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Commonwealth Bank Global Markets Conference

Reserve Bank of New Zealand Chief Economist Paul Conway spoke at the CBA conference in Sydney, Australia online from Wellington.

Past Event
Tuesday, 25 October 2022 to Tuesday, 25 October 2022
10:00 am - 10:30 am
Sydney, Australia

Mr Conway discussed the August 2022 Monetary Policy Statement, and the Monetary Policy Review on 5 October 2022. He also shared his views on the challenges and opportunities for productivity in New Zealand.

August 2022 Monetary Policy Statement

Monetary Policy Review — 5 October 2022

Watch a recording of the speech

Audio: Kia ora katou katoa. Ko Paul Conway ahau. Ko Chief Economist at Te Putea Matua, the Reserve Bank of New Zealand. Welcome nau mai, haere mai to this webinar in which I'm going to give a speech on the importance of data and economic research, particularly at times of economic change such as what we've been living through over the past few years. I'm also going to briefly comment on recent data developments, since our November monetary policy statement. And after that, there's going to be a Q&A session and I'm sure you've figured out how to submit questions, given that you've found the link and all of that.

So yeah, start typing in as we go, and we'll see how many of those questions we can get through at the end of all of this. The speech should be available on our website any minute now, if it's not there already. I'm pretty much going to read it out, I'll sort of bounce in and out of it, there's a few graphs that'll come across your screen as well. But in the interest of time, I might summarise here and there, but you've got the speech on the website there anyway. All right, let's go.

So the past few years have been unique in many ways, both for us here in Aotearoa, New Zealand, and also globally. Economies have suffered a series of shocks that have changed the economic landscape. Some of these changes will fade away in time. But in some respects, be it people working from home more, higher government debt, globally increasing geopolitical tensions, or the changing nature of globalisation, the economy is now significantly different to how it was before COVID-19. So today, I'm going to speak about this evolving economic landscape and the research that we are doing here at the Reserve Bank to understand it, because setting monetary policy in a time of exceptional change and adjustment is a mighty challenge.

So in meeting this challenge, our research agenda provides the monetary policy committee, so the MPC, with relevant and practical insights to help deliver on our monetary policy remit. And much of our current research agenda is guided by our recent review of monetary policy over the five years to 2022. So this review, it identified several areas where we need a better understanding of the economy to support high-quality monetary policy, decision-making, and our research agenda aims to provide that understanding. Now, of course, this challenge of understanding and navigating partially uncharted economic waters also highlights the importance of high quality and timely economic data, which I will also comment on. But first, let me briefly discuss some of the economic data that has been released since our November 2023 monetary policy statement. So recent economic data, at the time of the November statement, the balance between supply and demand, or capacity pressures in the economy was continuing to ease, and this partly reflects the effect of lifting the official cash rate, the OCR from near zero to 5.5%.However, at 5.6% in the September quarter of last year, inflation remained too high. In November, we judged that the OCR needed to stay at the restrictive level of 5.5%, so that demand growth would remain subdued, to assist inflation to return to the one to 3% target range. We also highlighted a risk that capacity pressures could surprise to the upside, creating the risk of a further monetary policy tightening later in 2024. Now, since the November statement, gross domestic product growth, and GDP growth in the September quarter of last year came out lower than estimated.

Visual: Graph showing contributions to revisions in expenditure GDP with the heading: weaker government expenditure drives the revisions

So that's inflation adjusted government expenditure accounts for much of the revisions, and you can see a breakdown of those revisions in the slide. Some of these downward revisions and real government expenditure is due to methodological changes such as Statistics New Zealand now accounting for school attendance, when measuring value added by the education sector. Private demand in the economy which is more interest rate sensitive has mostly been revised up, with stronger consumption and business investment than first reported. And again, you can see that in the figure.

In fact, the levels of consumption and investment in the third quarter 2023 GDP numbers are almost exactly as estimated in the November statement. Of course, when thinking about GDP, it also needs to be kept in mind that the latest GDP numbers are for a three-month period that began seven months ago now. Well, GDP has been revised down. Net migration continues to be revised up. Current estimates are that around 250,000 migrants entered New Zealand over the last year, quarter of a million. Well, just over 120,000 people left. So, that's a net gain of almost 130,000 people or nearly 2.5% of the population. Now, there are no hard and fast rules about the inflationary impacts of migration. It depends on the size of the inflows and the outflows, the reason why migrants arrived or left, the age and skills profiles of migrants, and the state of the host economy.

So in our case, it's clear that strong inward migration has clearly helped to alleviate labour shortages. So, in the latest NZIER quarterly survey of business opinion, businesses reported that it has become much easier to find workers. But the demand side effects of migration are also apparent. Strong population growth has likely contributed to continued increases in housing rents and construction costs, in the latest consumer price inflation data. So, in the December 2023 quarter, rents contributed 0.1 percentage points to the total 0.5% quarterly change. A high population growth may also put further upward pressure on local authority rates, which are contributing almost as twice as much to annual CPRI inflation as they have on average, over the past 15 years. 

Graph showing measures of annual core inflation from 2004 to 2023, with the heading: core inflation measures have fallen

Overall, the annual change in CPI in the December quarter came in at 4.7%, down from 5.6% in the September quarter, but measures of core inflation have also fallen. You can see that quite clearly in this graph.

Graph showing tradable and non-tradable inflation from 2005 to 2023, with the heading: inflation is coming down but remains high

However, annual non-tradable inflation, which is a rough approximation of inflation generated within the New Zealand economy, came in at 5.9%, which is higher than we estimated. And you can see this in the graph here, with tradables inflation dropping away nicely, but a bit of persistence in non-tradables in inflation. So to sum all of that up, monetary policy is working, with the economy slowing and inflation falling. But we still have a way to go to get inflation back to the target midpoint, and obviously, we'll have much more to say on all of this in the February statement, which will be based on an assessment of all incoming data.

