The dark side of the rock star economy

Why is there this clamour for a rise in interest rates? Just what are we trying to achieve?

I truly don’t get it. Many financial market commentators appear to be saying that because the New Zealand economy is a rock star, we need to now endure an increase in interest rates.

I won’t argue here whether or not our rock star status is justified – I’ll leave that for another post (although I am at a loss as to why one would want to be in the same company as Miley Cyrus).

But, I do want to address this clamour for an interest rate rise. The clamour has intensified as some production, employment, spending, price and confidence indicators have gathered positive momentum over the past 6 months. Indeed the clamour grew to a cacophony this week with the latest CPI inflation figure ‘soaring’ to the giddy heights of 1.6% per annum. Because many financial market commentators were surprised by this number it, apparently, underpinned the argument for urgent action by the Reserve Bank.

All I ask is, why? Just what is the problem? And how will an increase in New Zealand’s interest rates address that problem?

I infer from the clamour that the problem could be one of heightened inflation. But, the 1.6% is well within the 1% to 3% specified in the Policy Targets Agreements (PTA), and further, quite close to the 2% midpoint focus also specified in the PTA. Again, what is the problem?

I infer that some have issues with rising house prices, and perhaps that is the problem? But, we’ve been down that track before. Raising interest rates will only make us seem to be even more of a rock star, attracting largesse to the country to further fuel property market speculation. Increasing interest rates does little to address that ‘problem’ – indeed, it will exacerbate it.

I infer that due to our rip-roaring economy some suggest there is a risk of heightened future inflation. In particular, construction materials and labour costs are set to soar. So, is the problem our rip-roaring economy and, so, we need to slow down its growth rate?

Are you serious? I confess to being flabbergasted. Are we truly suggesting that to solve this ‘problem’ we should slowdown the re-build of Christchurch? Surely not.

Or, that we should slowdown the construction of new houses? This may cure the ‘problem’ illness, but the patient may expire as a result.

Or, that we should slowdown the infrastructure spend on UFB rollout? Or, that we should slowdown the renewal of plant, machinery and equipment that is taking place? Again, surely not?

I must confess to an unsettling feeling of déjà vu. I argue (again) that an increase in interest rates will hike our exchange rate even further. This will penalise our income earners (i.e. exporters), and reward our spenders with even cheaper imports (i.e. consumers). More specifically, one of our core problems remains our policy prescription that ‘buys’ low inflation at the expense of the productive, income-earning tradable sector. Indeed, while the CPI of 1.6% is well within the 1% to 3% range, inflation in the tradable sector is -0.3%, while that in the non-tradable sector is at 2.9%. And this discrepancy has been around for a while.

And what will the widely heralded increase in interest rates do for this problem? It will further underpin the rock star status of the Kiwi$. Hence, we will continue to achieve our inflation target by suppressing even more the income-earning tradable sector, and further rewarding consumers.

As I said at the start, I just don’t get it. But, I confess, I am but a mere economist and am not well versed in the sophistications of the financial markets.