This is a re-post of an article originally published on pundit.co.nz. It is here with permission.
Claims that our current inflation is due to government spending are nonsensical. There is a mantra which goes: if the economy is expanding, cut back public spending; if the economy is contracting, cut back public spending; if the economy is inflating, cut back public spending; if the economy is deflating, cut back public spending. Recognise a pattern?
The 1989 Reserve Bank Act places the responsibility for inflation in New Zealand almost entirely on the Governor of the Reserve Bank. I disagreed with the neoliberal analysis at the time and said so. Other economists thought much the same but, wisely, were not so vocal. The commentariat sided with the neoliberals and that was the way inflation was explained to the public. The political trick was that the Government was not responsible for general price rises; blame the Governor.
But times do alter, and now the commentariat (and the political Opposition) has abandoned their earlier views and are blaming the Government for the current price rises. Fashions change but the analysis remains superficial.
In fact, the professional analysis was more subtle than the statute or the commentariat. The Policy Targets Agreement between the Minister of Finance and the Governor, which sets out the consumer price range which the Reserve Bank is expected to aim for, recognises that there could be inflationary pressures with which monetary interventions could not reasonably deal. If the government were to increase GST the Reserve Bank is not expected to take action despite the price rise. If world inflation results in rising import prices, the Reserve Bank is not to blame. However, in each case the Bank is expected to take measures to prevent such events triggering an inflationary spiral.
Nobody is demanding the incarceration of the Governor for failing to restrain the current price rises. But someone ‘ought to do something about it’, so we are all demanding that the Government should. No analysis, just blind panic.
What strikes me for this bout of inflation is the turnaround in the relativity between tradable and non-tradables prices in the Consumer Price Index. To explain the distinction:
- Tradables are those items which are imported or exported (and also consumed in New Zealand). Their prices are set by international conditions – the exchange rate aside.
- Non-tradables are those items which are not internationally traded and so their prices are set here.
In the decade to the end of 2020 non-tradable prices increased twice as fast as all consumer prices whereas tradable prices actually fell. A major reason for the difference is that non-tradables include a lot of services which do not experience the same productivity increases as goods, although there is a view that our local markets are not competitive enough – a view increasingly appearing to be held by the Commerce Commission.
While non-tradable prices usually rise faster than tradable prices, the relativity has changed over the last year. As the chart below shows, tradable prices are currently rising faster than non-tradable prices so we are importing more inflation than we are producing locally. (The chart comes from a very useful article by Kiwibank economist Mary Jo Vergara.)
The two main reasons for the tradable price increase are the disruption of international supply chains caused by the Covid pandemic and the commodity price hikes which have been caused by Russia’s invasion of Ukraine. It is these influences which drove last year’s inflation. Had international prices risen the same as they did in the previous decade, then overall consumer prices would have risen at less than half the rate they did, and below the top of the Reserve Bank’s target range.
That makes nonsensical the claims that our current inflation is due to government spending. It is international inflation which is booming away and cuts will do nothing about that.
So who is to pay the international economy for their higher prices? Someone has to. Advocates of cutting government spending are saying that the young, the old, the sick, the environment and (possibly) public servants should pay. I leave you judge whether this is acceptable.
If you think those groups should not bear the burden, then who? The current convention is that we may not raise taxes on those on higher incomes, so it looks to me that your choice is between the workers and future generations. We’ll see what the Government thinks (and the Opposition, if it gets round to thinking).
At the moment the international inflation is seen as temporary by many, but not all, serious overseas economists. But even they worry that the blip may trigger more permanent inflation if everybody tries to compensate for their reductions in real incomes by hiking their prices and wages.
There is not a lot evidence of the spiral starting overseas or here – yet. This is despite many economies being near too fully employing their productive capacity. Many economists are optimistic that the supply chain snarl-ups and the commodity price booms will soon unwind and so the recent price rises will reverse.
However, there are some New Zealand economists who are more pessimistic, expecting last year’s consumer price rise to repeat itself this year. Their presentation is more headline than analysis but I think what they are saying is that they don’t expect the supply chain jams to unwind soon, while they think the commodity price boom from the invasion of Ukraine will continue and the mechanisms which generate an inflationary spiral may start cutting in. They also point out that interest rates are rising but interest rates are not in the Consumer Price Index.
Whatever, there is much policy activity aimed at restraining the inflationary spiral. The Reserve Bank is likely to continue to raise interest rates; it will have to, because world interest rates are rising and ours cannot get too far out of line. The government has cut taxes on transport fuels and increased subsidies on public transport but only for three months, indicating that it thinks the peak will be temporary. There will be other measures of varying effectiveness. (The Commerce Commission may be a bit slow and clumsy to play an urgent role, but it ought to be vigorous in its promotion of competition.)
It is true that the New Zealand economy is near capacity, but if the inflationary spiral can be restrained, politically harsher measures may not be necessary. It may be necessary to remind workers and others that it is better to have a job and good government services than an exact compensation for falls in their real wage. I doubt their rhetoric will take much notice.
Back to the debate between me and the Reserve Bank in the 1990s. I argued that the management of monetary policy had to take the government’s fiscal deficit into consideration. The Bank was reluctant to admit this in public, possibly because it might mean that they would have to criticise the government’s fiscal stance, compromising the Bank’s independence. (There was an invisible barrier down the centre of The Terrace between the two institutions’ buildings.)
Currently, the fiscal deficit is large, so one is uneasy. Funding the deficit generates additional liquidity which would fuel an inflationary spiral. Both the Reserve Bank and the Treasury will be nervous about the current fiscal stance; so should you be, even if you do not care about future generations.
The consumer inflation rates used in this column are:
Decade to 2021 2021
Tradables -0.3% p.a. 6.9% p.a.
Non-tradables 2.5% p.a. 5.2% p.a.
All Consumer Prices 1.3% p.a. 5.9% p.a.
I estimate that had tradable prices risen at the same 2021 as they had done in the previous decade, Consumer Prices would have risen less than 2.9% in 2021. I cannot tell exactly how much, because we don’t know how much tradable prices feed into the non-tradeable sector (as when it uses petrol for its transport).
Brian Easton, an independent scholar, is an economist, social statistician, public policy analyst and historian. He was the Listener economic columnist from 1978 to 2014. This is a re-post of an article originally published on pundit.co.nz. It is here with permission.