Okay. So a changing global economy. Let me return to the changing economic landscape of the past few years, because we've been living through an extraordinary series of economic shocks. So the COVID-19 pandemic caused widespread economic shutdown and acute global supply chain disruptions. It sped up the digital transformation, and it changed the shape of our cities, with people working and shopping much from home much more than before. Of course, in the middle of all of that, Russia invaded Ukraine, which sent energy and food prices sharply higher, especially in countries close to the conflict. 

Graph comparing Dubai oil prices and New Zealand petrol prices with the heading: global energy prices have increased pushing up New Zealand fuel costs 

But these factors did spill over into a significant increase in fuel costs in New Zealand, as you can see from the figure on the screen, and also into a sharp rise in the cost of New Zealand's broader imports.

Graph showing nominal New Zealand ex-oil import prices and projection with the heading: New Zealand import costs rapidly increased

You can clearly see that red line there ratcheting up, as we got into the pandemic. And of course back home, almost a year ago today, we had floods and storms over last summer that disrupted the lives of many, and added to supply-demand imbalances, and domestic inflation pressures in some markets.

So what's been the impacts of all of that? High global inflation is perhaps the most obvious macroeconomic consequence of this series of unfortunate events, and you can see that in the figure. 

Graph comparing the inflation rate in New Zealand with the OECD average, with the heading: inflation is high across developed economies

New Zealand CPI compared to the OECD average. Inflation increased globally, because of sudden surges in global demand and big swings in its composition, coinciding with widespread supply side disruptions and shortages. Now, of course, expansionary fiscal and monetary policies which were deployed in the early stages of the pandemic to support economic demand and job retention added to capacity pressures in many countries. Now, increased global inflation is just the beginning of the story. The series of events I outlined also kicked off or sped up many other changes across the global economy. 

Graph showing Government debt as a percentage of GDP, comparing New Zealand and other OECD countries

The pandemic led to a sharp rise in public debt, as governments increased spending and subsidies to counter the initial effects of the pandemic. So, across the OECD, government debt increased by about 14 percentage points of GDP.

With New Zealand, our increase of 23 percentage points are well above average, albeit from a relatively low level to start with. Globalisation is also changing in an era of increased geopolitical tension and war. Supply chain resilience and geopolitics have become relatively more important than lowest cost in determining international trade flow. So with nearshoring, friendshoring, and onshoring, global value chains are shortening, as production facilities are pulled closer to home. Now, as geopolitical tensions ratchet up, global trade continues to be disrupted. For example, container traffic through the Suez Canal is down over 60% compared to average. Climate change is also disrupting global trade, with traffic through the Panama Canal severely restricted due to drought in that country, and shipping costs are increasing globally. Now, more optimistically, the pandemic has sped up the digital transformation. So digital technologies, they gave us the ability to work and shop from home, so it made us much more resilient and adaptable during the worst of the pandemic. And in my opinion, increased digital adoption is perhaps the biggest silver lining of the pandemic.

Now, of course, these changes, they're occurring against the backdrop of other large structural forces, as I've alluded to. Addressing climate change is going to require swift reductions in greenhouse gases and global adaptation requiring large investments. An ageing population also poses questions for fiscal policy choices and is a key determinant of neutral interest rates, which I'll discuss in a minute. Okay. So what can we learn from what's been going on around us these past few years? And I don't think it's any exaggeration to say that recent global events will be studied for decades to come, because we need to understand the many lessons that this period has to offer, and integrate them into our analytical tools and models to inform future policy decisions including monetary policy decisions. Now, to learn these lessons, we recently reviewed the formulation and implementation of monetary policy over the five years to October 2022, and this review found that the formulation and implementation of monetary policy in New Zealand was consistent with its objectives over that five-year period.

And it also highlighted the need for a deeper understanding of the economy in several broad areas, which as I'll discuss in a minute, now form part of our research agenda here at Te Putea Matuau, the Reserve Bank. So the first area where we need some research insights is around the interaction of fiscal and monetary policy. So as I mentioned earlier, public debt has increased over recent years, as governments used new fiscal tools alongside stimulatory monetary policy to lessen the economic damage of the pandemic. So in New Zealand, this was primarily in the form of wage subsidies, but a range of other tools such as low-cost easy access loans for businesses, and direct payments to households were used elsewhere. And we need a clear understanding of the economic effects of these new fiscal tools, and how they interact with monetary policy, and that will be critical for macro stabilisation in future crises.

On the face of it, of course, monetary policy is effective at dealing with excess aggregate demand, while targeted fiscal policy is effective at dealing with distributional issues such as supporting people who lose their jobs. However, during the pandemic, the scale of the fiscal intervention also significantly influenced aggregate demand, so this necessitates a continued effort to ensure monetary and fiscal policy coordination is as effective as possible in smoothing out peaks and troughs in the economic cycle, in some circumstances. So what exactly are those circumstances, and what are the risks to central bank operational independence, and how can those risks be mitigated? We are working on these and related questions, and what best practise monetary and fiscal policy coordination should look like. All right, monetary policy and the supply side of the economy. So prior to the pandemic, under certain circumstances, monetary policy tended to look through the first-round effects of supply shocks, and only respond if those shocks influence general prices or inflation expectations.

For example, we would usually look through the immediate price impacts of a temporary spike in global oil prices, if it occurred in isolation. Instead, we would be on the lookout for any spillovers into broader prices for New Zealand goods and services, so in these situations our focus is on general prices, not a shift in relative prices. So why did we tend to look through supply shocks? Because they've often been volatile and short-lived, and so a monetary policy response could just increase economic volatility, but do little to keep overall prices stable. Supply shocks also tend to move inflation and employment in opposite directions. So, for example, responding to a negative supply shock such as caused by higher oil prices. Tightening monetary policy would reduce demand and inflation pressure, but it would also accentuate any fall in employment in the labour market. Now, looking forward, over coming decades, given the global trends that I outlined earlier, supply shocks could become larger, and more frequent, and persistent.

