With the Reserve Bank's reputation as an inflation fighter being questioned, the central bank came out swinging its blunt tool in Wednesday's Monetary Policy Statement (MPS). And economists are suggesting if inflation's to be dragged down to the Reserve Bank's target, unemployment needs to rise.
Not only did the Reserve Bank (RBNZ) deliver the widely expected 50 basis points Official Cash Rate (OCR) increase to 2%, the RBNZ also increased its forecast OCR peak in the current tightening cycle by 50 basis points to 3.9% by June 2023.
This comes against a backdrop of consumer price index (CPI) inflation at a 30-year high of 6.9%, well above the RBNZ's target range of 1% to 3%.
In what was probably the most Hawkish MPS since Adrian Orr became Governor in 2018, the RBNZ gives off the strong impression it's prepared to continue doing whatever's necessary to squash the inflation bogeyman.
"The [Monetary Policy] Committee is resolute in its commitment to ensure consumer price inflation returns to within the 1 to 3 percent target range," the RBNZ says.
This, bank economists say, means workers are in the RBNZ's sights. That's even though Orr says the RBNZ's OCR outlook wouldn't be different if it was tasked solely with targeting inflation, and not employment too.
Since March 2018 the RBNZ's Policy Targets Agreement with the Government requires it to target maximum sustainable employment alongside price stability when setting monetary policy. However, just what maximum sustainable employment is is somewhat vague. It's not a specific unemployment percentage.
Although other central banks including those in the United States, Australia and Norway also target employment in their formulation of monetary policy, it's inclusion in the Policy Targets Agreement came in for some criticism. Former RBNZ Chairman Arthur Grimes, for example, described the Treasury as “utterly incompetent” for advising the Government to make the addition, saying this led to the RBNZ lowering interest rates by more than it should have.
A school of thought is that tackling unemployment should be left to the Government, which makes jobseeker payments to those out of work, rather than the RBNZ. Others have suggested instead of having the RBNZ target the concept of maximum sustainable employment, the Government could implement a Universal Basic Income or a Job Guarantee.
'The Monetary Policy Committee will need to inflict some damage on the labour market'
The official unemployment rate is currently running at 3.2%, with 94,000 people out of work at last count. It's the lowest unemployment rate since Statistics NZ's Household Labour Force Survey began in 1986. But economists argue it needs to rise, and wage increases soften, if the RBNZ's to tame inflation.
"The biggest support pillar for the economy in the face of slowing growth and high inflation has been the tight labour market. The RBNZ expects a small reduction in the unemployment rate to 3.1% in the second quarter, before it lifts gradually to just under 5% in 2025 as monetary tightening squeezes the labour market. It’s clear that with inflation still overshooting their target, the [RBNZ's] Monetary Policy Committee will need to inflict some damage on the labour market in order to cool the domestic inflation impulse," ANZ economists Sharon Zollner and David Croy say.
They suggest the RBNZ's inflation-targeting credibility and the anchoring of long-term inflation expectations are on the line. While last week Westpac NZ Acting Chief Economist Michael Gordon said the RBNZ's inflation targeting framework, guiding its monetary policy since February 1990, is facing its greatest challenge yet.
”The RBNZ’s focus remains squarely on upside inflation risks, reiterating that under its 'least regrets' approach that given 'persistent cost pressures and rising inflation, the risk of moving too slowly and not far enough remained the most costly option.' That’s an entirely reasonable assessment when inflation-targeting credibility and anchoring long-run inflation expectations is on the line," say Zollner and Croy.
They also note that wage growth received a significant upgrade in the latest set of RBNZ forecasts, with annual labour cost inflation seen reaching 4.6% in mid-2023. (See chart at the bottom of this story).
"Surging wages in a productivity-constrained environment like COVID are a recipe for spiralling inflation, and the RBNZ is cognisant that in a tight global labour market, people are 'more willing and able to take up new roles for higher wages'."
'The RBNZ has clearly got nervous'
In a note entitled RBNZ signalling necessity of recession, BNZ economist Craig Ebert says the RBNZ has "clearly got nervous, all of a sudden, about achieving its inflation mandate, while seeing, more clearly, the necessity of higher unemployment to bring this about."
