Our inflation battle just got very complicated

With the Reserve Bank now needing to consider full employment as part of its mandate, attempts to rein in galloping inflation could have consequences

19th Oct 21, 3:37pm by David Hargreaves

And so now the Reserve Bank (RBNZ) is on a conveyor belt from which there will be no easy stepping off.

If the RBNZ had been contemplating thoughts of a 'pause' in the recently commenced cycle of 'normalising' interest rates, surely those were blown away by this week's super-hot inflation figures.

No, the RBNZ's on a fast-moving conveyor belt and there's no way off.

Such is the current magnitude of pricing pressures in the economy that our central bank will now presumably have to keep taking aim at the immediate target in front of it and hope it can stop it in its tracks.

Rampant inflation would do nobody any good, so stopping it will presumably be the priority.

But oh, that life was so simple.

Time was that the RBNZ and other central banks around the world could bring out the blunderbuss, crack off a few rounds, and down would go the inflationary beast, and all would be wonderful.

Things are looking a hell of a lot more complicated than that at the moment.

This time around the accepted playbook of raising interest rates to cool the economy could potentially end up blowing up in the RBNZ's face - and our collective faces as well. Potentially.

Let's quickly look at what has happened.

Last year we locked down the economy in response to the pandemic.

We miraculously eliminated the virus.

We opened up the economy and, flush with our success and the fact the housing market was moving from frigid to fast-boil, we went out and spent and the economy started revving in a way few people imagined would have been possible.

Then that ramping-up economy was met head-on by the growing global supply chain problems.

Additionally, businesses that had become accustomed to the quick fix of bringing staff in from overseas were hampered and frustrated by a closed border.

So, essentially we had an economy trying to grow faster than it could. That creates friction and heat - in the way of rising prices. Additionally, the closed border seems to be making it easier for firms to put up prices.

Okay, so by the middle of this year we were into no-brainer territory. Interest rates would have to go up to cool this smouldering economy.

Then we got Delta.

This leaves us with rising prices but now a hamstrung economy.

Whenever Auckland is allowed to open again it will do so with Covid in the community. And let's face it, this will not be Auckland's problem alone for much longer. Indeed Waikato now looks like it has Delta for the duration - and it will spread further afield. That's what it does.

I'm just not sure people will be in the mood to spend like they were last summer. I seriously doubt that with Covid in the community there will be anything like the bounce back of spending we saw in 2020, once the whole economy is open again.

Which is where it could become interesting.

What will the RBNZ do? I suppose the smart money is on another 25-basis point rise in the Official Cash Rate on November 24, bringing the OCR up to 0.75%. Then there's no more rate decisions till February 23, nearly three full months later.

Between the OCR rise and the rises we've already seen in the wholesale interest markets, you can bet that the banks will be ramping up the mortgage rates again. Given some of the momentous-sized mortgages out there now, this is going to be felt.

It all points I think to a very subdued summer of spending. And what does that do for businesses, many of which have been shuttered in Auckland for weeks? I really hope we don't see a lot of businesses closing down, but fear we may see a fair few - particularly if the money just isn't being spent out there.

Okay, so, there would be consequences. Now, as we know, our labour market has been on fire. But that was pre-Delta. If a chill breeze really does flow through large parts of the economy once things are completely open again, do we start to see that labour market going into reverse?

If we did, then things would get really, really interesting.

As I said further up the article, time was that the RBNZ's care in the world was sticking it to inflation and then seeing the populace enjoy the fruits of this. But monetary policy has a friend now.

That's right, this Government has made the RBNZ consider employment, and not just the inflation beastie.

This, specifically is what the policy is now:

The [RBNZ] Monetary Policy Committee (MPC) is responsible for formulating monetary policy in New Zealand, directed towards the economic objectives of:

achieving and maintaining stability in the general level of prices over the medium term; and

supporting maximum sustainable employment.

Those two things have existed happily alongside each other till now.

But what if?

What if the first part - involving raising interest rates - starts to have a serious impact on the second part, namely by helping to dampen and already dampening economy and leading to job losses?

If the two parts of the monetary policy begin to effectively argue with each other, what does the RBNZ do?

So far as I can see neither of those two objectives of the monetary policy are given a distinct order of preference.

Logic suggests the RBNZ will go all out to snuff out inflation. And as I say, that's the conveyor belt it's stepped on to.

