An interpretation of the OCR decision

By Bill Kaye-Blake 01/02/2013 1

I’m finding this monetary discussion interesting and useful. Matt Nolan and Eric Crampton have added a lot to it. Since the Reserve Bank decided yesterday to leave the OCR unchanged at 2.5%, I thought I’d offer an interpretation.

The Bank is balancing several different concerns. Some factors point toward looser policy: inflation below the target band, weak labour market, ‘fiscal consolidation’, and a high exchange rate. Other factors point toward tightening: house price inflation in Auckland, expectations for the Christchurch rebuild, positive business sentiment. They’ve split the difference and kept the OCR unchanged. Bernard Hickey explained this very well on Breakfast this morning.

Is it a good decision? We’ll only know that later in the year. But here are some thoughts on it.

First, the RBNZ has been consistently optimistic about the economy over the last several quarters, predicting increases in the OCR that didn’t eventuate. As part of that, the Christchurch rebuild has consistently underperformed. That suggests that if the Bank is wrong, they are likely to be on the high side.

Secondly, other people clearly have a more pessimistic view. Eric pointed to the iPredict website and the predictions for the economy. He noted:

markets also are pegging pretty stagnant GDP growth rates and an unemployment rate unlikely to drop below 6% before September quarter 2013.

That’s consistent with the Bank’s own forecasts in December 2012 (pdf).

The Bank had essentially two choices, with their own costs and benefits:

Cost Benefit
OCR lower Possibility of overshooting Greater economic activity
OCR unchanged Higher unemployment Inflation below 2%

Looked at this way, the OCR decision means that the Bank has chosen the certainty of higher unemployment rather than face the possibility of missing its inflation target, a possibility that should be considered against a backdrop of misplaced optimism. If I were being churlish, I would suggest that Auckland’s failure to deal with its planning issues is resulting in tens of thousands of people being purposely kept out of work. But I won’t — it wouldn’t be politic.

One Response to “An interpretation of the OCR decision”

  • This post looks like it was written to support the conclusion you had already reached – that the RB should have cut the OCR.

    But the real world is many-factored. For example, if the RB had explicitly reduced interest rates to encourage economic growth there would have been a lot of impacts. Reduced income for retired people on their bank deposits, for example. And another impact could be overseas investors getting more confidence in the profitability of New Zealand listed companies and pouring investment funds into NZ assets. Which could have resulted in a higher exchange rate than we have now.

    You said it yourself – The Bank is balancing several different concerns. How these factors interact is rather more complex than your payoff table assumes.

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