More credibilty at homeowners’ expense

More credibility at homeowners’ expense

More credibility at homeowners’ expense

Alan Bollard’s recent reappointment asgovernor of the Reserve Bank for another five years saw Michael Cullen lauding"his integrity and outstanding general management skills".   Those qualities maynot be in question, but in terms of actually doing his job and keeping acredible rein on inflation, Dr Bollard’s results have been unimpressive.  Nevertheless, this year’s interest rate rises have shown a steelier side to theReserve Bank governor, and imply little hope of relief for mortgage holders inthe foreseeable future.

As governor of the Reserve Bank, DrBollard has been charged with keeping inflation between 1% and 3%pa for thelast 18 quarters.   Simply running one’s eyes over the numbers shows that therehave been five quarters where he’s failed to achieve his target, giving him a62% success rate.   In contrast, if we look at Don Brash’s efforts between 1993and 2002, he hit the bull’s eye 78% of the time.   And Dr Brash had a moredifficult target to aim at, down at 0-2%pa for the early part of his reign.

Graph 1

Supporters of Dr Bollard will be quick tosuggest that he’s been a victim of circumstance.   After all, it’s virtuallyimpossible for anyone in little old New Zealand to prevent the 42% surge inpetrol prices that occurred over a 15-month period in 2005/06.   In thissituation, the Reserve Bank’s role then becomes one of containing the public’sexpectations of future inflation.

This area is where Alan Bollard’sperformance is most disappointing.   Over the last 4 ½ years, the Bank’s ownforecasts of inflation two years down the track have averaged 2.6%pa – not muchbelow the ceiling of the Bank’s 0-3% target.   Even last week’s Monetary PolicyStatement showed that the Bank expects inflation still to be at 2.8% bymid-2009.

Graph 2

If the organisation charged with keepinginflation under control is so unconvinced about its own effectiveness, whyshould the general public believe that price stability is a given?   The figuresare even starker when compared with the Bank’s two-year inflation forecastsbetween 1997 and 2002.   With an average forecast of 1.5%pa, Don Brash had hissights firmly on the mid-point of the inflation target band.

Domestic inflation has been Dr Bollard’sbugbear.   However, he’s been so scared of destroying the export sector with thestrong currency over the last four years that he’s almost felt obliged to letinflation pressures build more than they should have.   He now appears to havedecided to ignore any squeals of pain from exporters and focus on his core jobof ensuring price stability.

Alan Bollard’s reappointment follows twoyears virtually learning on the job and another two years working up thecourage to dictate to, rather than follow the lead of, financial markets.   Hisnext five-year term provides him the opportunity to atone for the mistakes ofthe last five years, when his approach to setting monetary policy has too oftenerred towards the "softly, softly" end of the spectrum.

Getting the public’s inflationexpectations back down will require an extended period of high interest rates.  Even if economic conditions are right for the official cash rate to be cut bythe end of next year, which is by no means a given, mortgage holders shouldn’tbe hoping for much of an easing.   An OCR of 7% (or floating mortgage rates of9%) may be all the pain relief the Doctor can administer.

The economy will suffer consequences of AlanBollard’s learning curve.   Demand conditions will be cramped by high interestrates, economic growth will remain below par, and some rise in unemploymentseems inevitable.   Profit margins have been heavily squeezed over the last twoyears, but there will be little opportunity for businesses to improve theirprofitability given the tough trading conditions now upon us.

The positive aspect of Dr Bollard’sreappointment is that he is in a position to rectify his past mistakes.   Hopefullyhe will repay this faith by coaxing the inflation genie back into its bottle,thus laying the foundations for a stronger economic performance further downthe track.

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