, 2017 Leave a comment

Below is a recent documentary from Deutsche Welle (DW – Germany’s international broadcaster) on the impact of exploding real estate prices, zero interest rate (see graph below) and a rising stock market. The higher income groups are benefiting greatly from these conditions but how does it effect middle income earners especially those in retirement. The DW documentary addresses these issues and explains how money deals have become detached from the real economy. Worth a look.

For years, the world’s central banks have been pursuing a policy of cheap money. The first and foremost is the ECB (European Central Bank), which buys bad stocks and bonds to save banks, tries to fuel economic growth and props up states that are in debt. But what relieves state budgets to the tune of hundreds of billions annoys savers: interest rates are close to zero.

The fiscal policies of the central banks are causing an uncontrolled global deluge of money. Experts are warning of new bubbles. In real estate, for example: it’s not just in German cities that prices are shooting up. In London, a one-bed apartment can easily cost more than a million Euro. More and more money is moving away from the real economy and into the speculative field. Highly complex financial bets are taking place in the global casino – gambling without checks and balances. The winners are set from the start: in Germany and around the world, the rich just get richer. Professor Max Otte says: “This flood of money has caused a dangerous redistribution.

ECB Rates.png

Those who have, get more.” But with low interest rates, any money in savings accounts just melts away. Those with debts can be happy. But big companies that want to swallow up others are also happy: they can borrow cheap money for their acquisitions. Coupled with the liberalization of the financial markets, money deals have become detached from the real economy. But it’s not just the banks that need a constant source of new, cheap money today. So do states. They need it to keep a grip on their mountains of debt. It’s a kind of snowball system. What happens to our money? Is a new crisis looming? The film ‘The Money Deluge’ casts a new and surprising light on our money in these times of zero interest rates.

When the NZ Official Cash Rate exceeds the US Fed Rate.

July 1, 2017 Leave a comment

With Janet Yellen increasing the US Fed Rates to 1 – 1.25% and Graeme Wheeler keeping the OCR at 1.75% it is anticipated that the US Fed Rate will eventually become higher than the OCR. What impact might this have on the New Zealand dollar?

With higher rates (or expected higher rates) in the US money flows will be attracted into the US with higher interest rate returns. This is referred to as ‘Hot Money’ and for international investors there are significant amounts of money to be made.

A higher interest rate in the US would mean a higher return from saving in a US bank. Therefore, New Zealand investors may sell NZ dollars and buy US dollars so that they can gain more interest from their savings. This increased demand for US dollars will push up the value of the US dollar against the NZ dollar.

RBNZ v Fed Rates.png

However it is not just interest rates that influence Hot Money. In 2011the Swiss Franc appreciated on the back off the turmoil in the Eurozone as investors saw the currency as a safe haven. The NZ dollar and the AUS dollar appreciated for similar reasons post the Global Financial Crisis.

Problems of hot money flows

Hot money flows can be destabilising. A rapid rise in the currency can harm a countries with exports become more expensive and imports becoming cheaper. However the latter might be favorable depending on the import content.

Hot money flows can create excess liquidity fuelling a future asset boom and creating more long-term problems.

Trump’s tax cuts likely to have limited impact on growth

May 14, 2017 Leave a comment

Donald Trump has indicated that the US economy needs a big tax cut to stimulate some growth and aggregate demand –  C+I+G+(X-M). His rationale is that with consumers having greater income they will spend consume more (C) and businesses keeping more of their profits will invest more (I). He is even so confident that the tax cuts won’t put a dent in the overall tax revenue of the government. However economists are suggesting that the US economy is already growing as fast as it can and in order to improve its growth rate it needs to investment in productivity.

D Pull Inflation.jpegNevertheless, US tax cuts in the 1980’s under Ronald Reagan proved to be very effective in stimulating aggregate demand but the economic environment then was different to that of today. The 1980’s was an era of stagflation with the US experiencing 10% unemployment and inflation reaching 15%. Since the GFC in 2007 growth has been positive and unlike the 1980’s unemployment has been falling  – from 10% in Oct 2009 to 4.4% in April 20178. Tax cuts are all very well when you have high unemployment but with the rate falling to under 5% companies may find it difficult to respond to the greater demand for goods and services by taking on workers to increase supply. Tax cuts would then lead to an increase in inflationary pressure (see graph) which is turn would prompt the US Fed to increase interest rates.

