Suggestions For The Reserve Bank Of New Zealand?

The government of New Zealand recently added housing prices to their central bank’s mandate. (I put the mandate at the bottom of this post). Previously, the RBNZ mandate was pretty similar to that of the Fed, 2% CPI inflation and maximum sustainable employment. Not surprisingly, I don’t believe adding housing is a good idea. Nonetheless, it is possible to address the government’s request in a way that would actually improve monetary policy.

I’ve never understood why central banks target consumer prices. Why not all prices? Thus during 2002-06, the CPI did not reflect the fast rise in house prices, because houses are considered an investment good. Then, between 2006 and 2012 the CPI did not reflect the huge decline in house prices.  Indeed during some of those years, the CPI actually reported housing prices rising faster than the price of other goods, even as the price of new homes was plunging rapidly. Consumer prices are not a good indicator of the state of the economy, to put it mildly. They aren’t even a good indicator of the price of domestically made goods.

Instead of targeting the CPI or the PCE, why not target the GDP deflator, which includes the prices of all goods produced in the domestic economy—including new homes? This sort of index would call for a slightly tighter policy during dramatic housing price bubbles, and a slightly easier policy when house prices are plunging. This might slightly moderate the volatility of house prices, which is consistent with the goals of the new government policy.

Of course, the RBNZ has a dual mandate, and thus also cares a lot about employment and hence real GDP growth. Thus they might want to consider a target that somehow incorporates both the rate of growth in the GDP deflator and also the rate of growth in real output.

Questions for readers: Can you recommend a new target for the RBNZ that would reflect both changes in consumer prices and changes in new home prices, as well as changes in output/employment.  Any ideas?

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