Matt Nolan

Targeting non-tradable inflation: Some points

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Bernard Hickey has stated that the RBNZ needs to target non-tradable inflation.  Fair enough, I’ve heard the argument for that before.

However, he says we should do it because of the “structural flaw” in our economy and to “help exporters”.  Ok, but remember that the RBNZ controls monetary policy – not all the structural policies in the economy.  So what happens when they target “non-tradable inflation”

  • The RBNZ lowers non-tradable inflation by increasing interest rates further … likely leading to an even higher currency.

In this context, the stated aim of targeting non-tradable inflation doesn’t met the goal.

Now Bernard Hickey likely believes that there are structural reasons why non-tradable prices are growing more quickly than relative-tradable prices.  And he would right.  The reasons are:

  • The Baumol effect, where services become relatively more expensive as we become more wealthy
  • A related issue that tradable goods experience larger increases in productivity than non-tradable goods (as they tend to be more capital intensive, and face more competition)
  • Competition issues due to our scale
  • Issues of the size of government
  • The combined impact of our rising terms of trade and productivity improvements in developing economies (which has held down imported cost pressures – ex fuel).

In this context the only two “policy relevant” issues that have changed the “structure” of our economy are competition issues and the size of government – both things that fiscal authorities and competition authorities should look at … not the RBNZ.  All the other changes were responses to fundamental changes in our economy.

Protip:  Our manufacturing sector is shrinking because it is relatively less efficient than the rest of the world – we are “relatively better” at making other things (comparative advantage).  NZ has done amazingly well from this – with our real incomes holding up, and our employment ratios still elevated, even WHILE the world has experienced the largest economic shock since the Great Depression.

tl;dr  Targeting non-tradable inflation won’t give the “structural changes” that are desired here – and “structural” issues are due to competition and fiscal policy, not inflation targeting.  Changing around the inflation target will actually lead to the opposite outcome than the one that is being targeted.