Deflate inflationary expectations: this is something we need to do as soon as possible

If there’s one thing I can say with some degree of confidence about the economy, it’s that the choice of 3.07% inflation for New Zealand two years from now in the last quarterly report Reserve Bank Expectations Survey will be “false”.

These surveys of a small group (usually in their 30s) of professional forecasters and business leaders have track records that include a forecast made two years ago that the rate of inflation would currently be of 1.43%.

It is 7.3%.

Well, that’s quite a dud, isn’t it.

Fire a lot of them and never bother watching this investigation again.

Yes, but wait…

What is the point of this survey, really?

I can assure you that it is not a question of gleaning predictions of numbers which will turn out to be “correct” to one decimal place.

The Reserve Bank (RBNZ) does not take such things as gospel. He won’t look at the latest survey results and pencil in 3.07% inflation like the number we’ll see in 2024.


What the RBNZ will do is breathe a huge sigh of relief that the two-year inflation forecast has come down significantly from the previous survey’s forecast of 3.29%. In terms of the types of movement in forecasts normally seen in this series of surveys, this is a big movement that happens in just the space of one survey.

What the RBNZ can take away from the latest survey is that its vigorous anti-inflationary rhetoric, coupled with super aggressive hikes in the official exchange rate, is starting to change views on what will happen to inflation. .

And that’s the point. The survey takes the pulse and finds out how people are feeling. Predictions as such are only a means of expressing sentiment.

I’m not sure the central bank would necessarily agree with this assessment, but these surveys can actually be seen as a sort of assessment of the bank and the work it does on monetary policy, and more particularly how it goes about keeping inflation within its target range of 1% to 3%. It really comes down to credibility and whether the wider population thinks the RBNZ is doing its monetary policy job. It’s about whether people believe the RBNZ when it says it will bring inflation down.

This inflation “forecast” of 3.29% in the previous quarter was the survey respondents actually telling the RBNZ, “Hey, guys, we don’t think you have that.”

The very steep drop to 3.07% this time could be interpreted as something like, “That’s much better. You’re not there yet, but you’re on the right track now.

The RBNZ itself, according to its May forecast, has an inflation rate of 2.2% two years from now. So bettors don’t fully believe in the central bank yet, but they are getting closer to the page the RBNZ is on.

The thing to remember about predictions of future inflation is that the predictions themselves can help influence the outcome.

If you run a business and expect your costs to increase by 20% in a year (God forbid!), then it makes sense to start anticipating the prices you charge. And guess what? Your actions then fuel inflation.

If, however, you think Mr. Reserve Bank has it all figured out and a life of carefree 2% inflation awaits you, then your future pricing will reflect that.

And as far as the RBNZ is concerned, remember that it is watching these survey results very closely and will be influenced by them in its interest rate moves.

If the latest survey had shown that these inflation expectations were rising again – despite the interest rate hikes and the RBNZ jaw that has occurred over the past quarter – then we can be very confident that a 75-point rise in OCR would come into play next week. (August 17) OCR review.

One of the most watched things in next week’s review (and I would say, in fact the MOST watched) will be what the RBNZ comes up with in terms of forecasts (over the next three years) of OCR .

Now, again, it’s not really RBNZ predicting what OCR will be like. This is the RBNZ’s best estimate, all things being equal, of the kind of level the OCR might need to be at to meet the central bank’s inflation target.

If inflation suddenly goes off a cliff, the RBNZ will not stubbornly stick to an OCR of 4% three years from now (well, I hope not!) just because it forecasts such a level. No. This will remove the OCR. The RBNZ will be happy to be “wrong” or “inaccurate” with its OCR forecast. Very happy!

The thing is though, by increasing these forecast levels when an OCR forecast ‘trail’ was last released (in May), the RBNZ did a lot to hammer home the message that it was seriously serious about bringing down the ‘inflation. And that in turn overturned those pesky inflation expectations.

This, in turn, means the RBNZ may not need to raise the OCR as high as it predicted in May – although that’s not clear yet (and I don’t foresee it !)

The inflationary shocks of the 1970s and 1980s left many ingrained inflation expectations in the public. People just expected prices to rise and so based their expectations of rising wages etc. on those inflationary expectations. It was one of the great triumphs of the modern era of inflation targeting that these expectations were – over time – drowned out.

Inflation has been back with us in a serious way for only about a year or so, but it is already showing signs of getting its feet under the table and getting comfortable. The latest labor market figures for the June quarter showed that wage increases are taking off – not surprising in the face of inflation at 7.3%.

But how are employers reacting to these wage increases? Especially if they don’t believe inflation will go down? Well, raising prices of course, which makes goods more expensive for their employees, who then come for higher wages, etc., etc.

The upshot is that the RBNZ didn’t have very long to “kill” inflation expectations before we faced a likely scenario of continued high inflation.

Economists believe that 7.3% will turn out to be the peak of our inflation – but that doesn’t mean the inflation behemoth will come back into the hole and leave us with a nice, benign 2% again. No. Imagine if inflation was still 6% in five years? Whole new generations of people will discover how unpleasant and pervasive persistent inflation is.

So, to go back to the very beginning. Hey, I admit I may have lied a bit. As far as I know, the inflation rate could be 3.07% in two years. I do not know. Nobody does.

What I do know is that the real story is that people are starting to believe that inflation is going to come down. And that’s what matters.

The RBNZ will not be outdone, however. Neither should he.

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