Alan Bollard’s job is to tame inflation. Sounds simple. But he has to do that for an economy which is a pingpong ball on the waves of the world economic ocean.
Michael Cullen has much the same problem, as Bill English will have if he succeeds him. At most a government in a mini-economy can adjust policy settings to optimise our capacity to make the best of human and other resources, whatever the world throws at us, good and bad.
Cullen and English can’t magically make us a “Middle East of minerals”, which Australia now is, nor fix world demand and prices for oil and dairy products.
They can influence the building of human capital through education and related social policies, encourage investment through tax, regulatory and planning consent policies, ensure the hard and soft infrastructure is up to scratch and ensure fiscal and social policies complement and do not thwart economic opportunity.
To do that they need rational, nuanced debate predicated on the national interest, not sectional or individual interest. Most pressure on ministers is of the latter sort. Ministers need votes. So we do not make the best of what the world throws at us.
Bollard is in theory above that debate. The Reserve Bank is legally independent and he is mandated only to run inflation within a 1-3 per cent band.
But there is always far more public clamour to loosen monetary settings than tighten them — that is, to have higher inflation rather than higher interest rates.
It is no surprise, therefore, that Bollard and Don Brash before him have run inflation mainly in the top half of their mandated bands.
Brash did briefly go below the floor of his then 0-3 per cent target band in 1999 in the wake of the Asian crisis but this was a singular exception. More often he was above his ceiling. Bollard has never gone below his floor of 1 per cent but has breached his ceiling. For five years of his six he has been above the 2 per cent midpoint.
An important ingredient has been non-tradables inflation (price rises for domestic goods and services not traded internationally) which throughout his time has run above 3 per cent and for four years above 4 per cent.
This was in part the result of the creation through low United States interest rates of a vast pool of cheap cash which sloshed around the world. Some sloshed here, fuelling a housing boom and in turn a spending binge.
Bollard could do little about foreign cheap cash, though some economists urged him to be more aggressive earlier — even though there was also a yearly expectation the binge would end, in which case higher interest rates would have been inapt.
In terms of overall inflation Bollard was saved (most of the time) by low tradables (imports) inflation, thanks in part to the high exchange rate.
Against that backdrop there would have been a public outcry if he had raised the official cash rate while overall inflation appeared to be within limits.
Now the domestic bubble has popped in the wake of the credit crunch and under the impact of refinancing two-year and five-year mortgages at 2-3 per cent higher rates. Bollard’s problem now is not non-tradables inflation. It is import prices.
First, there are the wild world prices for oil, minerals and food, which have flowed into the domestic economy. Bollard can do nothing about them but under his mandate he can “look through” those rises and act only if they become embedded in inflation expectations and in underlying inflation.
Second, there is the falling kiwi dollar. Bollard’s own forecasts project an 11 per cent fall over three years. Bollard could do something about that: he could keep interest rates very high. But that would deepen the slowdown. On the other hand, by lowering interest rates he may steepen the fall in the dollar and drive import prices up and so drive inflation above his projected spike of 4.7%.
In other words, while world prices are outside his control, how they translate to local prices is partly within his ambit.
But go back to how he got in this fix in the first place: loose cash round the world.
The apparent success of inflation targeting worldwide in the 1990s may owe much to the peculiarities of the time. Computerisation and China’s entry into world production drove down prices for goods and many services, creating a false impression inflation was tame and lulling central banks, led by the United States, into allowing money supply to balloon.
Loose money used to be inflation-busters’ target: too much money chasing too few goods boosts prices. Loose money also fuels asset bubbles. Maybe, some foreign economists have recently begun to argue post-credit-crunch, central banks should refocus on money supply. One idea: vary the financial reserves big lenders must hold.
Certainly, for this pingpong ball bobbling on the international waves it would help if the big guys got it right. Then policymakers here could concentrate on what they can do, not struggle to contend with what they can’t do.