Reserve Bank focus: Why managing inflation expectations is crucial – Mark Lister
Expectations matter because they influence behaviour, and behaviour drives outcomes – especially so when it comes to inflation, Mark Lister writes. Photo / 123RF
We’ve seen a lot of economic releases over the past several weeks, including the consumers price index (CPI), retail sales and housing market data.
However, the most important of all were probably the two that covered inflation expectations.
It might sound odd that what people think might happen trumps what’s actually happening across the economy, but right now that’s very much the case.
Expectations matter because they influence behaviour, and behaviour drives outcomes.
That’s especially so when it comes to inflation.
If enough people expect prices to rise, there’s a risk they’ll start behaving in ways that will ensure that they do.
Workers will push harder for pay rises because they expect living costs to keep increasing, businesses will lift prices if they assume higher costs are coming and consumers will bring forward purchases of goods they expect will cost more tomorrow.
When that happens all at once, inflation expectations can become self-fulfilling, which is why central banks spend so much time worrying about them.
As well as keeping today’s inflation under control, the Reserve Bank is also trying to convince all of us that inflation will remain low and stable in the years ahead.
That’s what it means when it talks about keeping inflation expectations anchored.
It needs to win that PR battle with consumers, businesses and financial markets, so we keep our behaviour in check.
In mid-May the Reserve Bank released two separate surveys looking at inflation expectations.
One canvassed about 40 economists, business leaders and professional forecasters, while the other surveyed more than 1000 New Zealand households.
The good news is that the experts are relatively relaxed.
Unsurprisingly, this group has raised its collective view on short-term inflation on the back of higher fuel prices and supply chain disruption.
More importantly, longer-term expectations remain remarkably well anchored.
Five-year inflation expectations sit around 2.2%, while 10-year expectations are slightly lower, at just above 2%.
The Reserve Bank will take comfort in that.
It suggests people who spend their lives watching the economy believe the system is working, and that inflation will eventually settle back to something more normal.
Then again, it’s not the opinion of this group that matters most.
Economists don’t drive the economy, households do, and the household survey painted a slightly different picture.
The typical New Zealand household expects inflation to still be around 5% a year from now, and 4% in two years’ time.
Even five years from now, households still expect inflation to be running hotter than the Reserve Bank would like.
You can understand why.
Most people don’t experience inflation by looking at the official statistics or through their spreadsheet models.
They see it when fuelling up the car, paying the rates or insurance bill, and checking the supermarket receipt.
Until 2021, nobody under 50 had experienced genuinely high price pressures.
New Zealand inflation was low in the 30 years leading up to that, averaging about 2% annually and only pushing much higher for brief periods.
However, it’s been close to 5% per annum these past five years and once people have lived through a cost-of-living shock, that experience lingers.
Just as we thought things were coming under control, another shock has emerged and households are braced for that.
They know what might come next, and those perceptions matter.
This doesn’t mean rampant inflation is a foregone conclusion, but it helps explain why the Reserve Bank is on high alert and watching expectations so closely.
If it can convince us all that the fuel price spike will be temporary and isolated, all will be well.
But if households lose faith in the bank’s ability or resolve to keep broader price pressures in check, that’ll make its job much harder.
Mark Lister is Investment Director at Craigs Investment Partners. The information in this article is provided for information only, is intended to be general in nature, and does not take into account your financial situation, objectives, goals, or risk tolerance. Before making any investment decision Craigs Investment Partners recommends you contact an investment adviser.