Interest Rate Inflation Targeting Undermined By Cost Of Housing Being Left Out Of Consumer Price Index

Interest Rate Inflation Targeting became the new mantra of the global financial architecture when New Zealand became the first of many countries that followed in trying it out from 1990 onwards.

The theory goes that given it is widely recognised that the greatest cause of a number of causes of inflation is excess quantity of money in circulation to available goods to be purchased will see prices inflate out of reach those on the average income as those holding greater expendable amounts of the excess quantity of money will pay above normal market rates for what ever they desire to purchase. Thus the senior financial management of the globe decided a basket of goods be monitored to detect if any rising of prices is occuring in process named Consumer Price Index (CPI). If rising prices are detected the demand for money would be slowed by raising the cost of it by raising interest rates on borrowing.

Despite the obvious hypocricy of targeting a quantity of money issue with a cost of money solution that would concern anyone with an indepth knowledge of Monetary, Banking And Credit Systems given where the extraordinary powers of credit origination as the primary money base and its distribution currently reside, it is not half as concerning as how obviously flawed the process would be if the cost of housing was left out of the Consumer Price Index allowing the quantity of money entering circulation to keep growing with artificially low interest rates. But the statements below from senior participants of the private global financial management make it quite clear that is exactly what happened;   

BoE boss wants house prices in inflation

This is Money

22 July 2007, 12:00am

The Governor of the Bank of England has admitted he is ‘surprised’ that rising house prices are not included in the official inflation figures, according the BBC.

Mervyn King told Radio 4’s Money Box programme that he wished the Consumer Prices Index (CPI) – the measure that tracks the cost of goods and services – did include house prices, as the previous official measure, the Retail Price Index (RPI), used to.

He said: ‘Some of these issues are controversial. I wish it did include housing, but it doesn’t – at least at present. Maybe one day it will.’

Since 1997 Mr King and the Monetary Policy Committee at the Bank of England has had the task of keeping the CPI around a target of 2%. It has raised interest as a method to reduce inflation if prices climb too sharply.

However, critics have said that because the CPI does not include the cost of mortgage repayments, official inflation figures are artificially low. Some say this has created a bubble in the property market as house buyers are able to over-borrow with cheap loans.

Currently the CPI stands at 2.4%, but the RPI – which includes mortgage repayments – stands at 4.4%.

Economists expect the Bank of England to raise interest rates to 6% by September, something that could prove a problem for some homeowners struggling with large mortgages.

Mr King said: ‘CPI is meant to be constructed in the same manner in all European countries, and so far the European statisticians have not worked out a way of how they can calculate the cost of housing in a way that can be done uniformly across Europe.’

Notwithstanding the limitations of the CPI, Mr King defended the record of the Bank of England in setting rates. He said: ‘The track record is pretty good, so if we have made wrong decisions from time to time, there can’t have been very many of them and they can’t have been that wrong.’ ‘The Monetary Policy Committee I think was well designed. I think it’s been successful for 10 years and I see no reason to believe that it cannot be successful for another 10 years and decades after that.’

Excerpts from;

Crisis: One Central Bank Governor and the Global Financial Collapse

Contributors: Alan Bollard (author Governor Reserve Bank Of New Zealand ), Sarah Gaitanos (with) Format: Paperback, 210 x 138mm 176 pp Publication date: 01 Sep 2010 Publisher: Auckland University Press ISBN-10: 1869404696 EAN: 9781869404697

Pg 122

(he said this of year 2009); “To make matters harder we were now about to introduce our new forecasting model, called KITT( Kiwi inflationary targeting technology). This new model would give us a better way of simulating households, firm and bank behaviours, including housing market developments, but first we needed to understand how to use it, how to calibrate it, where its strenght and weaknesses lay. It was a terrible time to iron out the kinks of a new system.”

Pg 183 Allan Bollard wrote;

“In self-interest, banks may encourage New Zealanders to take on more debt than is good for them individually or deliver more external liability than is good for the country.”

A speech by Governor Reserve Bank Of New Zealand Dr Alan Bollard and Enzo Cassino, delivered by Dr John McDermott to the Sim Kee Boon Institute Conference on Financial Economics Singapore, 5 May 2011

http://www.rbnz.govt.nz/speeches/4389919.pdf

John McDermott admitted that the central bankers had lost the plot on the quantity of money supply side;

“Identifying bubbles will require new empirical tools … but as with assessing disequilibrium in the goods or labour markets, we will still probably need to rely on information from a wide range of qualitative and quantitative sources to help identify the presence of a bubble and understand the nature of it,” McDermott said.

“How successful we will be remains an open question,” he said.

“The crisis had also prompted a revival of interest by central banks in money and credit, whereas in previous decades central banks had paid less attention to monetary and credit aggregates” he said.

“Overall, there has also been a recognition that credit growth over the past decade was excessive and a potential risk to financial stability given the build-up in leverage and rising asset prices that accompanied it. We are continuing to build our understanding of money and credit at the RBNZ, and its inter-relationship with both sectoral financial decision making and potential risks for the banking sector.” he said.

Joseph Stiglitz, Ex Vice President of the World Bank and Noebel Price winner for economics wrote of the shortcomings of Interest Rate Inflation Tagetting in a 2008 article;

“The answer came in the form of “inflation targeting,” which says that whenever price growth exceeds a target level, interest rates should be raised. This crude recipe is based on little economic theory or empirical evidence; there is no reason to expect that regardless of the source of inflation , the best response is to increase interest rates. One hopes that most countries will have the good sense not to implement inflation targeting; my sympathies go to the unfortunate citizens of those that do.  (Among the list of those who have officially adopted inflation targeting in one form or another are: Israel, the Czech Republic, Poland, Brazil, Chile, Colombia, South Africa, Thailand, Korea, Mexico, Hungary, Peru, the Philippines, Slovakia, Indonesia, Romania, New Zealand, Canada, the United Kingdom, Sweden, Australia, Iceland, and Norway.)”

http://www.project-syndicate.org/commentary/stiglitz99/English