Inflation analysis from NZ

Another great story from Keith Woodford.

New Zealand’s internal inflation from non-tradables is well alight at 2.8 percent for the last year. In contrast, prices for items traded internationally declined by 0.3%.  Understanding these differences and the reasons for these differences lies at the heart of the inflation issue. Non-tradables comprise 60 percent of the CPI with tradables comprising only 40 percent.

In recent times, the much-repeated mantra from the Reserve Bank has been that inflation is too low. Much of the mainstream media has then spread that message without critical analysis. 

The official mandate from the Government to the Reserve Bank says that the Reserve Bank should aim for a midpoint of two percent inflation per year, but inflation may range in the short-term from one to three percent.  The Reserve Bank mandate makes no explicit mention of the tradable versus non-tradable issue, despite the inflation reality that they are two different beasts.

Non-tradables are the items that we produce in New Zealand exclusively for our own consumption and where New Zealand has total control of the pricing. In contrast, tradables are the items where the items can be traded internationally and hence the local prices are determined by international prices. 

Tradables are therefore items that we either import, such as cars, or items that we export, but retaining some for our own use, such as butter.

An example of a non-tradable is local body rates. Another is house rentals. Some others are insurance (all forms), fast food, electricity, legal costs, real estate services and most medical costs excluding pharmaceuticals.

In contrast, further examples of tradables are liquid fuels, clothing, toys, computers and most processed foods.

Some items span both categories. For example, telecommunication costs are 18 percent tradable relating to the equipment which is imported, and 82 percent non-tradable being the local service costs.   Across the overall economy, 60 percent of costs are non-tradables and 40% are tradables.

 Here in New Zealand, our overall inflation rate has been driven for all of this century by the 60 percent of items that are classed as non-tradables. The comparison is stark over all timeframes.

For example, for the 20-year period from Q4 (quarter 4) of 2000 through to Q24 of 2020, the prices of non-tradables increased by 84 percent whereas tradables increased by only 49 percent.

Over a ten-year period from Q4 2010, the non-tradables increased in price by 29 percent whereas the tradables increased by only 14 percent.

Over a five-year period from 2015, the non-tradable inflation totalled 14.2% whereas tradable inflation totalled 0.1% – effectively a big zero.

The big message in all of this is that to a large extent our inflation is not imported. Rather, we do it by ourselves.   This has been the situation for a very long time but has become even more increasingly the case in the last five years.

In the latest 12 months, the non-tradable inflation totalled 2.8% whereas the preceding year it was 3.1%. The year before that it was 2.7%.    For 2021 it is almost certainly on an uptick again with the majority of businesses planning to raise their charges, plus minimum wage rates on the increase.

What these figures would seem to say is that the Reserve Bank efforts to further stimulate inflation are seriously misplaced. We are beating to a different inflation drum than most of the countries we trade with, our internally generated inflation is already well above two percent and nudging three percent, and we now need to find our own pathway.

Whereas tradable inflation has been muted for much of the last 20 years, that may not remain so for ever. One of the key items that may well increase is petrol for private use, which makes up around nine percent of the tradable group and 3.6 percent of total CPI. That is just the petrol for private use. Other items could also start to drift upwards, depending at least to some extent on what happens to the New Zealand exchange rate. 

The fact that inflation of non-tradables has been consistently higher than inflation of tradables raises further questions about the New Zealand economy. As a starting point, it suggests that the non-tradable sector has been less disciplined than it might have been in terms of cost efficiency.

All other things being equal, this higher internally generated inflation relative to internationally determined prices should have led to a decline in the exchange rate, whereas much of the last ten years has been characterised by high exchange rates.

But all other things have not been equal. New Zealand has been producing products in high global demand – comprising dairy, meat, timber, fruit and seafood – and this has led to particularly high terms of trade. Without those happenings, the New Zealand economy would have been in great difficulty.

Acknowledgement: My search for information on tradables and non-tradables was aided by Jenée Tibshraeny at interest.co.nz who came up with the key link as to the components of tradables and non-tradables. This got me on the investigatory journey.  The CPI numbers for tradable and non-tradables, and also the inflation rates for individual components thereof, are available at http://infoshare.stats.govt.nz/