Suggestions for the Reserve Bank of New Zealand?
By Scott Sumner
The government of New Zealand recently added housing prices to their central bank’s mandate. (I put the mandate at the bottom of this post). Previously, the RBNZ mandate was pretty similar to that of the Fed, 2% CPI inflation and maximum sustainable employment. Not surprisingly, I don’t believe adding housing is a good idea. Nonetheless, it is possible to address the government’s request in a way that would actually improve monetary policy.
I’ve never understood why central banks target consumer prices. Why not all prices? Thus during 2002-06, the CPI did not reflect the fast rise in house prices, because houses are considered an investment good. Then, between 2006 and 2012 the CPI did not reflect the huge decline in house prices. Indeed during some of those years the CPI actually reported housing prices rising faster than the price of other goods, even as the price of new homes was plunging rapidly. Consumer prices are not a good indicator of the state of the economy, to put it mildly. They aren’t even a good indicator of the price of domestically made goods.
Instead of targeting the CPI or the PCE, why not target the GDP deflator, which includes the prices of all goods produced in the domestic economy—including new homes? This sort of index would call for slightly tighter policy during dramatic housing price bubbles, and slightly easier policy when house prices are plunging. This might slightly moderate the volatility of house prices, which is consistent with the goals of the new government policy.
Of course the RBNZ has a dual mandate, and thus also cares a lot about employment and hence real GDP growth. Thus they might want to consider a target that somehow incorporates both the rate of growth in the GDP deflator and also the rate of growth in real output.
Questions for readers: Can you recommend a new target for the RBNZ that would reflect both changes in consumer prices and changes in new home prices, as well as changes in output/employment. Any ideas?
New Zealand was the first country to adopt inflation targeting; maybe they can once again lead the world to a new era of improved monetary policy
PS. Here’s a home in beautiful Queenstown NZ:
1. For the purpose of this remit, the MPC’s operational objectives shall be to:
a. keep future annual inflation between 1 and 3 percent over the medium term, with a focus on keeping future inflation near the 2 percent midpoint. This target will be defined in terms of the All Groups Consumers Price Index, as published by Statistics New Zealand; and
b. support maximum sustainable employment. The MPC should consider a broad range of labour market indicators to form a view of where employment is relative to its maximum sustainable level, taking into account that the level of maximum sustainable employment is largely determined by non-monetary factors that affect the structure and dynamics of the labour market and is not directly measurable.
2. In pursuing the operational objectives, the MPC shall:
a. have regard to the efficiency and soundness of the financial system; and
b. seek to avoid unnecessary instability in output, interest rates, and the exchange rate; and
c. discount events that have only transitory effects on inflation, setting policy with a medium-term orientation; and
d. assess the effect of its monetary policy decisions on the Government’s policy set out in subclause (3).
3. The Government’s policy is to support more sustainable house prices, including by dampening investor demand for existing housing stock, which would improve affordability for first-home buyers.