The case for not cutting

By Matt Nolan 22/11/2012

There is a growing call for rate cuts to the OCR in New Zealand given the high unemployment rate, indications that the September quarter was very weak, and the fact people are pissed off that the weakness in the New Zealand economy has been so persistent!

Now I’m not going to go one way or the other on this – after all I don’t really want to second guess the Reserve Bank.  However, the case for a rate cut appears to be weaker now than it was earlier in the year.

How can I say this?  The unemployment rate is undeniably higher.  Well remember that unemployment is a lagging indicator – usually the economy is well into picking up before we see a sustained drop in this.  You may retort (I know I would) with the hours worked figures, which have been very weak.  Hours worked is usually the first thing to pick up (either with or a bit after productivity) during a recovery.  For this all I can say is that hours worked are not as weak as they appear in the HLFS, but we would need to forecast them picking up soon!

Ultimately, we need to ask ourselves what a RBNZ forecast would need to look like to prevent a cut.  We would need them to first forecast no cut, and then to forecast an economy moving back to it’s “potential” level.  This will then be consistent with a forecast of inflation around the target band.

Why might we believe that the economy is heading back to potential (and without a lift in structural unemployment this would imply a swift drop in the unemployment rate in the coming years as well).:

  1. The lift in house sales and (soon to be) house construction – this rebound in durable good spending and investment tends to lead the economic cycle.  Generally households willingness to get involved in these things tells us that demand in the economy is on the up.
  2. Durable good sales to households have risen (although part of this is to builders and plumbers rather than consumers), and business investment has risen … business investment has dropped off in recent months, as part of the prior spike was “rebuild related”.
  3. A similar rebound in the US – with the prospects for the US picking up, underlying demand for a number of our export commodities (dairy, meat, logs) will firm.  Let’s not forget that the US is a big market for our (likely mismeasured) IT services export industry.  Why mismeasured – well if you know anyone who sell services online, you will know that they often avoid tax or business registration ;)
  4. Signs China has found its feet again
  5. Commodity prices are recovering sizably
  6. Easing bank funding costs.  The growing competition between banks in recent months is likely due to easier access to credit – there are reports this is flowing into businesses, albeit not evenly.
  7. The rebuild is now really getting underway.

This isn’t to rule out cuts – I’m avoiding taking a position here, as I want to save that for clients, and generally avoid upsetting people on the internet right now (what can I say, I’m a bit tired).  All I am saying is that, given the time it takes for a lowering of the cash rate right now to flow into the domestic economy, a rate cut when a lot of indicators have turned up in the last couple of months.

Also remember, if the Bank had been able to foresee what occurred through the middle of this year they would have cut earlier on – but they couldn’t foresee it.  This is not a criticism at all, because the Bank does have incredibly good “on average forecasts”, and as a result their actions can minimise the cost of policy mistakes.   But it does indicate that the Bank’s actions aren’t infallible, and that they should publicly explain what happened when we experience a situation of below target band inflation and rising unemployment to the public – instead of leaving all the commentary up to people who want to undermine them.