So, is looking through these shocks still appropriate? In what circumstances should monetary policy respond to bring demand back into balance with supply, and what are the implications for inflation expectations? On the face of it, working to keep inflation expectations well anchored to the target allows relative prices to change in the economy, without them spilling over into generalised inflation or deflation. Now, we also need to understand or better understand the monetary policy implications of long-run changes in the supply side of the economy. Well, our monetary policy tools have little to no impact on these trends. These long-run supply side trends have been shaping monetary policy and will continue to do so, so we need to understand them better. So, for example, as the global economy splinters into blocks of politically aligned countries, globalisation may become less of a disinflationary force than it has been over recent decades prior to the pandemic.

So this could mean that we should not expect substantial declines in imported inflation. We can't really, we might not be able to rely on that to achieve our inflation target. Instead, homegrown or domestic inflation or non-tradables inflation would need to be lower than it has been historically. We also need to improve our understanding of how changing technology impacts on monetary policy. So productivity growth, it's notoriously weak in New Zealand, but digital technologies could reduce the cost of us being globally remote, and increase the chances of our innovative ideas being noticed globally. And you only need to look at ongoing breakthroughs in artificial intelligence to see the transformative potential of the new technologies.

All right, neutral interest rates. So what are neutral interest rates? It's the rate of interest at which monetary policy is not slowing the economy down nor speeding it up, so neither contractionary or expansionary. So assessing the level of neutral interest rates is key to knowing the stance of monetary policy. And until recently, there's been a very gentle long-run decline in neutral interest rates, both globally and in New Zealand. However, the structural features of the economy that led to low neutral interest rates before the pandemic may be changing. On the one hand, changes in globalisation, higher government spending, and investment into climate change mitigation and adaptation could all mean higher neutral interest rates in future. But on the other hand, population ageing, weak productivity growth could keep neutral interest rates lower over the years ahead. So improving our understanding of what influences neutral interest rates and how that works will help us better understand the stance of monetary policy.

And finally, considerations around additional policy tools. So with low inflation comes low nominal interest rates, and the risk that central bank policy rates again hit their effective lower bounds. Now, this occurred prior to and during the COVID-19 pandemic, with many central banks, including the RBNZ, using additional monetary policy tools to lower interest rates and stimulate the economy. Now, given that these tools are new, to us at least, we will continue to refine our understanding of their macroeconomic and financial market impacts, their implications for central bank balance sheets, and which tools are best suited for different developments in the economy.

Visual: Our research agenda will help us deliver on our Remit

Our research themes:

  • Forecasting and modelling
  • Tools, transmission and communication
  • Small open economy macroeconomics
  • Inflation
  • Labour market
  • Monetary policy framework, strategy and coordination

Audio: All right, so what does all of this mean for our research agenda? Well, first and foremost, our research is guided by the need to deliver on our remit. So this implies six broad research themes which are on the screen now. You probably can't read that, but they're in the speech, and you can find all that on our website. Now, some of the work that we are doing within these themes is filling gaps in our understanding that were identified in our monetary policy review. 

For example, this agenda is helping us build a better understanding of supply side issues that have been important in fueling recent inflation, and also deepening our understanding of additional monetary policy tools and how they transmit to the economy.

Now, other research work in this agenda is in areas in need of continuous improvement. For instance, we're always working to improve our forecasting, and modelling capability, and to develop new sources of data. We also continue to research the labour market, because understanding employment and wage dynamics are key to achieving our inflation mandate. Now, to enrich our research, we need to work with others, and we need to support economic research in New Zealand. So, we are very open to partnerships not only with other central banks who are working on many of the same issues, but also with academics here and overseas, and also the private sector. And we also need to communicate the insights that come out of our research, which means you'll be hearing more from me and others in the economics team here at Te Putea Matua, as our research and analysis lobs up insights that inform monetary policy decisions. Because ultimately, we want to improve understanding of how we are likely to respond to economic developments, because this helps strengthen the transmission and effectiveness of monetary policy.

Now, just getting towards the end, I want to emphasise the importance of quality data, so frequent and timely releases of high quality data are incredibly important, especially, but not only, but especially in times of rapid economic change. Statistics New Zealand have recently added to the number of CPI indicators that are published monthly, meaning that we now have 44% of the basket available at the monthly frequency, which is a very welcome development. Now, data revisions, changes to already published data can also generate uncertainty for monetary policy makers. Data revisions are a good thing in that they result in a more accurate view of the economy. However, more accurate data in the first place would reduce the risk of significant and lagged changes in the starting point for our economic projections. 

Graph showing New Zealand GDP growth revisions with the heading: the need for quality data is vital for delivery of quality outcomes

Well, the latest set of GDP revisions were large, they were not abnormal and moreover, the size and volatility of GDP revisions in New Zealand have increased recently.

And there is some evidence saying that the size of our GDP revisions are relatively large in international comparison. Now, the events of recent years have really underscored the need for New Zealand to invest more in producing data that is robust, timely, and accurate. And for our part at the Reserve Bank, we have been investing to improve our measurements of inflation expectations, and we are also exploring, collecting much more detailed data from banks to support economic analysis, and research among other uses. We're working with Statistics New Zealand. We have been for a long time, but we are currently working with them on a consultation process that began in 2023, to better understand data needs and priorities. We've always worked closely with stats NZ to produce and support high-quality data. We support investment in maintaining and improving core economic statistics as critical national infrastructure for well-informed and timely decisions.

And of course, we're also developing, as I mentioned earlier, new sources of high-frequency data to incorporate into the MPC's assessment process. So in conclusion, I just want to say, inflation increased in recent years, because of sudden changes in patterns of demand and supply side disruptions. Now, these demand shifts would've been challenging for price stability even in the best of times, but the breakdown in supply chains globally, and within the domestic economy made matters worse, and inflation increased. Now, successfully navigating the current environment and the likely future environment requires a continued understanding of these and related issues, so that monetary policy can respond appropriately to future shocks. There isn't just one rule or one model that explains everything. We need to improve our understanding of how the economy works, where we're at in the cycle, and what is most likely coming over the horizon.

