Matt Nolan

Damned if you do, damned if you don’t

/in , /by

The daily post for today has been delay to next week – as this issue needs to be covered now.

That’s what the RBNZ is likely hearing when columns like this appear.  This one is from Bernard Hickey, where he bemoans the Bank’s decision to signal an increase in interest rates (which will increase long rates, and so IS an increase in interest rates) which has lead to a slight tick up in the currency.

The logic of the article might seem seductive for those who feel we must “transform” the economy, and those who believe we can truly “command and control” an entire economy.  But it is false.  Let me explain.

The argument

The argument is as follows:

  1. Putting up interest rates leads to a higher exchange rate,
  2. Overseas central banks have rates too low, which leads to a higher exchange rate for NZ and inflation overseas,
  3. New Zealand’s rates are also artificially low
  4. There is free flow of capital
  5. Therefore, we are giving money to borrowers not investing and not exporting.

To be frank, this is not an argument in itself.  I am sure that Bernard Hickey has an argument for what he believes – but this is a set of inconsequential facts and non-facts that don’t logically bring us to our conclusion.  This is just how I read the article, and that was the set of points I took out – and personally found contradictory in some ways.

That sounds harsh, but in this case I have to be completely honest – I am getting very sick of many people, including other economists, throwing out soundbites of jargon.  One of the best way I’ve heard it described is that “there is an issue, but we’ve defined it too loosely and so don’t understand it” – if we don’t understand it we DON’T know how to respond to it!

Now I do believe that Hickey has a consistent argument in his head.  I would say it is the following:

  1. Given foreign central banks are keeping rates too low (and therefore generating inflation) our dollar is being pushed up beyond its fair value
  2. However, due to the fact that not all prices adjust immediately, this causes hardship (effectively, other countries are subsidising exports) – as a result, potentially we should see if there is some way we can avoid exacerbating this “imbalance” while controlling inflation,
  3. Therefore, why not use a different instrument instead of the OCR – one that allows us to subsidise exports back, but keep control of inflation.

Now, I discussed on Wednesday why changing the core funding ratio doesn’t make sense in the current situation – we need a good full understanding of how other countries are “manipulating their currency” before we make these “structural shifts” to the economy – it isn’t a cyclical monetary policy instrument.   On top of that, there are real short and long term negative consequences from increasing the CFR – consequences that are being ignored constantly.  In the case the best, and sort of the only, instrument to battle inflation is the OCR.

One of the other issues with this argument is, if the interest rates overseas are “too low” where is the inflation?  If its in asset prices, where is the stockpiling of resources associated with this?  Keep in consideration here that the Euro zone is HIKING rates during this crisis – because it is so averse to inflation.  So the argument that debt is being inflated away doesn’t pass the smell test either.

One final point to keep in mind – say that there is currency manipulation, and that other countries are effectively subsidising their exports to sell them to us.  Read that line again.  They are PAYING part of the price of goods for us to buy them, they are PAYING out of their INCOME to give it to us.  In such a situation it might turn out that we aren’t the losers from this – the taxpayers in the country that is doing this are likely to be the real losers!