ProductivityTrump’s plan would also increase the Federal deficit and borrowing from the government. This would put upward pressure on interest rates for the private sector which reduces the potential for further growth. As noted earlier the area that needs to be addressed is productivity, with a shift of the LRAS curve to the right – see graph.

Categories: Growth, Inflation, Interest Rates Tags: ,

Global Liquidity Trap

April 4, 2017 Leave a comment

The FT had an excellent article back in April last year that covered many concepts which are a part of Unit 4 of the CIE A2 Economics course. It covers the liquidity trap, deflation, MV=PT, circular flow, Monetary Policy, Quantitative Easing etc.

The article focuses on the liquidity trap with Monetary Policy being the favoured policy of central banks. However by pushing rates into negative territory they are actually encouraging a deflationary environment, stronger currencies and slower growth.  The graph below shows a liquidity trap. Increases or decreases in the supply of money at an interest rate of X do not affect interest rates, as all wealth-holders believe interest rates have reached the floor. All increases in money supply are simply taken up in idle balances. Since interest rates do not alter, the level of expenditure in the economy is not affected. Hence, monetary policy in this situation is ineffective.

Liquidity Trap

Normally lower interest rates lead to:

  • savers spending more
  • capital being moved into riskier investments
  • cheaper borrowing costs for business and consumers
  • a weaker currency which encourages exports

But when interest rates go negative the speed at which money goes around the circular flow (Velocity of Circulation) slows which adds to deflationary problems. Policymakers pump more money into the circular flow to try to stimulate growth but as price fall consumer delay purchases, reducing consumption and growth.

The article concludes by saying Monetary Policy addresses cyclical economic problems, not structural ones. Click below to read the article.

The global liquidity trap turns more treacherous.

China and the exodus of cash

March 5, 2017 Leave a comment

Another very good video from PunkFT. As the Chinese economy starts to slowdown by its standards (even at 6% growth) the Chinese are sending their money overseas in search of safer investments. In doing this they are often violating currency controls which are there to keep money inside China. The housing market in many countries have been driven up by the flood of cash from China – Vancover, Sydney, Hong Kong, New York and Auckland. Chinese spent almost $30 billion on U.S. homes in 2015.

How will authorities stop the outflow? One way is to increase domestic interest rates to encourage people to deposit their money in local banks. However this impacts those Chinese companies that borrow money and could prompt some debt-laden companies into deleveraging. Worth a look and great animations.

RBNZ cut OCR but little mention of Trump

November 10, 2016 Leave a comment

Although the attention this morning was on the election of Donald Trump as US President the RBNZ cut the OCR to 1.75% with a mild easing bias of “numerous uncertainties remain, particularly in respect of the international outlook, and policy may need to adjust accordingly”. nz-cpi-nov-16

It is expected that the OCR will remain at this level in the near future with inflation expected to be back within the 1-3% Policy Target Agreement (PTA) by the end of January next year – see graph from ASB Bank. The reason for this is that:

  • Dairy prices have recovered considerably.
  • The labour market is tightening.
  • Growth is running at an above-trend pace.
  • The OCR is already at an expansionary rate and the economy.

Could there be another cut in the OCR? There would be pressure if the following eventuated:

  • there is a strengthening of the NZ dollar,
  • increasing bank funding costs,
  • any further weakness in inflation expectations,
  • any deterioration in the global growth outlook.

The change of US Presidency will also be a wildcard over the longer term, with its mix of potential fiscal stimulus and trade protectionism. Trump has already signaled that he is not keen to sign TPP and he wants to reopen the NAFTA – North America Free Trade Agreement. Furthermore, he might take umbrage on the Chinese with their manipulation of the Yuan to advantage its exports and put a large tariff on its goods coming into the US. For New Zealand it may mean that they have to go down the bi-lateral agreement option in order to increase trade.

Other than the US election, Graeme Wheeler needs to be aware of the following:

  • Theresa May has indicated she wants to trigger Article 50 by May 2017 – it is very unclear what the process will be and the negotiating strategy of both the UK and the EU. This could have implications for NZ trade.
  • In China the increasing of centalised  power of the President.
  • China has a huge amount of corporate debt relative to GDP – see graph below.
  • Brazil is still in recession
  • Russia still has issues in the Middle East

China Corporate debt.png

Monetary policy – not too tight in New Zealand?