Thankfully, inflation targeting, which is the policy framework developed in New Zealand, and we've adapted and refined over the past few decades, puts us in a good position to deal with uncertainty, to deal with relative price changes, and to deal with large economic shocks. But better research and data will improve our ability to be flexible in our analysis, adaptable to changing circumstances, and clear on what monetary policy can and cannot achieve. So, thank you very much for listening to that. Now, we're going to shift to a Q&A session, and James is going to read me out some of your questions, and I'll do my best to answer them. Thank you.

Questions and answers

James: Thanks, Paul. First question is from Neale Muston of Excalibur Trading. Do you feel the revision to GDP and lower than expected Q4 CPI paint a significant change to the starting point of the next MPS, or are these largely mitigated by other offsetting factors?

Paul Conway: 
Yeah. Thanks, Neale. As I said in my speech, and I'm being very careful here, I'm not going to give away anything about the likely future path of the OCR. We'll get to that in a few weeks in the February monetary policy statement, when we've done the work, and run the ruler over the economy in a very comprehensive way. And as I said in the speech, the GDP revisions, it's capacity pressures that matter. So what have those GDP revisions done for our starting point in terms of capacity pressures always? How have they affected our measures of the output gap?

And secondly, yes, inflation at 4.7% was a little bit below our 5% pick for the December quarter of last year, but you need to dig into it and non-tradables inflation, and I understand there are difficulties, determining tradable versus non-tradables inflation, as I said in the speech. It's a rough approximation of domestic demand pressures within the New Zealand economy, but at 5.9% non-tradables inflation, it's a long way from 2%. So yeah, as I said, we've got a ways to go in our inflation battle. We are getting there, we are making progress. But yeah, it's a long way to 2%.

Follow-up question from Neale, and I think you've partially answered it already. Is the significant market analysis over tradable and non-tradable inflation split of great consequence to the RBNZ, when the combined rate is hitting the pockets of households?

Paul Conway: 
Yeah. I mean, that's a good question. Inflation, it's overall, it's headline inflation that really matters for prosperity in the New Zealand economy. So obviously, we're very mindful of what's going on within all of the inflation basket. I think our focus on non-tradable inflation or domestically generated inflation, it's more about what can our monetary policy tools primarily in the form of the OCR, currently, what parts of the consumer price basket can we influence? And there's good empirical work showing that non-tradables inflation, we can actually influence that, whereas inflation pressures or deflation pressures, disinflation pressures coming over the border such as oil prices and the like, we obviously have no influence over that. So, that focus is about what we can influence. And it's a little arbitrary, that split, because obviously using that example of oil prices coming over the border, it's a key input for businesses, so that sort of has knock-on effects to what's happening domestically. So yeah, it is a tricky decomposition to undertake, but there is signal for us in that decomposition, which is why we pay attention to it.

A question from WO. Given central banks around the world, yourself included, consistently got their inflation forecasts wrong, what work is being done to improve this core function?

Paul Conway: 
I'll stick up for forecasters everywhere. Forecasting is a very challenging exercise at the best of times, and the last few years have not been the best of times. It's been a very volatile economy that we've been contending with, many issues pushing it around, so it hasn't been a golden period for forecasting. I'll totally accept that. In terms of what we are doing, we've got a lot of research digging into inflation, what drives inflation, what drives different bits of inflation, we're getting into the minutiae of the inflation data, how many of the individual components in there are changing, which are persistent.

Essentially, the message of or a key message of the speech is that we need to really do relevant research and have the right data, so that we can improve our forecasting performance, because obviously, that has a big impact on what we do with the official cash rate here and now, or at least in the next few weeks. So just to sum up, that's been a challenging time for forecasters. I think we've done work showing that the Reserve Bank actually does pretty well, compared to our peers within the New Zealand economy. But yes, we are working hard to improve the accuracy with which we forecast the economy, in general, including inflation.

We have a question from Kelly Eckhold of Westpac. What do you take from the apparently very weak labour productivity growth in the last year, given very strong population growth, but weaker GDP? Does this explain why core inflation has been so persistent and perhaps, it will take a good while to reduce further?

Paul Conway: 
Yeah. Well, that's an interesting question. Thanks. Kelly, as I said, New Zealand, our productivity data is not stellar. I want to use this question to make the point. I've sort of talked in the speech about coordination between fiscal and monetary policy. In certain circumstances, that might be appropriate, but also regulatory policies. If we did have a really good reform agenda that energised the supply side of the economy through pro-productivity reforms, then our underlying rate of growth would be stronger, and it would be easier for us to get inflation down, without imposing short-term pain on the economy. So, our underlying rate of growth would be stronger, meaning that we wouldn't have to be pushing it towards near zero to achieve our inflation mandate. So yes, please, to pro-productivity reforms.

A question from Glenn Pacey. To what extent do you think the Red Sea situation forcing shipping around South Africa will impact tradable inflation?

Paul Conway: 
Yeah. Again, it's how is that going to play out? It just seems to be sort of bubbling away, and with aggression across a broader swathe of the Middle East. So, it's definitely a risk. Currently, we'll have more to say on it in the monetary policy statement. So, I mean, it's consistent with what I was saying in the speech that I'm not sure we can rely on globalisation as much as we have in the past to achieve our inflation target. Shipping prices have recently just come down to pre-COVID levels after all of the machinations during the pandemic, and now, they're starting to bounce back up again. It's significantly more expensive to ship, or to not go through the Suez Canal. In terms of what it means for New Zealand trade into Asia, it's a more nuanced issue. It depends on where our trade routes are, et cetera, et cetera. So as I said, we'll have more to say about that in coming statements and the like.