But if the post Delta economy really does stutter, and businesses close, and jobs are lost, and some of those massive mortgages are not being serviced. Well, it might not be good.

And the questions will be asked around, what is the RBNZ doing about its employment mandate?

Look, there's a lot of supposition here. But the point I would make is that we are not on a one-way street.

Not everything is moving in the same direction.

We are not in a situation where we can assume (at all) that the economy will resume with the kind of vigour that saw it necessary for the RBNZ to move to a tightening monetary policy cycle. But with inflationary pressures very much here and now we are not in a position where it can just sit on its hands and wait either.

Last summer there was a lot of nervousness about what might happen with the borders closed and no international tourist season. In the event, we ourselves made things sizzle.

This year I think there could be some pretty chilly breezes.

We welcome your comments below. If you are not already registered, please register to comment

Remember we welcome robust, respectful and insightful debate. We don't welcome abusive or defamatory comments and will de-register those repeatedly making such comments. Our current comment policy is here.

48 Comments

by WhiskeyJack | 19th Oct 21, 4:04pm 1634612679

I don't think this inflation is being driven by people having more money. It's being driven by shortages and you can't fix that with interest rates. All raising rates is going to do is make people worse off without changing the fundamentals driving inflation.

by northman46 | 19th Oct 21, 4:31pm 1634614275

"All raising rates is going to do is make people worse off"

There's many of us who have been made especially worse off thanks to slashing interest rates.

by WhiskeyJack | 20th Oct 21, 11:13am 1634681596

I had no idea that was the case, in what way has lower rates, made you worse off?

by Carlos67 | 20th Oct 21, 11:31am 1634682687

26 upticks by people that did not own a house 12 months ago that have been screwed by low rates. Try 30% house price gains due to cheap money.

by Averageman | 20th Oct 21, 2:01pm 1634691695

Retired people living off their savings after moving into a retirement village. News flash - $1m in the banks has been earning you about $148 per week before tax. Then there is the Government employees like teachers, nurses, police, and then unemployed, people renting, people with disabilities, and pensioner....and on and on.

Seriously amazed your view of NZ doesn't include anyone in any of these groups.

by WhiskeyJack | 21st Oct 21, 8:00am 1634756442

I think you need to have another look at that list then try and explain how low interest rates are hurting them. Other than millionairs with savings of course.

by Foxglove. | 19th Oct 21, 4:33pm 1634614429

Potentially amidst that is a fall in value of the NZ$. If all of those import prices are already pushed up by short supply, then less purchasing power adds fuel to the fire. And speaking of fuel, even more so for what will be being paid at the pump. Things on the horizon are starting to look rather unwelcome aren’t they.

by Brutus Iscariot | 19th Oct 21, 5:14pm 1634616850

It absolutely is about more money. It's a function of the 60bn in printed money gradually multiplying through the economy via credit channels, on top of the government underwrite to business cash flows. The most obvious outlet as usual in NZ has been the housing market.

by Jonny.Foe | 19th Oct 21, 6:31pm 1634621466

Sounds convincing. I would be interested in what you think the 'credit channel' is? The first step is clear - RBNZ buy Government bonds by depositing newly created money into bank settlement accounts. So, explain how this money gets out into the wider economy, or how it 'multiplies'...?

by mews | 19th Oct 21, 8:07pm 1634627249

It's amazing how many people repeat the orthodox drivel when it's so clearly empirically wrong. If QE created CPI the US and Europe would have had rampant CPI for the past decade.

by Pragmatist | 19th Oct 21, 8:17pm 1634627865

It's amazing how many people think CPI is an accurate measure of inflation.

by Carlos67 | 20th Oct 21, 10:44am 1634679891

Actually its pretty much bang on the money if you just double it. CPI x 2 = Actual inflation.

by mews | 20th Oct 21, 6:49pm 1634708998

Of course not but CPI is what this article is talking about and what RBNZ are now targeting with increased rates. Hence the earlier commenter appears to be implying that CPI is the result of increased money supply when that money has primarily gone straight into assets not measured in CPI. That's exactly the point I'm trying to make. The difference now isn't QE which has been going on globally for years, it's the break-down of supply chains and labour shortages due to Covid.

by Roelof | 20th Oct 21, 9:27am 1634675227

Jfoe...

technically settlement money ( outside money ) can never be spent in the wider economy.

The reality is that any Private bank can "write a cheque" against those excess reserve deposits .

ie. A bank can create much more new credit , and then use those reserves to settle its account , each day, thru the payment system.