October 26, 2016 Leave a comment

Brian Fallow of the New Zealand Herald wrote a very informative article on the inflationary target that the Reserve Bank of New Zealand keeps missing – the CPI has been below the bottom of the bank’s 1 to 3% target band. Some will say that the RBNZ has been too tight with its monetary policy stance – maintaining high interest rates for too long. Assistant Governor John McDermott has defended the bank’s position for the following reasons:

  1. Nearly half the CPI consists of tradables where the price of goods is impacted by competition from outside New Zealand. For the last four years the global economy has been in a disinflationary environment caused by excess supply and in particular low commodity prices especially oil. Year ending September 2016 Tradables = -2.1%. This offset almost all of the +2.1% rise in non-tradables prices. See graph below.
  2. The recovery form the GFC has been quite weak and with the NZ$ strengthening (imports cheaper) accompanied by lower world prices has meant that import prices have been very low.
  3. The growth of the supply-side of the economy has been particularly prevalent which again has led to less scarcity and lower prices.
  4. Recent years has seen immigration boost the demand side of the economy but because the age composition is between 15-29 rather than 30-40 in previous years, the former has a much less impact on demand as they don’t tend to have the accumulated cash for spending.
  5. The RBNZ reckon that the output gap is now in positive territory (actual growth being higher than potential growth) which will start to put pressure on prices as capacity constraints become more prominent.
  6. Statistically with a weak inflation rate in the December 2015 quarter the December 2016 quarter is most likely to be higher as the percentage change is taken on the CPI of the previous year.

nz-cpi-2004-2016

The spectre of deflation hitting the New Zealand economy does not seem to be a concern at this stage especially with the longer-term inflationary expectations being in the mid range of the target bank i.e. 2%.

New Zealand and Global Economy Update for exams.

October 10, 2016 Leave a comment

It is important that you are aware of current issues to do with the New Zealand and the World Economy. Examiners always like students to relate current issues to the economic theory as it gives a good impression of being well read in the subject. Only use these indicators if it is applicable to the question.

Indicators that you might want to mention are below. Notice how low global interest rates are as economic conditions have warranted greater borrowing and spending in the world economy.

New Zealand

The New Zealand economy expanded by 2.8 percent over the year ended in the June quarter driven mainly by an increase in household consumption of 1.9 percent over the quarter, while exports of goods and services rose by four percent. The construction industry expanded by a further five percent in the quarter, while the retail, hiring, and real estate services industry expanded by 1.3 percent. The annual current account deficit totalled $7,383 million in the year ended June 2016, equivalent to 2.9 percent of gross domestic product (GDP). nz-economy-oct-16

Global Economy 

The OECD in its September Interim Economic Outlook comglobal-growth-and-unemp-ratesmented that the world economy remained “in a low-growth trap”, with GDP growth of 2.9 percent predicted for 2016, before rising slightly to 3.2 percent in 2017. Subdued economic growth is forecast for the major advanced economies, with growth for the United Kingdom expected to drop from 1.8 percent in 2016 to one percent in 2017. The Chinese economy is expected to grow by 6.5 percent in 2016, easing to 6.2 percent in 2017 as it moves from an investment-led to a consumption-led growth model. In mid-2009, the unemployment rate for both the Euro area and the United States was approximately ten percent. Since then the unemployment rate for the United States has fallen to 4.9 percent, while the unemployment rate for the Euro area peaked at over 12 percent in 2013, and currently sits just above 10 percent.

Low interest rates internationally have resulted in asset price inflation, particularly in share and house prices. Monetary policy can only do so much but with global interest rates at approximately zero there needs to be the support of the politicians to enlist a much more stimulatory fiscal policy.

central-bank-rates-oct-16

Source: Monthly Economic Review: New Zealand Parliamentary Library

Monetary Policy needs help

September 28, 2016 Leave a comment

In the 1970’s and 1980’s the global economy was battling the menace of stagflation – high inflation and high unemployment. In order to counteract this, monetary policy was seen as responsible for controlling the inflation rate through the adoption of targeting. The New Zealand government was the first country to introduce this through the Reserve Bank Act 1989 which gave the responsibility of the central bank to keep inflation between 0-2% (later changed to 1-3%). Monetary policy should therefore play the lead role in stabilizing inflation and unemployment with fiscal policy playing a supporting role with automatic stabilisers –  economic stimulus during economic downturns and economic contractions during high growth periods. Fiscal policy is therefore focused on long term objectives such as efficiency and equity.