A question from W Peck. Do you think there is sufficient understanding of the economic risks and impacts of climate change? What impact would an effective climate mitigation strategy have on inflation, interest rates, and economic growth?

Paul Conway: 
Yeah. Excellent question. No, I don't think there's enough understanding of the macroeconomics of climate change. It's obviously something that we are putting effort into understanding. From a monetary policy perspective, a lot of it is about understanding the impacts of severe weather events, which is a supply-side issue, as I talked about in the speech. So again, we need to better understand the supply side, and I think getting our heads around the macro effects of climate change is a key part of that. Obviously, Cyclone Gabriel gave us plenty to think about. Chances are, that type of event is going to become more common unfortunately, going forward, so we need to understand the macro effects of that and how we should respond. So we've got a chunk of research there directed at exactly that. Of course, climate change, it's also relevant for financial stability, which is another one of our mandates. We have research going on to try and understand the impacts of climate change, and that's completely consistent with achieving our inflation mandate.

A question from Kothari Douglas. Do you see minority groups feeling more, or less of the effect of these trends and impacts?

Paul Conway: 
Interesting question. I think, our tools affect aggregate demand. Broadly speaking, our tools affect aggregate demand in the economy. So distributional issues, we say that fiscal policy is better placed. Fiscal policy can be better targeted, compared to monetary policy, to impact different cohorts in the economy. I'm not washing my hands off this issue of the distributional consequences of inflation and changes in interest rates. We also need to understand those distributional effects, because that determines how monetary policy affects the economy. So, different cohorts within the economy will have different sensitivities to inflation, different sensitivities to changes in interest rates. And we need to understand that to make sure that we are getting policy right, even though policy affects the macroeconomy, so the economy and aggregate, and can't really get down into that level of affecting economic outcomes for different cohorts within New Zealand society.

A question from Kit Lowe of ITC markets. Given the RBNZ's mandate is on inflation, would a large rise in unemployment, while inflation was above 4%, mean that the RBNZ focus entirely on inflation only and not change the OCR?

Paul Conway: 
Yeah. In certain circumstances, a single mandate. So we had a dual mandate, where we were asked to consider inflation, or to target inflation, and to support maximum sustainable employment in the labour market. Now, it's all about targeting inflation. And normally, what's happening to inflation is... What's going on in the labour market is a really strong indicator of what's happening with inflation. So all of the time where we had that dual mandate, we never had the trade-off that you described in the question, where the labour market unemployment was going up, and inflation was high, and we had to make some kind of compromise across the state of the product market and the labour market.

But in response to a negative supply shock, we could have employment dropping, and inflation going up. So there will be circumstances in which our focus on inflation will trump what's going on in the labour market. I should say, in the long run, low inflation is optimal, it's good for everybody including, obviously, workers. So yeah, it's a delicate, tricky issue for us to understand and it's part of the reason, as I said in the speech, why we are still doing work on what's going on in the labour market, because it's an incredibly important chunk of our economy, and we still need to be right up with what's happening in terms of the labour market.

A question from AL. Does the government have the ability to stimulate the economy or provide support during higher unemployment periods, and how far can the government go with a rising unemployment rate nationally, and globally?

Paul Conway: 
Well, this is a fiscal policy question, so I'm not going to go into too much depth. But fiscal policy is better at targeting, as I said, distributional issues. I think there's really important roles, obviously, for both arms of policy to play, and in some circumstances, we need to think about how they play together. But yeah, I'm not really in a position to comment more broadly on fiscal policy.

A question from Dan Brunskill. Do you consider non-tradables to be a more important measure of underlying inflation than the factorial models RBNZ produces itself? Could you shine some light on what the different measures are designed to tell you?

Paul Conway: 
Nice question. I don't think we put more emphasis on non-tradables versus core inflation. They're telling us different things, both of which are important and relevant. So non-tradables, it's a measure of inflation, it's an approximation of inflation pressures generated within the New Zealand economy, whereas core inflation, it's more that underlying rate of inflation within the economy when we strip out, in various ways, volatile bits of the inflation equation. So, both are important. You can split inflation in a number of different ways and it's consistent with us being... We really need to deeply understand the drivers of inflation, and all of those factors that were mentioned in the question are important.

A question from Brad Olsen from Infometrics. Is there a need to dig into price-setting behaviours more, at a firm level, to understand if price-setting discipline has shifted, that's harder to measure but might be important to understanding broader trends in price pressures?

Paul Conway: 
So what we're seeing now, non-tradables inflation in New Zealand, it's stickier, it's more persistent than tradables inflation, and I think, in New Zealand, there are various reasons for that. We are quite an unusual economy, peculiar, particular economy in many different ways. Our markets tend to... We have this trade off between competition is very good for low prices and efficient businesses, but so is scale. Big businesses tend to be more productive and therefore, capable of passing on low prices to consumers, and in lots of New Zealand markets, we have this trade off. It's hard for us to have a competitor or markets that have many large firms, so I think understanding pricing behaviours at the firm level is totally legitimate. Of course, that's more Commerce Commission territory than it is monetary policy. But again, to get monetary policy right, we need to understand the underlying reasons for inflation dynamics in New Zealand. And I think looking at price setting behaviour at the firm level or at the industry level is totally part of that remit.

A question from David Cunningham from Squirrel. Given non-tradables inflation has averaged around 3% over the last decade or two, and tradables near a zero, do you believe this is going to change, given your comment that non-tradables inflation is currently a long way from 2%, or is higher than 2% non-tradables inflation acceptable, assuming tradables inflation is near a zero, through time?