The limits to this have more to do with finding "credit worthy" borrowers who want to borrow.

I u look at term deposit balances u can see that Banks dont have to compete for term deposits since they have excess reserves..

https://www.rbnz.govt.nz/statistics/s40-banks-liabilities-deposits-by-s…

by Jonny.Foe | 20th Oct 21, 10:09am 1634677793

Yes - I think we are saying the same thing. My question the previous commenter was pointing out that this 'QE cash washes into the economy' narrative is nonsense.

The only bit I would add to your explanation is that if banks ever run low on settlement balances they can borrow from each other or from the central bank. Credit is basically limited by regulators and borrower appetite, not bank balances (as you said)

by Roelof | 20th Oct 21, 12:03pm 1634684604

My main point is that QE can/does enable credit creation...... It that way, it "washes thru the economy", figuratively speaking ie... has an influence.

For me the real "transmission mechanism", is interest rates. ie.yield spreads... the diff. between borrowing costs and returns.

QE plays a part there , by influencing longer term interest rates... and thus the demand for credit.

The GFC was different... QE was mostly used to control longer term interest rates and also help heal Bank balance sheets , which were impaired by some loans gone bad !

In my view the RBNZ has used a GFC playbook for the wrong thing ( covid).... they have profoundly overstimulated.

just my view... of course.

by fortunr | 20th Oct 21, 7:39pm 1634711941

1) Savers are better off with raising interest rates

2) Raising interest rates will constrain spenders and will improve shortages, as indebted people will have less money to spend, so there will be less demand chasing the same goods

by chebbo | 19th Oct 21, 4:06pm 1634612776

Responsibility for both house price levels and unemployment levels have been palmed off onto the RBNZ, having been deemed by this Government as too unpleasant to have to deal with politically. You are right David that this is too many balls for the Bank to be juggling at once, and some tough decisions will have to be made.

From the MPC remit:

In pursuing the operational objectives, the MPC shall... discount events that have only transitory effects on inflation

So I suppose it will depend on whether these inflationary pressures are determined to be "transitory" or not as to whether they get dealt with at the expense of the labour and housing markets.

by brisket | 19th Oct 21, 4:28pm 1634614098

The problem is that there are some things the RB can't control, global interest rates being one of them.

If rates go up across the world, and inflation continues to rise, then we get that inflation too. Whether it's caused by demand or supply or logistical problems is irrelevant. We're a price taker. We could be in recession, low growth, interest rates as low as possible, and still get smashed by inflation. I think we've forgotten, after a period of relative strength and stability, just how brutally the NZD can get tossed around by the global economy.

But we can't raise rates without causing a recession, because our main industry has been borrowing money and using it to buy houses off each other. Because we are very. clever.

So what do we do? Likely outcome: keep rates as low as possible, take the inflation hit, and have the Gov't use billions of borrowed dollars to try and keep families afloat in an ever-expanding welfare state as the cost of living becomes increasingly incongruous with incomes. Better that than have landlords going bust, right? It'll be a bail-out of the rich that ultimately gets blamed on over-generous welfare when we end up begging the IMF for a cheque seven years from now. Because no one ever, ever learns.

by bw | 19th Oct 21, 4:55pm 1634615739

Good thoughts.

And as I've posted elsewhere today on China, just like them, we are going to have to make a choice between who-lives, and who-dies ( economically and socially speaking).

They've decided, and it's the only rational option really - those 'who have' are going to have to pay this time. Those 'who haven't got it' haven't got anything left to give this time (via Financial Repression) to support the economy.

And who are those 'who have' in New Zealand? Yep. The ones you suggest are prone to 'going bust' when we finally make the 'right' choice.

by Fluffybunny | 20th Oct 21, 2:12pm 1634692355

I don't know. I don't think a recession in house prices is the end of the world.

We could raise rates by 2-3%. Sure values would tumble. But even a 30% drop? back to 2019?

Lots of people re-finance. People that bought in the last 1 year and are leveraged will potentially suffer, but that's not a big portion overall. A few high leveraged investors may get into trouble but that's their problem.

The vast majority of people just feel less rich as they watch the 'value' of a family home (+1 or 2 rentals maybe?) devalue. That's not going to feel good, but if you think this level of house price / income ratio is normal and without risk then that's your problem also.

Lots of noise, life would go on.