In the post financial crisis world the usefulness  of monetary policy is dubious. The natural rate of interest has now dropped to historical low levels. The natural rate of interest being a rate which is neither expansionary or contractionary. The issue for the central banks is how to bring about a stable inflation rate when the natural rate of interest is so low.

Historical Natural Rates of Interest 

inflation-n-rate-of-interest

In the 1990’s the natural rate of interest globally was approximately between 2.5% and 3.5% but by 2007 these rates had decreased to between 2 – 2.5% – see graph. By 2015 the rate had dropped sharply and as can be seen from the graph near zero in the USA and below zero in the case of the euro zone. The reasons for this decline in the natural rate were related to the global supply and demand for funds:

 

  • Shifting demographics and the ageing populations
  • Slower trend productivity and economic growth
  • Emerging markets seeking large reserves of safe assets
  • Integration of savings-rich China into the global economy
  • Global savings glut in general

Therefore the expected low natural rate of interest is set to prevail when the economy is at full capacity and the stance of monetary policy in neutral. However this lower rate means that conventional monetary has less ammunition to influence the economy and this will mean a greater reliance and other unconventional instruments – negative interest rates. In this new environment recessions will tend to be more severe and last longer and the risks of low inflation will be more likely.

Future strategies by to avoid deeper recessions.

Governments and central banks need to be a lot more creative in coping with the low natural rate environment. Fiscal policy could be used in conjunction with monetary policy with the aim of raising the natural rate. Therefore long-term investments in education, public and private capital, and research and development could be more beneficial. More predictable automatic stabilisers could be introduced that support the economy during boom and slump periods. Additionally unemployment benefit and income tax rates could be linked to the unemployment rate. The reality is that monetary policy by itself is not enough especially as the natural rate of interest  and the inflation rate are so low. What can be done:

  1. The Central Bank would pursue a higher inflation target so therefore experiencing a high natural rate of interest which leaves more room to cut to stimulate demand. The logic of this approach argues that a 1% increase in the inflation target would offset the harmful effects of an equal-sized decline in the natural rate
  2. Inflationary targeting could be replaced by a flexible price-level of nominal GDP, rather than the inflation rate.

Conclusion

Monetary policy can only do so much but with global interest rates at approximately zero there needs to be the support of the politicians to enlist a much more stimulatory fiscal policy. Monetary policy has run out of ammunition and we cannot rely on central banks to fight recessions. However a less politicised fiscal policy, which is free to act immediately, has the ammunition to revive the economy.

Sources:

Monetary Policy in a low R-star World – FRBSF Economic Letter

The Economist: September 24th 2016 – The low-rate world

A2 Revision: Keynes 45˚ line

September 14, 2016 Leave a comment

With the Cambridge A2 exam coming up here is a revision note on Keynes 45˚ line. A popular multi-choice question and usually in one part of an essay. Make sure that you are aware of the following;

Common Errors:
1. C and S are NOT parallel
2. The income level at which Y=C is NOT the equilibrium level of Y which occurs where AMD crosses the 45˚ line.
To Remember:
1. OA is autonomous consumption.
2. Any consumption up to C=Y must be financed.
3. At OX1 all income is spent
4. At OB consumption = BQ and saving= PQ
5. Equilibrium level of Y shown in 2 ways
a) where AMD crosses 45˚ line
b) Planned S = Planned I – point D

Remember the following equilibriums:
2 sector – S=I
With Govt – S+T = I+G
With Govt and Trade – S+T+M = I+G+X

New Zealand Household Debt

September 9, 2016 Leave a comment

Household debt in New Zealand is now equivalent to 163% of annual household disposable income – see graph below. Record low interest rates has seen credit growth rising at a pace not seen since 2008. How do low interest rates contribute to this?

