KEY POINTS:
An economist says Reserve Bank Governor Alan Bollard has fallen into a trap - using tools designed to battle inflation in big economies that have the opposite effect here in New Zealand.
Debasis Bandyopadhyay, of the University of Auckland, says the tactic of raising official cash rates (OCR) to stave off inflationary pressure is serving only to make the NZ dollar more attractive and leading to an influx of overseas buying that is raising monetary liquidity, boosting inflation here.
Ten of 17 economists polled by Reuters expect the Reserve Bank to raise the OCR on Thursday, and the ASB bank expects it to rise from 8 to 8.25 per cent.
"Upside surprises to growth and inflation leave the RBNZ with little inflation headroom," says ASB treasury economist Daniel Wills. "Domestic demand, export prices and housing will be the key focus areas for the RBNZ ahead."
Bandyopadhyay says other countries with much bigger economies can cope with tactics such as this, but not New Zealand. Bollard now needs to cut interest rates dramatically, so that the value of the NZ dollar falls.
Michael Cullen, with his recent comments about political intervention, may be giving Bollard some excuse to cut interest rates next week, says Bandyopadhyay. If Bollard cuts on his own, it will be admitting he has been wrong until now.
Bandyopadhyay, who was speaking to the Herald on Sunday from a conference he is attending at the National Bureau of Economic Research in the US, says his discussions with international economists have convinced him even more of the damaging impact that Bollard's methods may have on our very small, but open, economy.
Another critic of the inflation-busting approach of the Reserve Bank is Berl economist Ganesh Nana, who says inflation is not that bad in NZ.
Every piece of economic data - no matter how positive - is now being examined in a desperate search for possible inflationary signs.
The Government's directions to Bollard are not much different from those in other countries, but Nana's concern is around "the behaviour - the interpretation, the approach" to the targets.
He asks: "How evil you think inflation is? Do you try to take those pre-emptive strikes around something that you think might happen - if you think inflation might go outside the bounds?"
Nana says a good example of analysts looking for the bad in data could be seen with the release of this week's CPI numbers.
"They said that CPI was 2 per cent for the year, and the target is 1 to 3 per cent. Now when I went to school, two was between one and three, so inflation is under control.
"The CPI is an average of a lot of other numbers, some higher than two, others lower. Before you do anything else, why should you immediately go searching for signs of inflation? That's the interpretation I take out of it.
"All the commentary is - searching for inflation, finding inflation, evidence for inflation - that goes and justifies a call for increase in interest rates. That's the trap we've been in, and we've got to get out of that trap."
Bollard's policy targets were to keep inflation between 1 per cent and 3 per cent on average over the medium term.
"Now if you look at the CPI for the past three or four March years, on average, it's always between one and three. There have been the odd two or three quarters above three, but we're well within that zone," says Nana.
"Why are we continually trying to search for evidence that there is inflation? That's our immediate, knee-jerk response."
Nana says that people look for inflation even in positive news, such as the low unemployment figures: "People say 'it's inflationary, it's a tight labour market'. Well that's not what it's telling us."
Low unemployment shows the economy is going well and employers are out there looking for staff.
"Many economists, and so therefore some of the policy, is being set in a framework where inflation is the number one public enemy and anything else is subsidiary to that," says Nana. "There was no doubt that inflation at, for instance 5 per cent, would be damaging to business and make New Zealand uncompetitive."
But there is no suggestion inflation is heading that high, and this exact same kind of damage to New Zealand business is being inflicted by the high exchange rate.
Economists who focus on the money markets tend to be more focused on inflation and it is these people who have their "commentaries" published.
"NZ has made great macho play that we've controlled inflation. We've won that war," says Nana.
The mechanisms are now in place to ensure that inflation doesn't hit the 6 or 7 per cent that it did before.
Nana also uses the example of rising payouts to New Zealand dairy farmers as an area where people only focusing on inflation see the negative, rather than being "welcomed with open arms".
Nana's comments about money-market economists not seeing the economic wood for the inflationary trees were met with a reaction of "that's rubbish" from ANZ National Bank chief economist Cameron Bagrie.
Inflation is high - the "non-tradeable", domestic side of price rises stronger than the Reserve Bank has been expecting.
"Most of the inflation pressure they are seeing is coming from the domestic economy, the so-called non-tradeable inflation," says Bagrie.
"That is the sector of the economy that they control, everything else is beyond their control.
"Secondly, the Reserve Bank is just not concerned about inflation today, they are concerned about inflation 18 months down the track."
"They have absolutely no inflation headroom, that's the real issue here. The medium-term inflation pressures are intense."
Bagrie has been talking to a range of businesses and households - and the "big theme" is how much domestic inflation pressure there is.
The latest CPI figure of 2 per cent, while seemingly in the middle of the Reserve Bank's band, is "a bit of mirage", dragged down by imported inflation that make big ticket items, such as cars and plasma TVs, cheaper.
"If you talk to the average man on the street, and ask how much it costs to live, they're going to say it's gone up an awful lot more than 2 per cent," he says. "And the reason for that is that it's true."
Domestic inflation is running at about 4 per cent, says Bagrie.
"I think people have failed to appreciate the big evil here.
"It's not that the Reserve Bank is anti-growth, they're actually trying to support this economy over the next five years, but what they know is that if inflation is not contained, then there is a real big risk of an accident down the track.
"You're better to have a small sacrifice now, as opposed to a big growth sacrifice in five years' time."
Bollard has repeatedly been warning people over the past 12 months, but no one has listened, says Bagrie.
"You can't exactly have a go at the guy at the moment after he's been out there for the past 12 to 18 months delivering these warnings.
"It's not a very PC thing to say, but there's only so many times you can scold your child before you've actually got to take some more action."