Last week BNZ Head of Research Stephen Toplis suggested the RBNZ needed the unemployment rate to rise to about 4.5% to meet its maximum sustainable employment objective.
Ebert says the thread that appears to best explain the RBNZ’s underlying worries about inflation is the labour market.
"It’s as if the [Reserve] Bank has lifted its estimate of the equilibrium unemployment (NAIRU), entailing it has to more to do to take the steam out of the labour market in order for wage inflation to reduce to a rate consistent with the CPI inflation target. Its forecasts of wage inflation were certainly ramped up quite a bit for 2022/23, compared to the February Monetary Policy Statement view," says Ebert.
In Wednesday's Monetary Policy Statement the RBNZ reiterates that employment is above its maximum sustainable level.
"A strong labour market and higher costs of living have driven wages higher in recent quarters. The share of annual wage increases greater than 5% is near its peak prior to the global financial crisis. Despite this, wage growth for those staying in the same job has not generally kept up with inflation. Overall, household incomes have been supported by workers switching jobs for higher pay, promotions with the same employer, and working longer hours. Once these factors are taken into account, aggregate labour income growth has been stronger than consumer price inflation over the course of the pandemic – albeit to a much lesser extent in the past year," the RBNZ says.
"The labour shortage and increases in the minimum wage are expected to result in further increases in wage inflation over the coming year. Higher wages are one of many increased costs that businesses are expecting to pass on into higher prices."
Kiwibank's economists note the RBNZ sees the unemployment rate bottoming out at 3.1% this quarter, with next year seeing the return of migrants and "a rebalancing" of the labour market. The RBNZ forecasts the unemployment rate rising to 4% in 2024.
"Annual Labour Cost Index (LCI) private sector wage inflation is expected to continue to increase, peaking at 4.6% in 2023. This is due to ongoing labour shortages, the increasing minimum wage and rising living costs," the RBNZ says.
The Maximum Sustainable Employment (MSE) indicator suite below comes from the RBNZ's latest Monetary Policy Statement.
*This article was first published in our email for paying subscribers. See here for more details and how to subscribe.
61 Comments
RBNZ & the major bank economists are still stuck in academic theory Econ 101 from the 1980s & ignoring decades of real world evidence that NAIRU is a mostly flawed concept.
Further, we all owe it to ourselves & our families to completely ignore self-justification from macroeconomic pontificators on huge salaries who have no responsibility or interest in housing & feeding our families at the microeconomic household level.
Yea considering recession and lower cashflows with higher costs, I'd imagine the order of operational changes would be as follows:
- Cost cuts (excluding wages) - cut back on any possible costs to the business spending, pay off as much debt as possible before entering recession.
- Structure - ensure the correct hierarchy is in place and the right people are doing the right jobs, delegation done right should increase efficiency without overburdening workers. Hard nut to crack this one!
- Offer reduced working hours, starting with those who have the least impact on generating cashflow efficiency, offer to cut back a day a fortnight or month or similar to reduce costs without reducing cashflow (this is usually a top down exercise)
- Last resort, redundancy. Redundancy has an inherent cost which increases the more comlpex the work is. If it comes to redundancy, you will be either acting on a restructure or reducing cashflow, so best to do that first anyway. And know that redundancy has a flow on effect which inhibits productivity and causes growth restrictions coming out the other side. Simply put, a redundancy may lead to a new hire in the wake of the storm, at this time morale may be down so onboarding may take longer and the skill level of the worker may be lower.
Looks logical, couple of fish hooks in there though that I have seen go wrong before from cost cutting.
For example if you decide to hold less inventory and buy smaller amounts more frequently that could be a good cashflow decision but it will lead to your warehouse/store becoming busier as they are processing more frequently and pay for more freight costs from the increased deliveries.
It is a good test of character if the person running the process recognises they are adding less value than someone further down the chain and actually publishes that in their final report
Good point - efficiency is key and that doesn't mean faster. During lockdown 2020 a business I observed cut costs, skipped structural/process changes and instead made redundancies. The redundancies were both front line staff and Director/Management level staff (more than half of management). Through 2021 recovery, the replacement staff took longer to settle into their roles and were performing at <50% of the previous staff, and the business morale was very low due to overburdened management working multiple roles and burning out - all of which have since left, including the management and front line replacements.
