I.3G Reserve Bank of New Zealand, Monetary Policy Statement, November 2018 Report of the Finance and Expenditure Committee Fifty-second Parliament Michael Wood, Chairperson December 2018 Presented to the House of Representatives Michael Wood Chairperson
I.3G MONETARY POLICY STATEMENT, NOVEMBER 2018 Contents Recommendation... 3 Introduction... 3 Official cash rate unchanged... 3 GDP growth has slowed but is projected to increase... 3 Scenarios for changes to the OCR... 4 Ongoing international risks... 4 CPI inflation has increased to 1.9 percent... 4 Business confidence remains low because of cost pressures... 5 Employment is near its maximum level... 5 Household consumption higher than real wage growth... 6 Productivity growth remains low... 6 Wage growth is lower than expected... 7 KiwiBuild expected to contribute to residential investment... 7 Appendix... 8 2
MONETARY POLICY STATEMENT, NOVEMBER 2018 I.3G Reserve Bank of New Zealand, Monetary Policy Statement, November 2018 Recommendation The Finance and Expenditure Committee has conducted an examination of the Reserve Bank of New Zealand s Monetary Policy Statement, November 2018, and recommends that the House take note of its report. Introduction This report summarises the contents of the Reserve Bank s monetary policy statement (MPS), released on 8 November 2018, and the main issues we discussed in our meeting with the Governor of the Reserve Bank. Official cash rate unchanged The Reserve Bank has left the official cash rate (OCR) unchanged at 1.75 percent, where it has been since November 2016. This is because the Reserve Bank still sees a need for monetary stimulus while core inflation remains below the 2 percent midpoint of the target range. As in the monetary policy statements of August 2018 and May 2018, the Reserve Bank considers that there are both upside and downside risks that could affect the OCR. If these risks materialise, the Reserve Bank may need to move the OCR either up or down to meet its inflation target and support maximum sustainable employment. If they do not materialise, the Reserve Bank expects to keep the OCR at 1.75 percent through 2019 and into 2020. GDP growth has slowed but is projected to increase Growth has slowed since 2016, with annual GDP growth reaching 2.8 percent in the June 2018 quarter. This is slightly lower than the Reserve Bank s estimate of the economy s potential growth rate. The slowdown in growth has coincided with moderating growth in household spending and falling measures of business activity. Over the medium term, GDP growth is expected to rise because of increased Government spending, stimulatory monetary policy, and higher net exports. In this context, the OCR of 1.75 percent is expected to support growth and employment, and contribute to an increase in the use of resources. This is expected to develop capacity pressure (where the economy nears its maximum potential output), helping to lift inflation to the 2 percent midpoint of the target range. 3
I.3G MONETARY POLICY STATEMENT, NOVEMBER 2018 Scenarios for changes to the OCR The Governor floated two possible scenarios that could affect the Reserve Bank s predictions for GDP growth and result in changes the OCR. Scenario for increase to the OCR The Reserve Bank warned that inflation could increase faster than projected if firms responded to increasing input costs by raising prices. In this scenario, the Reserve Bank would raise the OCR to around 2.45 percent by late 2020 to dampen higher than expected inflation. This measure would drive inflation back to around 2 percent by late 2020. Scenario for decrease to the OCR In the past year, most businesses have experienced a slowdown in activity. If this signalled a lasting decline in domestic demand for goods and services, GDP growth (and inflation) could remain weak for longer than expected. Slower GDP growth would result in an increase in the unemployment rate. In this scenario, the Reserve Bank would reduce the OCR to around 1.0 percent to help stimulate demand and the economy generally. This measure would boost GDP growth, help to raise employment to its maximum sustainable level, and help bring inflation up to the Reserve Bank s target of 2 percent. We asked what would happen if this scenario occurred alongside shocks to the international market. The Governor informed us that if the Reserve Bank was under pressure to reduce the OCR below 1.0 percent, it could use non-conventional means to provide monetary stimulus. While the likelihood of this scenario is low, the Reserve Bank considers it within the realm of possibilities. Ongoing international risks The Governor highlighted a number of offshore risks that could precipitate higher global volatility and affect New Zealand s ability to sell products on international markets. Recent trade tensions have resulted in the reintroduction of trade barriers between a number of major economies. If further tariffs are imposed, as