DON BRASH - INFLATION: ARE WE OUT OF THE WOODS YET?
The last time inflation was over 7% was more than 30 years ago, and I was responsible for doing what Adrian Orr, the current Governor of the Reserve Bank, is trying to do now: get inflation back to the target mandated by the Minister of Finance, in my case within a 0 to 2% range, and Mr Orr’s case within a range of 1 to 3%.
A few weeks ago, there was at least some cheering when the inflation figure for the year to September was announced: it showed that the Consumer Price Index – which is how most people think of inflation – had risen by just 7.2% in the 12 months to that month, down fractionally from an increase of 7.3% for the 12 months to the end of June. Perhaps at last inflation was slowing and we could look forward to the Reserve Bank easing off the brake of steadily rising interest rates.
Alas, celebration is premature. If we look not at how far consumer prices have increased over the last 12 months – which is the 7.2% figure – but rather at how fast prices are moving at the moment, the picture is less encouraging. Because in New Zealand the Government Statistician only collects price data on a quarterly basis, we don’t have a completely up-to-date estimate of how fast prices are moving at the moment, but we do know that over the three months to the end of September prices rose by 2.2% - which is equal to a rate of increase of nearly 9% per annum.
And yes, part of the upward pressure on prices comes from international factors over which New Zealand policy has little or no effect – the price of oil being one obvious example.
But, more ominously, the rate at which prices for so-called “non-tradable” goods and services has been increasing is concerning. (“Non-tradable” goods and services are those which are not typically exported or imported, such as houses and hair-cuts.) In the year to December 2021, the prices of non-tradable goods and services increased by 5.3%; in the year to March 2022 by 6.0%; in the year to June 2022 by 6.3%; and in the year to September by 6.6%.
We’re clearly not yet in a situation where the Reserve Bank can afford to ease up on the steady increase in interest rates which the Bank has projected.
Not everybody is affected adversely by current inflation. Those who derive some of their income from savings will be welcoming the more positive interest rates which their savings are yielding, even if the price of shares they hold is well down. Median weekly earnings from wages and salaries rose by 8.8% in the year to June, modestly ahead of the 7.3% inflation in the year to that month. In aggregate, income support payments from the government – payments for NZ Super, student allowances, welfare payments of various kinds – increased by 8.5% over the same 12-month period.
The group who are probably most severely squeezed as the Reserve Bank increases the Official Cash Rate in order to dampen inflation by reducing the incentive to borrow and increasing the incentive to save are those who, in the recent past, stretched their personal finances to “get onto the property ladder” near the top of the housing cycle and opted to borrow with a floating interest rate.
They are faced with rapidly rising interest payments on their mortgage and the likelihood that their house has gone down somewhat in market value – servicing their mortgage suddenly eats up a much larger portion of their income, while selling their home to pay off the mortgage runs the risk of losing the savings they used to buy their home in the first place. They worry that their home may decline still further in value with the interest rate on their mortgage continuing to rise. Although all banks assess the ability of borrowers to service a mortgage using a higher rate than current market rates, there is no doubt that some recent first-home borrowers are under increasing financial stress, and that stress looks like to continue for some time.
What lies behind this sudden increase in inflation, to rates not seen in more than three decades? Yes, the war in Ukraine and the effect that that has had on oil and some other prices has played a part. But in the year to December 2021, two months before war in Ukraine even began, consumer prices in New Zealand increased by 5.9%, almost three times faster than the mid-point of the 1 to 3% target which the Reserve Bank is committed to deliver and almost double the top of that range.
The main cause of this sudden increase in inflation has been the failure of both the Government and the Reserve Bank to quickly rein back the stimulatory policies which they adopted to offset the reduction in private sector demand caused by the Covid pandemic.
When they published a review of their own performance in mid-November, the Reserve Bank admitted they were too slow to ease off on the accelerator of very low interest rates, purchases of government bonds, and special programmes to encourage banks to lend. It would be good to see the Government also acknowledge their own part in causing the big increase in inflation by spending significantly more than they take in in taxation well after Covid had ceased to dampen demand.
Getting the inflationary genie back in its box will be a painful process, as the Reserve Bank increases interest rates to restrain demand – demand which is clearly running well ahead of the economy’s capacity to deliver at stable prices, as illustrated daily by the chorus of employers desperate to hire staff.
The pain will be minimized to the extent that the Reserve Bank and the Government can convince the public that they are deadly serious about killing inflation, even at the cost of short-term pain.
I have never forgotten being one of the judges in a competition which TVNZ ran some decades ago. Viewers were invited to write in with their suggestions about how best to kill inflation. The person who was awarded second prize submitted that inflation was caused by a widespread view that prices were going to increase, a view which motivated people to rush out and buy before prices rose further. And that very behaviour caused prices to rise, as people had expected. The secret to reducing inflation, it was submitted, was to spread the rumour that prices were going to be coming down. To the extent that people could be persuaded of that, people would stop or delay their purchases, retailers would be forced to reduce prices, and the disinflation would be self-reinforcing. He suggested the creation of Price Slump Sleuth Teams, or PSST for short, to spread the rumour!
There is obviously more to getting inflation under control than spreading rumours about falling prices but it is nevertheless true that expectations of future price movements influence behaviour. Little wonder that the Reserve Bank pays close attention to surveys of inflation expectations.
There has to be some risk that, faced with growing public concern about inflation and the impact of the rising interest rates which the Reserve Bank is using get on top of inflation, the Government will reach for a dopey policy like reducing GST to produce a one-off reduction in the inflation rate. That would do nothing to reduce the underlying inflation rate – and could well accelerate it if Government failed to offset the loss of tax revenue by increasing tax rates somewhere else.
This column was first published in E-local and pre-dated the Reserve Bank increasing the OCR.