A couple of weeks ago, the Waikato Times (23 September 2002) had an editorial praising the new Policy Targets Agreement which the Minister of Finance had just concluded with the new Governor of the Reserve Bank.
Among other things, the editorial stated that “the aim of the new PTA is to give an opportunity for greater economic growth…. Critics say changing the inflation band will not produce economic growth. They miss the point. Changing the band won’t produce growth but it can promote growth by creating more certainty for businesses.”
The new PTA won’t “produce” economic growth but it can “promote” economic growth, it was claimed. This is playing with words.
The reality is that there is no evidence, or certainly none which I have seen, that tolerating a bit more inflation (which seems to be the Minister’s intention) will promote or produce any more growth at all.
Why would more inflation create “more certainty for businesses”, and therefore more growth? On the contrary, we know from experience that higher inflation tends to create more uncertainty, not more certainty.
Higher inflation tends to go hand in hand with greater volatility of prices, making investment decisions more difficult.
Higher inflation clearly leads to higher interest rates, not lower interest rates.
But surely the new PTA is an improvement, in that it directs the Reserve Bank to achieve the inflation target over the medium-term, not over every 12 monthly period? But the Reserve Bank has interpreted the PTA in exactly that way for some time, operating monetary policy with a view to getting inflation back to target over a period of years, to avoid unnecessary volatility in output, in interest rates, and in the exchange rate.
Recall that inflation in the year to December 2000 was 4.0 per cent. Yet the very next interest rate move by the Reserve Bank, in March 2001, was a reduction in the Official Cash Rate, precisely because it was aiming to get inflation back within target over a rather lengthy period.
Recent research by the Reserve Bank, written after I left the Reserve Bank and published just a few weeks ago, makes it clear that in recent years monetary policy in New Zealand has been operated in a way closely similar to that in the United States and Australia.
Certainly, to judge by the current buoyancy of the economy, it is very hard indeed to argue that monetary policy has been too tight in recent times.
In many ways the most worrying thing about the new PTA is reflected in the Waikato Times’ editorial reaction. There is a perception that somehow the Government has done something significant towards advancing the goal which we all share, of increasing New Zealand’s growth rate.
That is undoubtedly a crucially important goal, and in my view the most important goal facing us as a country. Unless we succeed in doing that, the gap between our living standards and those in Australia – a gap which has opened up over the last 40 years – will continue to widen, with devastating medium-term implications for our way of life.
Sadly, tolerating more inflation does nothing for that goal. And creating the perception that it does reduces the pressure which should be on the Government to do the things which can really make a difference to growth, like reducing the compliance costs facing small and medium-sized businesses, improving the skills of the workforce, fixing the infrastructure problems which are holding us back, and reducing the tax burden which we all carry.
Copyright © 2024 Don Brash.