Household debt as a share of disposable income (including investment housing)

house-debt-dis-inc

Low borrowing rates have made it easier to purchase property with bank funds especially as the supply of housing hasn’t matched the increase in demand. The strong growth in property prices has meant that those who already own a house are using that security to purchase additional property. According to the IMF New Zealand has the highest ‘House Price-to-Income Ratio’ – see graph below.

house-price-income-ratio

Other parts of the world are experiencing high household-debt to income levels (see graph below) but does high debt levels mean that the economy is going to hit a major recession? Since the credit crisis of 2008 the global financial system has seen tighter regulations put in place to improve stability with banks limiting access to credit so there is less exposure to the risks associated with highly leverage lending.

Growth in house prices and household credit 2011 – 2015.

house-prices-household-credit

However debt servicing remains tolerable with low interest rates and much of the debt secured against investment housing. Also debt-to-asset ratios have fallen to levels that were experienced in 2007 but this has eventuated from low interest rates which have boosted house prices. Ultimately with a fall in house prices, and depending on its severity, those who recently entered the property market would suffer some degree of hardship whilst those already well established in the market might have a financial  buffer.

Debt and future growth in New Zealand

Household debt still has implications for the long-term growth of the economy.

  1. With larger proportions of their income being allocated to debt consumers have less disposable income for other goods and services which creates less aggregate demand.
  2. High debt levels mean households have more exposure to unfavorable economic conditions that could lead to rising unemployment. In this case they have less money to fall back on.

Source: Westpac Economics Overview – August 2016

Yellen’s Taylor Rule suggest Fed Funds rate of 1.33%.

September 7, 2016 Leave a comment

From her Jackson Hole speech US Fed Chair Janet Yellen used the Taylor Rule to suggest that the Fed Funds rate today should already be around 1.33% – currently at 0.50%. She also used the Taylor rule to explain how US interest rates should have been negative after the Global Financial Crisis. This same rule suggests that the rate should already have been 1.25% in June – see Chart below.

Taylor Rule

Source: National Australia Bank: Australian Markets Weekly – 5th September

What is the The Taylor Rule?

This is a specific policy rule for fixing interest rates proposed by the Stanford University economist John Taylor. Taylor argued that when:

Real Gross Domestic Product (GDP) = Potential Gross Domestic Product and

Inflation = its target rate of 2%, then the Federal Funds Rate (FFR) should be 4% (that is a 2% real interest rate).

If the real GDP rises 1% above potential GDP, then the FFR should be raised by 0.5%.

If inflation rises 1% above its target rate of 2%, then the FFR should be raised by 0.5%.

This rule has been suggested as one that could be adopted by other central banks – ECB, Bank of England, etc for setting official cash rates. However, the rule does embody an arbitrary 2% inflation target rather than, say 3% or 4%, and it may need to be amended to embody alternative inflation targets at different times or by different central banks. The advantages of having such as explicit interest rate rule is that its very transparency can create better conditions for business decisions and can help shape business people’s and consumers’ expectations. Central banks prefer to maintain an air of intelligent discretion over the conduct of their policies than to follow rules, but to some extent they do unwittingly follow a Taylor rule. This makes the rule a useful benchmark against which actual policies can be judged.

RBNZ cut OCR but NZ$ on the rise

August 15, 2016 Leave a comment

Last Thursday it was no real surprise that the RBNZ cut the official cash rate to 2%. With this cut you would have expected some fall in the value of the $NZ but instead it appreciated. So why did the $NZ appreciate? Graeme Wheeler was interviewed by NZ Herald reporter Liam Dann and explained to him that we live in a phenomenal situation. Global interest rates have been incredible low especially in countries like Japan, the UK and Australia – see table below. Add to that the impact of quantitive easing since 2009 and negative interest rates in countries which account for 25% of world GDP and you have a very unusual situation.

CB Rate Aug 16

Some key assumptions from the RBNZ are that:

The global economy will start to pick-up which will mean that there will be less pressure on the NZ$ as investors look to other currencies to invest in. Remember that the NZ$ is the 10th most traded currency in the world and at uncertain times in the global economy it is seen as safe place to ‘park’ your money. This therefore increases the demand for NZ$’s appreciating its value.

