MNI INTERVIEW2: RBNZ's Conway Sees Era Of Economic Volatility

Central banks and economists confront the prospect of heightened economic volatility due to supply shocks which could deliver a more inflationary environment and higher neutral rates than over recent decades, Reserve Bank of New Zealand chief economist Paul Conway told MNI.

Climate change is viewed as a major supply-side challenge, with the demand for investment to fund the energy transition possibly putting upward pressure on neutral interest rates.

"It is going to be a more volatile economic environment. Supply side shocks with climate change are probably more likely than they have been over recent decades as well, which is inflationary and volatile," he said in an interview.

"It means central banks, economics departments, they have to be on top of their game. We need to understand what's going on and set policy appropriately. So it's game on for people."

Conway noted there is a body of literature that suggests neutral rates "may well be increasing a bit going forward."

"I think for a central bank it reduces the chance of us running into the effective lower bound around policy rates, which is kind of a good thing really," he said.

GLOBAL INFLATION PRESSURES

Conway also highlighted the challenge to policymakers from the global nature of inflation pressures. This has been reflected in research by his team showing a strengthening correlation between New Zealand's non-tradables inflation and global inflation since the Global Financial Crisis.

The correlation between New Zealand's non-tradables inflation and the global CPI component rose from very low positive levels after the GFC to about 0.68 by the end of 2022. The tighter relationship could reflect greater economic integration, or similar policy responses to events such as Covid.

"On the face of it, it could mean that domestic central banks do get a little less purchase on headline CPI than what they have in the past. Whether or not that matters remains to be seen, because we do have that global coordination aspect going anyway."