Eric Crampton: NZ Initiative Chief Economist on the report looking at the Reserve Bank's handling of Covid inflation

The Reserve Bank has been learning lessons from its handling of the Covid pandemic. 

Chief Economist Paul Conway says they now have a deeper understanding of supply shocks and the structural drivers of inflation and are better equipped for future shocks. 

He says in hindsight, going earlier or harder to OCR hikes would have reduced inflation sooner. 

New Zealand Initiative Chief Economist Eric Crampton told Ryan Bridge pumping money into a locked-down economy was the wrong approach. 

He says it's great the Reserve Bank is recognising its mistakes now, but it would have been better if they'd recognised them earlier. 

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Episode Transcript

Speaker 1 (00:00):
The Reserve Banks taking a hard look at itself. Findings
aren't exactly shocking, are they. Its own reports says it
didn't hike interest rates fast enough to tackle COVID inflation.
Interest rates fell to just zero point two five percent
in twenty twenty one, they rocketed up to five point
five and twenty twenty three, this is as inflation hit
seven point three percent. Doctor Eric Crampton, chief economist at

(00:20):
the New Zealand Initiative, Eric, good morning, Good morning. Have
they hit the nail on the head?

Speaker 2 (00:26):
Well, they've identified some of the problems. They noted some
of them were a little bit surprising, but I guess
we should have realized what was going on. They noted
that some of the monetary policy models that couldn't deal
well with supply shocks, and we had dealt with the
supply shock in COVID. They're ended sim model, which is
the core backbone that they used for forecasting what's going

(00:47):
on in the world. It wasn't able to handle the
kind of supply shock that has a lot large cross
country interactions. So they're trying to beef that up. They're
trying to beef up a lot more real time data
to a better handle on what's going on. I guess
one of the disappointing bits is that they're saying in
hindsight on some of this. It wasn't just hindsight. There

(01:08):
are plenty of people saying at the time that the
reserve Bank was printing too much money, that it would
have strong inflationary consequence, and that it was fundamentally the
wrong response to a large negative supply shock. So what
I mean by that reserve banks are used to dealing
with things like the GFC from the two thousands or

(01:30):
other financial crises, where the shock is coming out of
the financial side of the economy. It's not coming out
of the real side of the economy, and they'll often
deal with that by printing money, reducing interest rates to
boost aggregate demand, to get people spending a bit more again,
and things then sort of ride themselves out. That doesn't

(01:51):
really work when the underlying productive capacity of the economy,
both here and elsewhere, has substantially shifted inward. Just every
combination that you'd have just won't be as productive as
it used to be because COVID is keeping everybody at home.
Factories couldn't run, cold stores weren't running well, nothing was

(02:11):
really working well, and if you pump money into that environment,
you just have more money chasing the same number of goods,
and that ramps prices up. They should have realized this
a lot faster. We'd been putting up notes on this
from our shop around June twenty twenty. I think I
had a blog post on it in April. Bryce Will
consented seeing it, but also folks like Grant Spencer and

(02:33):
Arthur Grimes had been talking about the asset price run
up that you're going to see from the monetary policy.
We had so great that now four or five years later,
they're fixing some of this, But it's it would have
been better if they had identified it earlier.

Speaker 1 (02:52):
It would avoid absolutely Eric So in a nutshell, you
know that I've admitted that they were too slow. If
that'd been quicker, would that have been as state? Did
the speed effect the destination and therefore would we not
be in as much shite as we are now.

Speaker 2 (03:10):
I don't have the big macro forecasting models behind me
like they do. I would expect that had they realized
by mid to late twenty twenty that they were really
dealing with a large supply shock rather than a shock
from the demand side of the economy. They would have
engaged in less of the initial money pump printing, fewer

(03:32):
large scale acid purposes purchases, and less of a reduction
and interest rates, and they would have started to increase
those again more quickly. That should have avoided hitting the
peaks that we did hit because we wouldn't have hit
the same inflation outcomes that we hit. But the Reserve
Bank has had to be fighting these past couple of years.

(03:53):
Isn't just the inflation that got away from it, but
also the really high expectations about inflation that started getting
baked in. So if you look back a couple of
years ago, inflation expectations were running well north of the
target range that the Reserve Bank tries to hit. That's
what we call unanchored. So if everyone expects that the

(04:15):
Reserve Bank is going to do a good job and
keep inflation around two percent, it has a lot easier
time of doing that. When people start expecting more inflation,
they have a hell of a time getting it back down,
and we're experiencing some of the consequences.

Speaker 1 (04:28):
Yeah. Plus, and I also had the government spending, didn't
I don't be Eric Crampton the New Zealand Initiative.

Speaker 2 (04:34):
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