Long story short, do whatever possible to keep people in their jobs, and use redundancy as an absolute last resort. Not always possible to avoid, but saving money this way can come at the greatest cost.
Yes, satire indeed.
The other factor is you give a pay rise to a family earner and the wff and tax will take 60% or so. The oldie will keep all the pay rise with no cut to super or gold card.
On the basis that oldie and youngie are equal in task, much more wage effective to keep the oldie.
Hadn't expected to get into an employee motivation discussion today but happy to go with it
The oldie does keep all their payrise (ignoring my underlying issue with this) but there is also the risks that come form them needing the job less. If you try to bring in a change and they don't like it then they can just walk out as they have super as a backstop
Some of the older workers do have the better terms in their contract, but there is also a good chance in a higher unemployment environment they are less likely to be hired elsewhere. Technically not able to include age as part of the hiring decision but also hard to prove that it was the reason for being unsuccessful...
The company I work for was an American Multinational Corporate 10 years ago, that was merged with an even larger AMC (Head office in Ireland). Part of the merging process, everyone's logins/employee IDs were changed from their names to an E123456 number.
I suspect this was to remove the human element of their resources pool because what followed was laying off staff, a musical chairs of making people reapply for their jobs with a reduction of positions. Makes it more palatable when you're sorting a spreadsheet high to low annual expenses and you can identify where to cut without using names.
Yes, right. I'd file this one under "things that are apparent to normal people but economist dont understand."
Businesses don't cull headcount when the labour market is tight because they won't be able to rehire easily. First to try it will lose because they'll kneecap their future growth. Headcount will remain a strong HOLD until we actually have a recession.
Agree - the reality is that its not terminating existing employees that creates the initial wave of unemployment - its the businesses collapsing and entering liquidation that creates the first wave.
Higher prices, rising debt costs, inability to secure supply of materials and labour are all issues businesses are currently facing and those that cant repay debt, or secure materials/ labour to meet contracts/orders and generate revenue will go first. Employees become the collateral damage.
The second wave effect then will kick in - as the first wave of businesses collapse this places pressure on associated businesses who lose revenue from the collapsed business - they then lay off workers as revenue declines or in some cases also collapse.
The third wave is consumer confidence collapses as people fear losing their jobs either as they are in a vulnerable industry (at risk of liquidation) or an associated industry. People stop spending - retailers and hospitality lay off people
this is then called the recessionary spiral, unemployment rises as fear sets in and people stop spending leading to a rise in unemployment and a lower GDP due to lower consumption. The system continues to replicate in a spiral until a circuit breaker can be initiated to create consumer confidence - usually lowering of interest rates is the trigger.
The RBNZ has the job of managing the economy enough not to create the spiral effect - an unenviable position to be in - its going to be a very delicate balancing act.
The construction and property sectors are going to shed 50-80% of their workers. Looking forward to very large pools of unemployed young men who are physically strong, proficient in various tools and totally unemployed.
I think we had better get some major infrastructure stimulus ready to go ASAP or massively expand the NZDF unless we want an enormous crime surge.
The building sector stands to take the biggest hit as developers will start to pop as buyers walk on deposits or are denied funding as things tighten. End of the day developers have paid to much for the land and become stuck in a short squeeze of materials and labour. Thus is the risk of development.
Just like the GFC all motivated recently quallified tradie's will end up in Aussie. We will be left with the retiring workers, and the non motivated. And around it goes again.
Since wages are a component of the cost of goods, and not the full cost of goods, an increase in wages does have its benefits.
Let's say a company's wage bill goes up 10%.
- $50 labour, $30 materials, 20% GP = $100.00 item
- $55 labour, $30 materials, 20% GP = $106.25 item
6.25% increase in the price of goods. 5% if the company maintains their profit dollars amount. Obviously depends on the ratio of Labour vs other costs.
Let's say a company's wage bill goes up 10%.
- $50 labour, $30 materials, 20% GP = $100.00 item
- $55 labour, $30 materials, 20% GP = $106.25 item
How about also looking at inflation at 7% for materials?
- $50 labour, $30 materials, 20% GP = $96.00 item
- $55 labour, $32.10materials, 20% GP = $104.52 item.
8.9% cost increase per item.
