Treasury's Makhlouf sees no need for 'radically different' inflation target

Wednesday 30th March 2016

Treasury secretary Gabriel Makhlouf says he's seen no evidence that the policy framework between the Reserve Bank and the Finance Minister needs to be "radically different" despite weak inflation, and the department's regular review of the policy targets agreement will be "business as usual".

The PTA requires monetary policy to hold inflation between 1-to-3 percent on average over the medium term, with a focus on keeping future average inflation near the 2 percent midpoint. Inflation barely registered at a 0.1 percent annual rate in the final three months of 2015 and has now been below the target band since September 2014. That's prompted speculation that the agreement may need tweaking when it comes up for review at the end of governor Graeme Wheeler’s five-year term in September 2017, to reflect a global economy where inflationary pressures have dissipated.

"The phenomenon of low inflation is one that most of the industrialised world is experiencing," Makhlouf said in an interview. "We have seen no evidence in the Treasury that’s led us to conclude we would need a different framework. We always review the policy targets agreement, and that’s a process we are going to go through in the next 12 to 15 months but it's business as usual, as opposed to a special project.

"It will involve as much care as we have always done and if we conclude we need to change something that’s what we’ll do but I’m not sitting here thinking we’re going to have something radically different in the future. I think it’s really important having a stable macroeconomic framework and allowing businesses to operate within a stable macroeconomic framework is an incredibly important thing that we have in New Zealand so if we were going to change it we would change it with care on the basis of very careful analysis."

Makhlouf said Treasury's review will "almost certainly" look at the experience of other countries with different systems, although he noted there was no obvious alternative.

"There’s no system out there today that’s clearly producing something that an objective analysis would say is better than that system," he said. "Everybody in a developed world is dealing with the issue of low inflation, everybody, and everyone has got slightly different systems. The system we have got has served us well for quite some time. You’d want to change that only having done quite a lot of careful work and concluded that there is definitely something better."

The Reserve Bank, which cut interest rates to a record low 2.25 percent this month, has indicated it will lower the benchmark further if expectations for future inflation continue to fall. Its survey published last month showed expectations for inflation two years out fell to 1.63 percent, the lowest since 1994, while an ANZ Bank survey showed inflation expectations at a record low 1.39 percent. ANZ is due to release its latest survey of expectations tomorrow and Bank of New Zealand expects the rate to fall, tracking declines in headline inflation.

Finance Minister Bill English has said he's prepared to wait for the scheduled review of the PTA next year to consider whether it's still appropriate, but noted he hadn’t seen any compelling intellectual argument that the agreement itself could change or any particularly coherent alternative proposal.

Makhlouf said the current inflation environment wouldn't necessarily persist over the medium term, given the shake-up in the oil sector was unlikely to be repeated in the near term.

While low inflation was beneficial for those who wanted to borrow money to invest in good ideas, it wasn't favourable to those seeking returns on their cash savings, he said.

"There are swings and roundabouts in the economy as a whole but we would expect and the bank is working towards seeing inflation getting back to the mid point."

Returning inflation to the middle of the band over the medium term was important, he said.

"If you get locked into a cycle of expecting lower and lower inflation, there are bigger economic risks as people start to postpone decisions and that then slows down economic activity, so it does matter."

(BusinessDesk)

BusinessDesk.co.nz

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