Deborah Coddington for Reserve Bank Governor
Former ACT MP Deborah Coddington has got it dead right with her excellent article on Reserve Bank heavy handedness in yesterday's NZ Herald. Some excerpts
It's difficult to admit you were wrong, so I'll take a deep breath. Thirteen years ago I wrote in praise of the Reserve Bank Act's price stability agreement and its single objective of achieving stable prices. Foolishly, I didn't ask why price stability was a noble objective, just accepted that keeping inflation below 2 per cent was a good thing.
But when the current Reserve Bank Governor Dr Alan Bollard lifted the official cash rate for the ninth time in two years, I started to wonder... We don't have massive unemployment, free trade with China has given NZers cheap and plentiful goods, the Labour Government hasn't dramatically reversed much of the Lange-Douglas deregulation and privatisation. So where's the inflation bogeyman we're so terrified of?
Why do we persist in calling a commodity price rise inflation?
At the moment property's to blame - there are more buyers than land and buildings for sale, so prices go up. Dr Bollard wants property prices to fall, so he raises the price of money. I don't get it. Money suppliers are permitted to earn more, but property suppliers aren't.
Lifting the cash rate makes the Kiwi dollar very desirable, so the exchange rate goes up and that really hurts exporters, who are also manufacturers and/or producers. They get squeezed, respond rationally by closing plants and reducing staff, unemployment goes up, productivity goes down, social welfare spending increases, so we get inflation. You could argue the Reserve Bank causes inflation.
How can those who say they support a free-market economy based on supply and demand also support a state-owned institution legally charged with freezing prices?
Last week Dr Bollard raised the cash rate to 7.25 per cent - the highest it's ever been. But two out of three homeowners in New Zealand don't have mortgages and 80 per cent of those who do have mortgages are on a fixed rate of interest. Yet Bollard firmly predicts his intervention means house prices will drop by 5 per cent and reckons he's been "saying this for two years so you'd have to be pretty thick not to get it".
Well, how thick do you have to be to answer me this: New Zealand is hugely dependent on manufacturing, agricultural production and exporting, so why do we tell that sector they're bad people, not needed for wealth creation? Just because good people want to buy property?
Indeed Deborah. Commodity price rises are not inflation. They are simply manifestations of the law of "supply and demand". Inflation is the process whereby government "inflates" the money supply and dilutes it value to cover budget deficits.
In other words, a government doesn't have enough cash to pay its bills. Its afraid to put up taxes. So it prints extra money so that more and more paper money or credit is in circulation. This bids up prices all over the economy .
Inflation is the cause, rising prices are the effect. Alan Bollard is attempting to smash down housing prices by beating up on the whole economy. It's like cutting off your leg to get rid of an ingrown toenail.
Question. Deborah Coddington is a journalist. How come she understands economics better than the Reserve Bank governor?
posted by Trevor Loudon at
12/19/2005 11:11:00 AM
2 Comments:
Finally some compalaints! I wonder how much inflation is excluding oil? How does putting up the NZ OCR reduce the world price of oil?!
Rising costs of production is one of several causes of inflation. Reserve Bank analysts do try to separate cost related inflation from demand related inflation, at least to some extent. Sometimes cost push inflation can indirectly effect demand pull inflation if it causes consumers to expect a price rise in the future. If consumers have this expectation they would spend up now if possible which causes prices to rise even further due to an increased demand.
Another cause of inflation is printing off new money without replacing the old money. This is done mostly by uneducated dictators.
Another cause of inflation is credit creation. Let’s say that someone deposits $1000 in a bank. The bank lends that $1000 to someone who spends the money on something. If the person who receives that money puts that money in a bank account with the same bank, the bank could lend out that same $1000 again. This is the reason why notes and coins only represent a small percentage of the real money supply. Banks expand the money supply and in doing so, cause inflation. If everyone tried withdrawing all of their savings at the same time, all banks would go bankrupt.
Some governments put in place rules which enforce banks to match at least a certain percentage of their deposits with notes and coins. This percentage changes as the business cycle does in order to keep inflation at a consistently low level. New Zealand uses a different method where the Reserve Bank changes the OCR (official cash rate). Registered banks may lend to or borrow from the RB at 5 points below or above the OCR respectively.
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