has been threatened, it could negatively affect global GDP. Likewise, the removal of monetary stimulus by the US Federal Reserve has resulted in investors moving capital out of Asia, attracted by the higher interest rates in the United States. This has resulted in many Asian central banks raising their interest rates and making credit more difficult to secure. This could negatively affect demand for New Zealand s products among Asian importers. CPI inflation has increased to 1.9 percent Annual consumers price index (CPI) inflation has increased to 1.9 percent from 1.5 percent in the June quarter, and is expected to climb further over the next few quarters. This increase can be attributed to rising fuel prices and increases in the costs of imported goods owing to the lower exchange rate. (On a trade-weighted basis, the New Zealand dollar is about 3 percent below its January 2018 level, and about 10 percent below its peak in 2017.) 4
MONETARY POLICY STATEMENT, NOVEMBER 2018 I.3G The Reserve Bank does not intend to change the OCR in response to the fuel price spike. However, it is monitoring whether increases in fuel prices are passed on into the prices of other consumer goods and services, causing more generalised inflation. Business confidence remains low because of cost pressures Surveys indicate that business confidence remains low. However, in practice the Reserve Bank does not see this as a concern for growth in the economy. The Reserve Bank regularly meets with a range of businesses and organisations to improve its understanding of economic conditions. It has found that the lack of business confidence derives primarily from concerns about the rising costs of inputs and the extent to which businesses can pass those costs on. The rising costs are a result of increasing international oil prices, recent pay equity settlements, minimum wage increases, and the depreciation in the exchange rate causing an increase in the cost of imported products. To date, cost pressures have been absorbed by businesses through lower profit margins without producing a substantial increase in prices to consumers. The Reserve Bank says this is because the economic environment is very competitive. New Zealand firms have found themselves unable to set prices themselves, but instead must conform to global prices, which are not projected to rise in the short term. The Reserve Bank expects the limited pass-through of rising input costs into overall consumer prices to continue in the short term. Nonetheless, the Governor acknowledged that there would be limits to businesses capacity to absorb cost pressures. While the Reserve Bank does not expect full pass-through, it definitely expects some increase in the prices of goods and services to consumers, resulting in higher inflationary pressure. Employment is near its maximum level According to the monetary policy statement, New Zealand is near or at the level of maximum sustainable employment. We note that the MPS was written on the basis of an unemployment rate of 4.4 percent. However, the day before it was released, new labour market statistics put the unemployment rate at 3.9 percent. We asked whether this indication of tighter capacity constraints meant that a slowdown in GDP growth was more likely (a scenario which would lead to a decrease of the OCR). The Governor said the lower unemployment rate is a more likely indicator of rising, rather than falling, economic growth. The Governor observed that businesses are struggling to find labour to meet demand for their products. We agree that this is particularly evident in some New Zealand regions. The Governor noted that this would traditionally have led to higher wage pressures in those regions and more wage movement there. However, the Reserve Bank considers it a sign of the more globalised economy that the traditional models of price and wage movements no longer apply. We are interested in how close the economy is to the non-accelerating inflation rate of unemployment (NAIRU). That is, a level of unemployment at which the economy would be in 5
I.3G MONETARY POLICY STATEMENT, NOVEMBER 2018 balance, without inflationary pressure in the labour market. The Reserve Bank said the unemployment rate is not a precise measure, and its estimates have a plus-or-minus range of about 1.5 percent. On one measure, New Zealand is at NAIRU. The Reserve Bank highlighted that the practical utility of NAIRU as a policy tool is limited in New Zealand. This is due to New Zealand s rapidly expanding (rather than stable) labour market participation and the fact that labour market participation is not independent of monetary policy. The Governor highlighted, however, that monetary policy has limitations with what it can do around job skills, willingness to work, and locations. Projected growth in the labour force The MPS forecasts a decline in the growth of the labour force over the next few years as a result of lower net