Its needed in my opinion. A little bloodbath doesn't hurt. Can't have the nanny state hold our hands forever.

by company of heroes | 19th Oct 21, 4:46pm 1634615176

I don't agree with the narrative about inflation being transitory. It seems that supply chain disruption is the only cause, but it is actually not if you look more into this.

Easy concept, supply and demand. For supply side of thing, we can look at lockdowns. Productivity reduced, 90% businesses have been not able to run under level 4 while they still receive government's wage subsidy, which means people are getting paid by not producing anything. So supply goes down. How about demand? Housing price increased 30%. That's the 30% extra money on already over inflated housing price for people to spend / invest. Smart people won't let their money just sit in the bank being eaten away by inflation. They will look for places to invest or spend. Investing into houses? That will push building cost further up, unless if the deposit rate is attractive enough for them to keep their money in bank.

RBNZ needs to stop following what other reserve banks saying and really looking into New Zealand's own situation. And stop using uncertainty as excuses to wait and see. There is always uncertainty.

by Brutus Iscariot | 19th Oct 21, 5:17pm 1634617028

Yes. The shortages are one aspect, but there is also a fomo driven leverage frenzy as people chase any sort of positive return.

We need base money to have a meaningful time value attached to it again, so that people start parking their money back in the bank, sucking liquidity out of the system to settle things down.

by Brock Landers | 19th Oct 21, 4:55pm 1634615730

What exactly is the point in being employed if your pay is worthless?

by refactornz | 19th Oct 21, 5:06pm 1634616360

Because no pay is even more worthless

by Brock Landers | 19th Oct 21, 7:05pm 1634623519

Wrong. Your time on this planet is valuable and in limited supply.

You don't give it to an "employer" for worthless tokens.

by refactornz | 20th Oct 21, 8:01am 1634670106

You have to eat though

by Foxglove. | 19th Oct 21, 5:06pm 1634616389

When you reach that point, the reality is that you are facing either serfdom or welfare dependency. Researching one part of my family history in 19th century England, was astonished to find so many that had been tradespeople, jockeys too, farm labourers, holding their own ok but then ended up dying destitute in the poor house.

by philthy | 20th Oct 21, 9:49am 1634676555

It's a ridiculous mandate, by a government that doesn't understand what it's doing.

by ikimpaul | 19th Oct 21, 5:01pm 1634616100

This whole article should be labelled "stagflation has arrived"

Stagflation can be defined as a slowdown in growth with relatively high unemployment, during a rise in inflation

Since the GFC countries have thought the way to stop recessions was Quantative Easing - which was a largely untested economic solution. The advantage been it created economic stimulation and allowed countries to avoid the hard yards involved with Fiscal Stimulus ie governments having to put in infrastructure and job creation schemes and raise taxes to fund it,.

What we will realise post Covid-19 is that there is no "real way" to avoid economic pain and all Quantative Easing will have done is caused assets to rise in a distortionary manner resulting in high inflation with no underpinning support for the economy ie not the "real" job creation that fiscal stimulus creates.

The result is stagflation an ugly economic situation where you cant go forward ie raise interest rates to stop inflation without creating massive unemployment and you cant lower interest rates because whilst that stops job losses it creates more inflation - resulting in a massive wealth divide.

Hopefully we will return to the tried and true process where monetary policy must go hand in hand with Fiscal policy and there are no "recessionary shortcuts"

by Brutus Iscariot | 19th Oct 21, 5:12pm 1634616730

Grab the popcorn and see what happens to inflation with zero immigration, negative real rates, and 2-5% of the labour force removed due to vaccine mandates.

The govt won't dare withhold benefits from the unvaccinated so we are about to turbocharge wage inflation in tandem with all the other stuff going on. OCR should be 2% tomorrow, let it sit there for 6 months then reassess.

by Quidgybo | 19th Oct 21, 5:12pm 1634616755

Most of this is caused by the RBNZ and their ilk, slashing interest rates when Covid hit, people borrowed enormous sums of money. Governments printed enormous sums, I heard 1 in 5 USD was printed in the 6 months to January 2021. Then compound it all with various shortages at the moment....

