Monday 18 April 2011

RBNZ vs Sumner

Scott Sumner's been a one-man and very influential crusader for central bank nominal GDP targeting over inflation targeting.

The NZPA asked the RBNZ for comment. Their response:
  • Inflation targeting has been successful and continues to be used by all those who adopted it;
  • GDP numbers are subject to large revision, making policy difficult to communicate;
  • the Policy Targets Agreement allows RBNZ to respond to output and to look-through one-off price level adjustments.
I'd definitely take Sumnerian NGDP targeting over a mismash of central bank policy targets. But I'd expected a better reply from RBNZ. "Everybody's doing it" isn't a good answer to Sumner's "Everybody's wrong." They're right to point to their very specific mandate to ignore one-off changes in price levels - a more mechanistic form of inflation targeting could have negative real consequences. Their pointing to the broadening of the PTA worries me, as always, though that's the fault of the PTA, not the RBNZ. And I'm not convinced by the potential for GDP adjustments to bollocks things: surely in an NGDP targeting world RBNZ would be running output gap models and setting policy to make up the difference. It might be harder to hit an NGDP target, but that just argues for larger error bands around the target.

The better answer Sumner gave himself: NGDP targeting works best in large diversified economies anyway. I can imagine a few problems resulting from our GDP figures' sensitivity to global dairy prices.

Further, NGDP targeting would have hit the exact same problems as inflation targeting over the last decade. In 2005/6, RBNZ was too loose relative to its own inflation target; why do we think that an NGDP target would have then been any the more constraining? In 2008, RBNZ saw the crisis coming and increased the money supply; I'm not convinced that they would or should have done more in an NGDP regime than they did do under inflation targeting.

As a final note, I'm really hoping that, once NZPA is gone, somebody else takes up asking the RBNZ questions about policy papers coming out of the Adam Smith Institute.

The usual caveat that I am neither a macro nor a money guy applies.

5 comments:

  1. "In 2005/6, RBNZ was too loose relative to its own inflation target"

    But was it ex-ante? Everyone was forecasting a recession in 2006 following a supply shock (sharp lift in oil prices) ... if anything an NGDP target would have seen them set the policy rate lower (note that NGDP growth, as measured at the time, was falling ... in December 06 when the June 06 data was out NGDP growth had fallen to 4.1%pa).

    "I'd definitely take Sumnerian NGDP targeting over a mismash of central bank policy targets"

    Agreed.

    With regards to the Bank's response to the article - I would note that inflation targeting and NGDP targeting are very similar (in the wide range of targets), but the questions seemed to imply they were very different. As a result, the Bank might have been dismissive because of that.

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  2. Inflation in non-tradeables was above 3% from mid 2002 through mid 2009. Unemployment dipped below 4% late 2004 and mostly stayed there. Wages pressures were strong. The 2005 budget / election pushed out a ton of new spending.

    Seems a tough call to reckon it would all just go away on its own.

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  3. "Inflation in non-tradeables was above 3% from mid 2002 through mid 2009. "

    Yar, but the target is general price growth - not non-tradable price growth. There was a secular decline in the price of tradable goods, and so average non-tradable price growth need to be higher to ensure that average price growth was within the target.

    With regards to unemployment we have to ask what the RBNZ felt the "NAIRU" was - a factor that was very unclear following the introduction of working for families.

    It is easy, really easy, to look back now and say they were wrong. But look at what everyone was saying at the time - a lot of economists were demanding rate CUTS on the back of forecasts, and the RBNZ was holding firm on leaving rates unchanged.

    "Seems a tough call to reckon it would all just go away on its own. "

    I'm very hawkish out here, and I think they seem to be implicitly targeting the top of the band which is something I hate.

    However, I don't agree that they were too loose relative to their actual target - we know this because their forecast was consistent with targeting the top of the band.

    All they have to do to "achieve their mandate" is to forecast that they will achieve their mandate, that is why the mandate needs to be tighter and there needs to be external cross-checks on their forecasting procedures.

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  4. Of course they're targeting CPI not non-tradeables. But the ongoing high non-tradeable inflation rate coupled with strong domestic wage pressures meant that unless inflation in tradeables continued to be very low, the overall rate was going to be high.

    I was doing a lot of shouting at the time (not on blog, but probably in your comments sections somewhere) that RBNZ was way too loose. I've no crystal ball either though - I was worried about high inflation in early 2008 and was clearly there very wrong.

    I recall in 2006 having a bit of fun by taking averages over CPI series (forecast and historic) and seeing how wide a band you'd need for average CPI to be below 3% - that then gets a functional definition of the medium term. It was pretty wide. Center an average on the December 2005 quarter when inflation was in its second quarter above the top of the band. Over how many quarters do you need to average in order for it to be true that inflation is, on average, between 1-3%? Averaging over 11 quarters gets it down to 3%; over 13 quarters to 2.9%. I recall its having been longer than that based on their expected rates - it dropped lower in 2007 than they had expected, if I remember right.

    I don't like playing cute with differences between the letter and the spirit of a mandate. A band is supposed to give you an interval for error. Kinda like how the cops won't take as an excuse that you were trying to drive 110 kph but your foot slipped so you were caught going 112.

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  5. "But the ongoing high non-tradeable inflation rate coupled with strong domestic wage pressures meant that unless inflation in tradeables continued to be very low, the overall rate was going to be high. "

    But that was the key - their forecast was for a continuing secular decrease in tradeable good prices. A forecast that seemed reasonable at the time, and also came true. As a result it was still consistent.

    "I was doing a lot of shouting at the time (not on blog, but probably in your comments sections somewhere) that RBNZ was way too loose. I've no crystal ball either though - I was worried about high inflation in early 2008 and was clearly there very wrong."

    I was exactly the same. I was especially concerned about the fact that it appeared to be appearing in wage-setting behaviour. These concerns on our part were fair because we felt they were going to violate their mandate - but I just think its a bit strong to say that they did violate their mandate in 2006.

    "Over how many quarters do you need to average in order for it to be true that inflation is, on average, between 1-3%? Averaging over 11 quarters gets it down to 3%; over 13 quarters to 2.9%. I recall its having been longer than that based on their expected rates - it dropped lower in 2007 than they had expected, if I remember right."

    Don't forget that when evaluating their own policy performance they ignore past mistakes - so its a forward looking average ... hence why they always just discuss their forecast.

    I'm a bit uncomfortable with that myself, but I prefer to say that their implied target it too high - not that they are violating their mandate (which is so vague its almost meaningless in some ways).

    "I don't like playing cute with differences between the letter and the spirit of a mandate. A band is supposed to give you an interval for error."

    They do. It sounds to me like you would prefer price level targeting and a tighter mandate. On that note I'd agree with you 100%.

    Comparing the language of our Bank to other central banks I often find that they don't like the idea of things being "testable" - there are too many unknowns they will say. I compare that to the Fed who says "if average inflation over a 5 year period is much different from 2% we've failed". And the difference here stems from pure forward looking inflation targeting relative to some implied price level targeting (on the part of the Fed).

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