Monday, 19 December 2005

Denying prosperity by misunderstanding inflation

Goodness me, Deborah Coddington's quite reasonable article pointing out the absurdity and destructiveness of the Reserve Bank's myopic control of interest rates has caused the mild-mannered DPF to reach for his smelling salts.

Perhaps he just doesn't understand basic economics, huh? Tell me again how it's a good thing to strangle producers and exporters in a bid to keep down the prices of property? As I asked last time Bollard flopped out his blunt instrument:
  • Does anyone else wonder at the sanity of strangling the backbone of our economy -- producers and exporters -- in order to deal to "the profligate household sector"? Is that sane? And, given that many household borrowers are fairly well insulated from Reserve Bank interest rate hikes, will another Reserve Bank interest rate hike deal to them anyway?
  • And why should they be 'dealt to' anyway? Why is the 'price stability' of Bollard's 'basket of goods' such an important thing, and should New Zealand producers and exporters be sacrificed on the 'cross of stability' of this basket? Don't prices in a free market rise and fall naturally as a way of clearing markets? Is that such a bad thing? Don't free markets, when they're left free, exhibit over time a gentle 'deflation'? Why is that a problem?
  • How "profligate" is the household sector? Why is it "profligate" to pay what you can afford? And just whose money is it anyway?
There is an enormous misconception about inflation that helps fuel the Reserve Bank's meddling, and that sees otherwise intelligent free-marketeers supporting the meddling. What is usually thought of as inflation, ie., a galloping increase in prices and a consequent fall in the purchasing power of a dollar, is in fact the consequence of real inflation, ie., the money supply being inflated. 'Price inflation,' has become become conflated and confused with real inflation. There is no way to determine the difference between price increases due to the increase in the money supply -- ie., 'price inflation,' prices increasing for real and genuine market-induced reasons, just as there is no way for the interest rates to to stop 'price inflation' without also stifling producers and exporters.

The biggest effect of the Reserve Bank's inflation fighting has been to strangle producers and exporters and to deny New Zealand's future prosperity, just as much and in a similar way as Muldoon's wages and prices freeze of 1973 did the same job. The truth is that as long as the money supply itself is not inflated (which is what 'inflation' actually means) there is little need and every reason not to try and achieve price stability. Let prices be what they should be: signals to the market, not a call for strangulation and the use of Alan Bollard's blunt instrument.

[UPDATE: A couple of years ago, Don Brash defended the Reserve Bank at an Auckland SOLO conference -- an audience of committed libertarians. His presentation, 'Do We Need a Central Bank?' is linked here in MP3 (64MB though, so you'll need broadband). As you'd expect, the question period was very, emm, interesting.]

Linked Article: High price of doctor's medicine - Deborah Coddington
Recent Related Articles at 'Not PC':
Questions, rhetorical & otherwise, about Reserve Bank meddling
NZ businesses ready to shrug?
Related topics: Economics, Politics-NZ


  1. Dead right Peter. While the Reserve Bank has been a good disipline on government to get deficit spending under control, it is now a danger to our future prosperity. It is attempting to crush a perfectly natural bubble in the property market, by beating down the entire productive sector. What the hell do we need a reserve bank for anyway? All we need is a cap on government spending and the market will take care of the rest.

  2. What's wrong with what the RBNZ does is that it tries to stabilise prices is that it reverses cause and effect. It tries to push up interest rates to reduce the demand for money whereas it should (while it still exists) try to mimic what banks would do in a free market and limit the increase in the monetary supply to an approximation of the growth in real capital and let the interest rate rise or fall to match demand with supply.

    Though I can't really be sure, I think interest rates would go much higher in a truly free market if it were instituted tomorrow. I believe they have been printing money faster than the pool of real capital (consumer goods) has been growing and that if the market were freed tomorrow (RBNZ says it will stop printing money) interest rates would go up as the most productive projects bid up the rate on capital.

  3. Good bloggin' but.

    Tell me again how it's a good thing to strangle producers and exporters in a bid to keep down the prices of property?

    Okay, I'll tell you again.

    The arm of government is up to it's elbow in the economy anyway, especially in reguards to the labour market. Inflationary macroeconomic policy goes a way to acting as a big bandaid on the sore created by the other kinds of macroeconomic policy.

    Furthermore, the economy has become dependent on the drug of inflation such that withdrawal would hurt it like an angry mother-fucking tiger that was already in a bad mood anyway but had been growing rapidly more pissed off from having his tail pulled and had been waiting for you to let go his tail so he could rip you to ribbons.

    And you think folk draw 30year plans for Mt Wellington malls with the expectation that government macro policy can undergo radical change? Shut down the Reserve Bank and it's going to scare the shit out of everybody on all sorts of levels for years and years. Got the balls to do that?

  4. god i hate economics. the minute i think i understand it, i get confused by something else :(

  5. absolutely right PC. Trevor is right that the discipline has been good but the NZ economy is missing out on high end growth through government intervention. the diffence between a barely adequate 3% and an OECD position improving 4.5%.

  6. Much as I dislike Bollard the RBNZ is absolutely essential for the free market. It does far more than set the underpins the currency and is the custodian for the open market banking systems. And somebody HAS to do it.

    BTW my email keeps getting rejected by your server. I have tried 3 times to reply to you.


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