Paul Conway: 
Well, yes. If tradables inflation was near zero, through time, our remit is to get CPI inflation to 2%. How that happens, there's different ways in which that can happen. And prior to COVID, you're exactly right, we saw tradables inflation, inflation coming over the border was near zero. So globalisation there, China being the workshop for the world, and exporting disinflation globally was a big part of the reason for that, whereas non-tradables inflation was towards the upper edge of our one to 3% target then. So what I was saying in the speech is that there's a risk, given changes in globalisation, given climate change, all those supply-side factors that I talked about, there's a risk that the global economy isn't going to be as helpful to us in achieving that 2% overall inflation mandate as what it has in the past. And if that is the case, if that does come to pass, then by definition, we are going to need non-tradables inflation, inflation generated domestically to be lower than it has prior to the pandemic.

Now, note I'm talking subjectively, this might come to pass. These are risks, at the moment. I'm not saying this is definitely how the future's going to unfold, and we're obviously keeping a watchful eye on all of these developments. But there is a significant risk that tradables inflation will not be as helpful as what it has been prior to the pandemic.

We've probably got time for just a couple more questions. This is about the research agenda. What are you most looking forward to in the research programme, and what will be the biggest challenge?

Paul Conway: 
We are in it, we're doing it. There is a really good vibe in the economics department. The research team is on fire. People really see the value of what that work is bringing the work to the mahi of the monetary policy committee. So, the research agenda is just a vital part of us achieving our remit. It's hard for me to single out one particular bit that I'm particularly excited about, because the whole thing, it hangs together as a package. It's not just a look at this, a look at that, and look over here. It's about what is that whole, how can we use research to construct a compelling narrative of how the New Zealand macroeconomy works. So the whole thing really hangs together very well. In terms of challenges, well, I've talked about the data challenge, the fact that our data is quite lagged and can be significantly revised. I mean, having said that, we've got really good macro data in New Zealand. So there are areas of data where we've got a comparative advantage, if you will, globally on the research front.

Research is hard. It's challenging to really nail it, to really get it right, to go beyond casual correlations or whatever, and to get into causality, and what's actually driving the inflation dynamics, and the macro dynamics that we see, so building that capability, that capacity within the team. We are there now, I believe we've got a great group of people focused on all of that. As I mentioned in the speech, we're really looking for collaboration opportunities. And also, I think a challenge with research is, how do you translate the research findings into the policy space, I think, as researchers speak research language, policy speak policy language? But here at Te Putea Matua, we're lucky in that we have people that can cross that divide. They have feet in both camps.

So our research, it's practical, it's applied, it's research that people can understand. No need to pop up and give speeches on it, it's comprehensible. It's about the world around us. People live in the world, so therefore, they should be able to understand what we're talking about in the research space. And by the same token, monetary policy or the monetary policy committee can fully... Who influence the research agenda, what do you really need to know for the next round, or over the next year or so? And they can really grab hold of it and run with those insights as well. So, that's the ultimate aim is that our research agenda leads to a better... It really helps with making optimal monetary policy decisions, going forward.

A question from Sophia Rodriguez from Observatory Group. What is your current view on risks from China, given the monetary policy easing there? Is it to the upside or downside, and how important will it be for RBNZ's monetary policy decision next month?

Paul Conway: 
I'm not going to comment on whether it's upside or downside compared to the November statement. But in the November statement, and the August statement, and a bunch of statements prior to that, we have been pointing to the risk of a significant slowdown in the Chinese economy. Obviously, it's a hugely important market for New Zealand exporters, so what goes on in China has an effect here. It's part of what I've been talking about more broadly around globalisation. China was the workshop for the world for a good decade or two. There, the eastward migration of Chinese peasants and farmers off the farms, and into the cities really was felt globally, and it's just not clear that China is going to play that role again, going forward. Obviously, there's risks around China and the property sector that we're very cognizant of. So definitely, a risk factor going forward. As I said, I'm not going to comment whether it's upside or downside compared to what we've said about it in the past. But yes, we are watching the Chinese situation very closely.

A question from Darren. Were you encouraged by the significant step-down in the quarterly rates of trimmed mean and weighted median inflation in the December quarter?

Paul Conway: 
Yes. I am really pleased that core measures of inflation are falling, and that headline inflation is falling. It's quite an experience for us. The fact that we are so focused on inflation and we get an inflation number once a quarter, it's a big moment in the economics department here at Te Putea Matua. I was on the edge of my seat waiting for the numbers, and yes, monetary policy is working. It is reassuring that inflation is falling. But the point that we made in the November statement, and that I'm making in this speech is that we still have a ways to go, especially with non-tradables inflation where it is. So we're heading in the right direction, but we are not there yet.

Right. Paul, I think we're about out of time now. Thanks very much for those great responses.

Paul Conway: 

And appreciate all the questions that came in today. I'll throw it back to you.

Paul Conway: 
Great. Thank you, everybody. Thank you for those excellent questions. Thank you for tuning in. As I said, get used to us popping up a bit more with the research and insights over the months, quarters, and years to come. Thank you for your time. Very much appreciated. Ka kite.


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Thanks for that introduction and thanks for having me on the call. It’s a pleasure to be speaking with you all. Apologies for doing it virtually. I would’ve loved to combine going to this conference with a long weekend in Sydney, but that was not meant to be. 

And indeed, the fact that I can just pop in on Teams, you know, I think I’ll talk about this a little towards the end of my intervention but it speaks to the incredible potential of digital technologies that they bring for a small and isolated economy like Aotearoa, New Zealand. 

Before I heard those opening remarks I was thinking that the timing for me giving a near term  what’s changed economic update was a little bit tricky because we’ve got a MPS – Monetary Policy Statement coming out in a few weeks. So I’m not going to talk much about near term economic issues and developments but I will talk about the inflation number that came out last week. But I’ll just sort of stick to the facts, I won’t interpret it in any way because I don’t want to pre-empt conversations around the Monetary Policy Committee table that are yet to take place.

Of course we will give a full read on our view of the world on November 23rd at our next MPS. So what I am going to talk about, which follows on nicely from those introductory remarks is the broader economic context that’s shaping that near term outlook and recent data developments. 