migration. It projects the net increase in the working age population falling to 29,000 per annum by the end of 2021. The Reserve Bank told us this was based on the relative performance of the New Zealand labour market compared with overseas, including how growth in the Australian labour market would affect the labour market in New Zealand. The Reserve Bank s forecasts are broadly consistent with those from the Treasury. Household consumption higher than real wage growth The Reserve Bank predicts that household consumption will increase in the short term owing to minimum wage increases, higher transfer payments, and population growth. However, in the long term, household consumption is expected to slow. This is due in part to higher petrol prices, which are expected to squeeze households disposable incomes. We were interested in the Reserve Bank s projection that household consumption will increase significantly faster than real wage growth. The Reserve Bank said that its projection for an increase in household consumption was based primarily on an increase in the overall number of people employed rather than real wage growth. Productivity growth remains low We note that New Zealand is currently experiencing some of the highest terms of trade in its history. Given this favourable situation, we asked why New Zealand is not achieving higher levels of growth, particularly growth in productivity, measured on a per-person basis. The Governor confirmed that, despite positive economic conditions, growth in productivity per person remains low. This can be attributed to the relatively low added value of the products New Zealand sells and the inability of local firms to set prices when competing in a globalised marketplace. The Governor also attributed the low productivity growth to a global trend over the past three decades of a greater share of profits shifting toward the owners of capital and away from labour. 6
MONETARY POLICY STATEMENT, NOVEMBER 2018 I.3G Wage growth is lower than expected Since the global financial crisis, the labour cost index, which measures actual wage growth, has been significantly lower than the Reserve Bank s expected wage growth. In the past year, increases to the labour cost index have been driven primarily by government intervention (namely, increases in the minimum wage and pay equity settlements). We were interested in why actual wage growth had diverged from expectations. The Reserve Bank agreed that wages have not been growing as expected considering market conditions, and attributed this in part to significant growth in the supply of labour. This has occurred through both immigration and an unprecedented increase in labour force participation. Other contributing factors include the technology-driven growth of the gig economy (characterised by a shift toward temporary and short-term work), and the emergence of superfirms which control larger shares of the market. Both of these trends are reducing the ability for employees to negotiate higher wages. The global shift in profit share from labour to capital (driven in part by low-cost finance) may also play a role. The Governor confirmed that the Government s plan to reduce net migration would put some pressure on the labour market should all other factors remain equal. KiwiBuild expected to contribute to residential investment The MPS projects that KiwiBuild will contribute an additional $2.55 billion toward nominal residential investment between now and 2022. This projection, which is less than half that in the February 2018 MPS, is consistent with the Treasury s assumptions. We were interested in how many new houses would be built between 2019 and 2022. The Reserve Bank informed us that its projections were based on the value of new builds, rather than the number of new builds. It said the number of new builds can be estimated based on different construction cost assumptions, and ranges from 14,200 houses (at 50 percent of the average value of a building consent) through to 7,100 (at the average consent value). These revised estimates are approximately half those that the Reserve Bank made in the February 2018 MPS. 7
I.3G MONETARY POLICY STATEMENT, NOVEMBER 2018 Appendix Committee procedure We met on 8 and 28 November and 5 December 2018 to consider the Monetary Policy Statement, November 2018. We heard evidence from the Reserve Bank of New Zealand. Committee members Michael Wood (Chairperson) Hon Amy Adams Kiritapu Allan Andrew Bayly Rt Hon David Carter Tamati Coffey Hon Judith Collins Ian McKelvie Willow-Jean Prime Dr Deborah Russell David Seymour Fletcher Tabuteau Dr Duncan Webb Advice and evidence received We received the following documents as advice and evidence for this review. They are available on the Parliament website, www.parliament.nz Monetary Policy Statement for November 2018. Independent Economic Adviser briefing paper. Reserve Bank of New Zealand responses to questions from MPS hearing. 8