Where does it end is the interesting question? Will wages keep up? Will interest rates penalise all those who bought assets in the last 24months?

by DTRH | 19th Oct 21, 5:17pm 1634617054

Everyone is aware this housing market is only high because of super low interest rates the tide has to turn sometime people who have million dollar mortgages will have service this. I think a lot of people will be selling investment property to help paid for this hopefully this will bring house prices down to a level which average wage earners can afford a house and still live without being like hermits.

by brisket | 19th Oct 21, 5:19pm 1634617142

from your lips to God's ear...

by brisket | 19th Oct 21, 5:17pm 1634617073

A thought: maybe we're in an unexpected inflationary spot not just because of fiscal policy by government (though of course that's a factor), but because of unrealistic and unrealised growth expectations in the private sector. By which I mean, assets are priced as if we are in a world of 5% growth, when the reality might be 1%. If all 'productive' assets are overpriced, and investors are leveraged, that's a lot of money created that has nowhere useful to go; it's just added to the general pool. Which we see in things like the raw commodity speculation that's taking place now. It's not investment, it's just a giant blob of money rolling along, chasing anything that can be squeezed or monopolised long enough to turn a profit.

by Zack Brando | 19th Oct 21, 6:20pm 1634620809

The woman in this country seem to have more nuts than the men.

It would take balls to raise interest rates to a level that flushes out the bad debt - aka causing mortgage defaults and subsequent bankruptcies.

Seems they're choosing technocratic neo-feudalism

by CWBW | 19th Oct 21, 6:54pm 1634622891

NZ wages are overvalued; house prices are the equaliser.

by Brock Landers | 19th Oct 21, 7:21pm 1634624501

Could you elaborate on that stunning gem of wisdom, gramps?

by DTRH | 19th Oct 21, 8:48pm 1634629704

The problem is when people can’t afford to buy food and put a roof over family’s head that’s when society unravels and people with abundance will lose as well. What is the point of having more money and property’s while your fellow citizens can just get by. What’s happening with housing in this country is going to cause huge problem for years.

by Roy1 | 19th Oct 21, 9:05pm 1634630718

Inflation has no relevance today and is just a number ......am I correct Mr Orr.

Beside Uncle Orr is their to support by printing money and distribute to avoid ........

by Neil21 | 20th Oct 21, 6:03am 1634662997

More money with the same goods = inflation.

Same money with less goods, still equals inflation.

Global money creation still affects us.

How much did we print & just give to people?

We're stuffed.

by Warwick D | 20th Oct 21, 9:07am 1634674069

Add to that the rapidly rising cost of energy and in particular that of oil which is still so essential to our economic system and has such a big impact on costs (renewables are not reliables!) and it looks like inflation is unlikely to disappear any time soon.

What was it Robertson said a few months ago when the first signs of rising inflation officially appeared. Something to the effect that the figures were likely to be just a temporary thing brought about by the ohh so successful post-Covid rebound of our economy; really Grant?. Inflation should be a concern for most people but particularly a sitting government me thinks.

by Squishy | 20th Oct 21, 8:37am 1634672226

New Zealands immigration boom will finish soon. Immigrants come predominantly from China, India and the UK to New Zealand. Well Chinas population is declining as are the number of workers, Indias population is now only just at the replacement rate now and the UK is also suffering from acute worker shortages.

It's a demographic inevitability that our future growth will not be able to be built on the back of cheap immigrant workers as it was in the past. The world is getting older, most immigrants are young.

by swingtrader | 20th Oct 21, 10:17am 1634678241

In the short term China has stopped issuing and renewing passports, and India’s population has very low vaccination rates, which will both hamper the flow of immigrants. Businesses can forget about their cheap labour coming to their rescue any time soon.

by TheAnalyst | 21st Oct 21, 9:53am 1634763210

Good! Then maybe NZ business will finally invest in training the next generation of workers. We wonder why our productivity is poor when we have spent the last decade importing cheap labor.

Surely we can give the next generation some hope after screwing them over with housing and student loans.

Once covid settles down I am predicting a 'brain drain' exodus from NZ. Unless the cost of housing decreases significantly-which no politican in NZ will let happen.

by Ezy | 26th Oct 21, 1:22pm 1635207756

Those immigrants are going to be pissed when they realise they've been suckered into moving to a newly minted third world country.

by philthy | 20th Oct 21, 9:48am 1634676498

The RBNZ needing to consider full employment in it's mandate, as changed by Labour is ridiculous, especially in a country that has large numbers of people that just don't want to work.

All it's done is predictably created another bigger housing bubble.

Time to get rid of a government that doesn't understand 101 economics.

by Ezy | 26th Oct 21, 1:19pm 1635207543

Hyperinflation. The cost that dare not speak it's name.