So I’ll start with a look at New Zealand’s big picture economic dynamics over recent years. Then we’ll spend a few minutes talking about the global economy and what’s been going on there and the effect that likely to have on New Zealand and I’ll end with a few thoughts on the supply side of the New Zealand economy and how events playing out in that space could work to our advantage over the medium to longer term, or not, depending on how we play our cards. 

So, that all might sound like it’s a bit big picture, and a bit real, in terms of the real side of the economy for a conference aimed at bond traders, but as I said, it’s quite consistent with those opening remarks. We are living through extraordinary times. It’s a really unique and a uniquely challenging period in our economic history. I think that sort of understanding the big picture is fundamental, certainly for a monetary policy maker, in terms of not messing it up and indeed for bond traders and banks. I think having a deep understanding of the economic fundamentals, of what we’re living through right now is also critical in getting it right, whatever that means to you – not screwing up in terms of your portfolios and positions, given the tremendous volatility in the economy and financial markets we are currently experiencing. 

Alright, so let’s start with New Zealand, we’ll start with inflation. Let’s look the beast, the monster in the eye. Inflation came out last week for Q3. It was stronger than pretty much everybody expected. In terms of The Reserve Bank, we had a 6.4 annual increase in CPI inflation in our August Monetary Policy Statement, and it came in at 7.2% so quite an overshoot there from what we were expecting – both tradables and non-tradables inflation were higher than expected. So, non-tradable sort of home grown inflation pressures came in at 6.6% versus our expectation of 6.3%. So not too much of a surprise there but still a big number, and that big number was driven in large part by construction costs and local council, local authority rates made large contributions as expected and when you sort of get down into that data you can see evidence of a sort of shift in consumer spending from goods back to services combined with a very tight labour market – you can see evidence of that throughout the CPI data.

Now the biggest forecast error that we did make was in terms of tradables inflation, so this is inflation coming over the border. That came in at 8.1% whereas we were expecting 6.5% so that was due to a 17% quarterly increase in fruit and vegetable prices –  huge number and we had a 20% quarterly increase in international air fares as our border has progressively reopened. We did have a 4.5% decline in petrol prices which was a bit of a partial offset. 

Now, a point I want to make here – tradables inflation is usually our friend. So over recent history, recent decades it has been low to negative across the globe and that's for a few reasons. First of all, you know globalization a sort of slow, moving positive supply shock has kept the lid on global prices. Relatedly, the Chinese labour market – so Chinese moving from sort of farms in the west to factories in the East and China being the workshop for the world has also contributed to low tradables inflation and favourable demographics across a bunch of countries has also contributed. But much of that is changing at the moment. So in the first instance, that's because of the pandemic and associated supply shocks but globalization is also changing. Demographics are changing and China isn't the deflationary force that it once was. So there's talk and serious academic papers arguing that greater international inflationary pressure could be a theme going forward — obviously hopefully not as extreme as what we've been witnessing over the last year or so, but that era of helpful tradables inflation may be coming to an end.

All right, so how did we end up with inflation at 7.2% in New Zealand? A rather unpleasant situation for all of us. So let's just take a quick look back over the last 2 and a half years or so. It’s obviously been a very bumpy ride in terms of GDP.  We’ve seen heaps of volatility over the last few years, given sort of intermittent lockdowns and associated health sort of aspects of the health response but overall, the New Zealand economy has done incredibly well over COVID. We sort of roared through COVID. We did see spending decline during lockdowns but then it would just sort of roar back out of lockdowns, you know as they came to an end. So the reasons for that, you know we saw a very strong policy response to the health emergency. We saw big government spending on things like the wage subsidy and of course we had ultra low interest rates. Our health response was also really effective. We pretty much eliminated COVID up until the end, oh sorry up until the start of this year. So, for about an 18 month period there, for many of us life sort of went back to normal while most of the rest of the world was battling and dealing with the virus.

Another reason demand stayed strong in our economy over this period is that we got really good at using digital technologies to work and to shop from home. So, we saw a big lift in the digital economy — while anything involving face-to-face connection or contact took a major hit which is a global story. That dynamic is ongoing to a large extent. This process of digital adoption —pandemics they often sort of reinforce or accentuate trends that were already underway in the economy and in society and digital adoption is clearly one such trend.

Other reasons why our economy stayed strong over that period — household balance sheets actually strengthened over the pandemic. New Zealanders, we actually saved over the pandemic. The housing market which we'll talk about more in a minute also helped strengthen household balance sheets with house prices going up pretty strongly over that period. So you know even now there's still a good buffer there. On average, household balance sheets are still in reasonably good shape. 

The labour market has also been crazy strong throughout the pandemic. We've got unemployment around 3.3%. The employment rate has been around record high. So workers, again a global story here, but workers have been becoming increasingly difficult to find, which is you know a fundamental change for New Zealand businesses. The labour market has really been a rock sort of supporting strong demand in our economy over recent years.

So for all of those reasons — a strong health response, household balance sheets in reasonable shape, really low unemployment, strong labour market, more generally domestic spending
and demand has stayed pretty robust. Of course, you know as I mentioned, it took big hits during lockdowns — particularly the one in March 2020, but then as I said at spending,
we've just come roaring back out of those lockdowns. We're also currently seeing tourism grow back reasonably strongly essentially from zero over recent months. So you know that's
that's the demand side of the New Zealand economy and it's been a story of strength at least so far.

All right, so on the supply side of the economy and again this is a global story — it's been a story of constraints. Perhaps most obviously migration. Net working age migration fell off a cliff going into COVID what with the border being shut and all, and net migration now is still negative currently but it is forecast to slowly pick up. So you know this is another fundamental change in New Zealand's economic model if you like.