Exactly. But it's not 10% so the wage earner is still better off, because not only are the cost of materials factored in but they also keep a bit of their Labour, and the business makes a higher profit in dollar terms. All that's holding things back is how much money there is in the system to be spent and where it ultimately gets spent.
Also, your calculations achieve a 16.6% GP as you've used a 1.2 mark up. Should be 1.25 to achieve a 20% GP.
Prior to CCCFA regulations being taken seriously by the banks. The stress testing of borrowers was BS. There is a huge pool of mortgages that the RBNZ or Trading banks have NO IDEA if serviceable at 5-6% interest rates. If they are serviceable then the hit to discretionary spending will put us into recession anyway. Those on flexible hour contracts in hospo in retail will have their hours and incomes cut. But even one hour of paid employment per week keeps you out of the unemployment stats according to the household labor force survey.
So here we have big money advising the government to trash the people it is supposed to serve. A telling comment is here; "Surging wages in a productivity-constrained environment like COVID are a recipe for spiralling inflation...." While surging wages will be a factor in inflation this comment utterly ignores the logistics issues on the supply side. Is the price of fuel so high because people are being paid more? Not a chance! These people are advocating that big profits are more important than the well being of the people. They need to be robustly challenged on their position.
Yeah, that's how I saw it too. They are only looking at it through their dated economic lens, which thinks we are in a perfectly competitive environment. Which we definitely are not... they could decide to support the people or big business, seems like they are thinking that supporting big business is supporting people in the long run, which of course is the trickle down fallacy.
I find yesterdays OCR hike the most interesting since the drop to emergency levels. With it came an equal hike in predicted trajectory. Even with the 50bps raise, we're equal distance from the target, and since these raises impact interest rates in a ~linear fashion it's easy to assume this:
Yesterdays news was the equivalent of a 100bps rise 7 weeks ago. The only difference is that we already have higher rates. Still a long way to go.
Yeah, they can go to Australia where inflation is climbing at a faster rate than here... or maybe the UK which is at 9%?
The grass isnt always greener.
Young kiwis, for the last 10 years already cannot afford to live in NZ. Our inability to build enough houses, remove high density planning constraints and to do anything about property investors driving the price of property higher and higher has already done the damage.
Buying a property here in most places is already out of reach and has been for a decade. You cant pretend it has only just become an issue this year. The only reason why more people will leave this year is that they literally not been able to for a couple of years.
National and Labour, both equally to blame.
Look. The real unemployment rate is 11.2% or 349,000 when you take into account. 1 hour of work per week means you're employed. Also if you don't generate 50 CVs per year of your current set of skills or training updates and not hitting your kpi's for appointments with a case manager you are on another list of statistics. No looking for work.
With a huge chunk of mortgages coming due for renewal and many that qualify to be sold without incurring a penalty tax for crossing the bright-line. This will spur on a long-tail of inflation over the next year or so too won't it?
I wonder how many property owners with houses to spare will peal off one or two properties to ameliorate their financial position?
Impossible house price. Hostile reserve bank, banks and government.
A totally rigged economy.
If National get into power next election it is only going to get a lot worse for Luxons" bottom feeders" (and middle feeders for that matter).
The only rational answer for young Kiwis is to leave the country.
... yep , it's all turning to custard faster than an explosion in the Edmonds factory ...
Looks like Rotorua is gonna be completely overrun by poverty stricken citizens seeking a taxpayer funded free motel room ...
... nice one Adrian , good work Robbo .... Jacinda , you're doing fantastic work for NZ whilst in America , please stay there ....
I think at some point various countries will start blocking people. The USA has kept on with their title 42 so they can circumvent the international asylum seeker status. I can see other countries slowly shutting borders as the world problems escalate. This year the world hit a record 100 million displaced people and "Looking for a better job" is going to be the least of some peoples problems.
What will the national unemployment rate be when we finally have the unemployment insurance scheme foisted upon us?
Will the timing of it being implemented (and the cost on the employer for their part of the premium) be a trigger point for letting go of some staff before they get hit with it?
At least RBNZ have pulled the collective finger and started to operate (under urgency). When can we say likewise for this lousy government. They're even beginning to make Luxon sound rational, but not overly. Chloe please start a new party so we have someone to vote for...please.
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