Also the growth of the domestic economy with GDP expanding by 2.4 percent over the year ended in the March 2016 quarter, could mean a rise in inflationary expectations which should bring the inflation rate closer to the 2% mid point method in the policy target agreement. However this is a drop from 3.2% from the previous year.

According to Stephen Toplis of the BNZ 

Clearly, the NZD is already higher than anticipated and inflation expectations could well be constrained for longer as annual headline inflation falls, potentially, sub-zero. It was also interesting that the RBNZ did not repeat its upside scenario for interest rates due to higher house prices. This reaffirms the Bank’s easing bias.

All things considered then, and noting there is still significant uncertainty as to the exact way ahead, we can reasonably comfortably conclude that:

–  There will be at least one more rate cut;

–  The balance of risk is for even more;

–  The cash rate is going to be at least as low as it is now for a long time;

–  Inflation is likely to continue surprising to the downside in the near term;

–  Only when the rest of the world plays ball will the NZD wilt.

Does the RBNZ need to cut the OCR?

August 7, 2016 Leave a comment

With the RBNZ to announce the Official Cash Rate next Thursday there is common agreement that there will be a 0.25% cut to leave the OCR at 2.00%. However with 2.8% growth and a favourable PMI do the RBNZ need to cut rates? With inflation at 0.4% it is still not between the 1-3% target range (as outlined by the Policy Target Agreement in the Reserve Bank Act 1989), and there is pressure for the central bank to hit a target of 2% inflation. With the global economy in an era of very low inflation (even a threat of deflation) one wonders the logic of keeping the PTA at 1-3%. In fact it is being reviewed by the RBNZ in the next month. The logic behind the lower OCR will be to stimulate more spending but also trying to make the NZ$ less attractive for foreign investors.

NZ Economy

With NZ rates being significantly higher than other developed countries the NZ$ is seen as a good investment and ultimately attracts a lot of ‘Hot Money’ into the economy. The NZ$ is the 10th most traded currency in the world and this is also due to the stable environment in the NZ economy as well as relatively high interest rates. But have the lower rates had the effect of reducing the value if the NZ$? A lower dollar makes exports prices more competitive and increases the price of imports.

Interest Rates NZ$

If you contrast the OCR with the TWI over the last year you will see that a lower OCR doesn’t necessarily mean a lower NZ$. Furthermore the lower rates do nothing to halt the rise in the property market especially in Auckland.

The RBNZ faces potentially conflicting outcomes as it tries maintain financial stability and price stability. The Policy Targets Agreement demands lower interest rates in a bid to raise CPI inflation while financial stability concerns, especially with the housing market,  probably demands higher rates.

Images from ANZ Bank

Negative Interest Rates – What it means?

July 8, 2016 Leave a comment

The aim in many developed countries is to stimulate economic growth and to raise inflation within the target bands as stipulated by many government’s central banks. For some countries the immediate objective has been to prevent their currency from rising making their exports more expensive and imports cheaper. Therefore the thought of negative interest rates discourages investors from buying your currency which would push up its value. The EU, Denmark, Sweden, Switzerland and Japan, central banks have decided to have a negative rate on commercial banks’ excess funds held on deposit at the central bank. In effect, private sector banks have to pay to park their money – see graph below.

New Zealand is currently in a bit of a predicament in that the OCR (central bank rate) is at 2.25% which is relatively high compared to other central banks and therefore does attract ‘hot money’ into the economy – money that ‘parks’ to earn interest. However if they drop interest rates to ease the pressure on the NZ$ they run the risk of further inflating the housing market by making borrowing cheaper.

For the consumer as soon as the rate banks offer fall below 0%, savers have an incentive to withdraw their money and put it under the mattress. By charging negative rates the central banks are hoping that the trading banks will keep more of their money and therefore lend it out to investors. However the desire to reduce a banks reserves is futile as if someone borrows money from a bank and buy a new car the money is paid to the car company who will then deposit the money in their account which increases the reserves of the bank.

Overall negative rate reflect the constant state of weak aggregate demand in many developed economies since the 2008 financial crisis. Central banks have kept their policy interest rates very low to stimulate economic growth and more recently to get higher inflation. However, how low can they go?

Negative Interest Rates

Below is a very good cartoon from the FT looking at negative interest rates.

 

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