Traditionally, we've grown our economy. New Zealand businesses, you know grow our businesses by throwing workers at them and but that model is sort of looking less likely going forward. I think migration inflows are always going to be important and beneficial for the host country and for the migrant but there are increasing signs that the days of very large inflows of low-cost labour into the country may be behind us. Indeed if you ask New Zealand businesses, labour is currently the biggest constraint limiting production across New Zealand businesses currently. All right so demand holding up — you know demand has changed in composition. It sort of went from services to goods during that lockdown period and now it's going back to services. On top of a very tight labour market we've had relative price shocks spilling over the borders given supply chain issues and the war in Europe so of course that equals inflation 7.3% in Q2 of this year. 7.2% in Q3 obviously too high but as you no doubt expect from a central banker, we expect to see inflationary pressures easing going forward, where you know we're hopeful that it has peaked and why do we think that? 

I just want to run through a few reasons why we see inflation moderating and I think you know in no small part, it's because monetary policy works. So the OCR — the official cash rate has increased from 25 basis points over the sort of lockdown period. It's currently 3.5% with financial markets pricing and further rate hikes to come as was mentioned in the introduction. So this is a very rapid tightening in monetary policy and it is starting to have an effect. There are early signs that the economy is starting to cool, that demand and supply in our economy are coming back closer into balance. I guess the most obvious sign is falling house prices. So house prices are down about 10% in aggregate from their high which was last November I think the end of last year, but some of the major centers have seen significantly larger declines in house prices over recent months. You know partly that's about higher interest rates but it's also about more sort of fundamental factors so slower population growth, looser zoning regulations across major cities. So you know again this is a big change for the New Zealand economy.

Traditionally we've sort of traded houses amongst ourselves at ever increasing prices thinking that we were creating prosperity but that's not what's going on currently. So we've sort of seeing a reverse wealth effect which should work to slow down consumption. Related to that, we're also seeing signs of a slowdown in construction activity. Consents — building consents have been
and continue to be very strong, but code of compliance work put in place that sort of stuff is starting to slow and they're certainly consistent with what we're hearing from industry
contacts. Unfortunately construction here it's a boom bust industry and we've actually it's been booming. We’ve actually been building quite a few houses over the past couple or 3 years, which is great and part of the reason why we're seeing this moderation in house prices. But there are lots of signs pointing to a sort of upcoming bust or at least a significant slowdown in construction activity.

Now let's sort of turn to the international front — the global economy and it's that kind of a question of where to start. Financial Market turmoil, growing signs of stress in the global economy. Global inflation is nudging double digits. We're seeing a coordinated tightening across central banks in most economy — certainly developed economies. We're seeing U.S dollar strength meaning currency depreciations for the rest of us and of course we've seen a bare market in equities.

Now I think you know when you get beyond the sort of hurley burley of financial markets and look at longer run trends in the global economy, you know those longer run trends are also giving us plenty to think about. As I mentioned earlier, there's a sense that globalization is changing compared to what we've become used to over recent decades. We've got huge geopolitical tensions. The global economy is sort of splintering into factions or clubs of countries. We’ve got a war in Europe and China has a number of significant issues confronting policy makers there and they’re sort of starting to turn inwards a little bit again.

We're also seeing governments getting bigger across the developed world. There's been a structural rise in spending and investment across many countries. To start with that's been about fighting COVID, fighting the pandemic but population aging means greater expenditure on health care. Geopolitical tensions means greater spending on defence. Climate change and energy security mean more investment in renewables and the like, and of course active industry policies are coming back into favour. Now offsetting this sort of tendency towards greater government spending is the fact of aging population. So older people, as we age, we tend to save more meaning higher savings in aggregate, which tends to sort of dampen aggregate spending in the economy but who knows how that's all going to play out.

All right, so there's some fundamental shifts going down around us. It’s certainly a great time to be doing economics. The optimist in me thinks that these changes could hopefully be the catalyst for sort of allowing the global economy to escape the sort of low growth period that we've been in since the global financial crisis, and to tackle some of the major problems confronting us, particularly climate change. But of course it could also signal - well it does signal huge challenges. From Financial Market chaos to central banks sort of running low on ammunition and out of control public spending going forward, so certainly it is game on people in terms of navigating our way through all of those challenges.

Now let me end just with a few words on New Zealand's longer term economic prospects. As I mentioned, 2 of the key growth drivers in our economy being the housing market and strong
inward migration has fundamentally changed.  The dynamics have changed. At least for the meantime, or it sort of raises the question you know where's economic growth going to come from in future. I did a number of years at the Productivity Commission so it's pretty natural for me to say it's going to come from a lift in our productivity of course, and I think that now is the perfect time to finally fix our relatively poor productivity performance. Now that's a huge challenge in itself, transitioning from an economic growth model that's being based on working more hours to one that's based on greater investment and technological adoption is obviously more easily said than done. We've been in a capital shallow sort of labour-intensive equilibrium for some time and it's kind of worked to some extent but that's a huge challenge to be moving from there to a more investment driven, high productivity, growth equilibrium.

But having said that, I think that transition is more possible now than certainly any period in my living memory. I say that you know, because of technology we're living through the 4th Industrial Revolution and behind all the chaos that is our day jobs. I think the biggest deal for us as I sort of alluded to at the beginning is that new technology makes it easier for Kiwi businesses to do business over distance. Economists, we talk about lower spatial transaction costs which allow businesses to expand beyond their geography — both domestically and internationally, makes it easier for small, remote firms to connect into large international markets. It makes it easier for Kiwi innovation to be noticed internationally. It makes it easier for us to tell our story. So that's the opportunity. As to whether we'll take it — this digital opportunity in front of New Zealand. There’s lots of work to be done in that space as well — education skills, innovation regulation, responding to climate change. Again it's a long list, but  the opportunity is there and I think the biggest sort of mistake that we need to avoid in this work is sort of the failure of imagination based on the assumption that today's regime is going to last forever. It never does.

Change is going to keep coming. Get ready.

So with that I'm going to leave it at that.

Thanks for your attention and listening.