While the post-Covid inflationary surge was bad, its 2022 peak of 7 percent wasn’t that bad

By Chris Trotter*

Inflation. How easily we have forgotten how bad it used to be, and why beating it still matters. 

A story.

Forty years ago I was a regular participant in the industrial award-based system of state mediated wage bargaining. Paid union officials and rank-and-file representatives from the relevant industry would be seated at a table on the other side of which sat representatives of the industry’s employers. My industry was retail. I was a shop assistant employed by the University Book Shop (Otago) Ltd.

The bargaining round in question was the first since the defeat of Rob Muldoon’s National government and his notorious wage and price freeze – itself an attempt to rein-in an inflation rate that, by June 1982, stood at 16 percent.

I returned to my colleagues at the book shop in 1985 with the news that the union had settled on a wage increase of 14 percent. Big number? I thought so. But, instead of being slapped on the back and congratulated for substantially increasing the size of my workmates’ pay packets I was greeted with frowns.

“Only 14 percent?” Was their indignant refrain. I was crestfallen. Little did I know that the employees of the Captain Cook Tavern on the other side of Albany Street had been boasting that their union had just negotiated a new award which included a wage rise of 16 percent!

I am recalling this story to put into historical perspective the extremity of the  inflationary spiral gripping New Zealand in the early-1980s; the sheer vanity of Muldoon’s attempt to control wages and prices by government fiat; and the inescapable need of workers, regardless of whether they be unionised or non-unionised, to keep their wages in step with the ever-rising costs of living.

Just so you know: in 1985, following new Labour Finance Minister Roger Douglas’s, ending of the wage and price freeze, the annual rate of inflation soared to 15.42 percent.

So, you see, my fellow retail workers were quite right to frown. Fourteen percent was not enough.

Hopefully this anecdote from New Zealand’s social-democratic past will enable the reader to see that while the post-Covid inflationary surge was bad, its 2022 peak of 7.17 percent  wasn’t that bad.

Much worse than rising inflation, however, is what the economy in general and working-class people in particular are required to endure to stop it rising and finally put an end to the wage-price spiral.

Faced with rising inflation any liberal-democratic government – regardless of whether it identifies itself as centre-left or the centre-right – has only one effectual course of action. It must induce a sharp and enduring decrease in the demand for goods and services.

Not to put too fine a point upon it, the government must take a hefty wad of cash out of working people’s pockets and then rely upon the inevitable corollary of falling demand – unemployment – to prevent them from attempting to make good their loss by demanding higher wages from their employers.

Since the late-1970s the most effective way of engineering a sharp fall in demand has been to raise interest rates. Rising mortgage repayments, coupled with the rent rises imposed by cash-strapped landlords on low-income tenants, leave working-class people with less money to spend. Across the table, meanwhile, businesses’ rising debt obligations reduce hiring and increase firing. Very quickly their employees get the message and stop asking for wage increases.

It’s simple. It’s brutal. But it works. The rate of inflation plummets. Wages and prices cease chasing their tails.

John Maynard Keynes, the preeminent economist of the Twentieth Century, argued that a more equitable solution to the inflationary problems arising from excessive demand was to let the state’s fiscal policies do most of the heavy-lifting.

Curb demand by increasing tax rates, and then, with inflation falling, restore demand by announcing tax cuts. This fiscal strategy possessed the added attraction of keeping the business owners out of the clutches of the banks. Mass unemployment would no longer be an integral feature of the deflationary process.

Lofty Bloomsbury brahmin that he was, Keynes never quite spotted the obvious flaw in his remedial scheme. In a liberal democracy, the political party that announces substantial tax increases from the Treasury Benches is inviting a radical rearrangement of the seating plan at the next election.

Tax policy is like one of those ratchets that operate in only one direction. Taxes can be cut, yes, but they cannot then be raised without incurring an unacceptably high electoral penalty. The voters aren’t interested in Keynesian economics, no matter how generous its ultimate effect upon the welfare of the working-class. Nor are they persuaded that taxation is the price we must all pay for a civilised society. Sure, everybody wants to go to heaven, but nobody wants to die.

Herein lies the political brilliance of passing over the responsibility for keeping inflation under control to the central state bank. Transform the whole process into something resembling a physics problem: What force needs to be applied where in the economic system to produce the desired movement of prices and wages? Convince the voters that it is infinitely safer to entrust these matters to economic science and economists than to leave everything to politics and politicians.

Of course this solution only works when politics has become a dirty word and politicians are positioned a step lower than real-estate salesmen. The fastest way to generate this degree of fear and loathing is for a government to follow an economic course that not only fails to curb inflation, but also causes unemployment to soar. Saddle the electorate with the worst of both worlds and it is highly unlikely that the government responsible will be rewarded with another term.

Paradoxically, the condition of high inflation and high unemployment – stagflation – is caused by the politicians’ unwillingness to saddle their voters with higher taxes. Rather than risk the inevitable electoral backlash, governments borrow the money needed to keep the economy going.

It’s a strategy that almost never works. The state’s debt-servicing costs rise sharply, along with interest rates. At the same time, with all that borrowed cash sloshing around the system, inflation also rises. Business confidence fails. Capitalists put away their chequebooks. Unemployment surges. The state and the economy enter a period of prolonged crisis.

This was precisely where New Zealand found itself in 1984. Rob Muldoon had run out of options. Increasingly, the public was being encouraged to turn away from the populist policies of blinkered politicians and place their country’s future in the hands of independent economic specialists.

Some might argue that Roger Douglas, having lifted the wage and price freeze, was willing to let the market rip, at least in part, as an educative exercise. Let shop assistants win their 14 percent pay rise. Then let them discover that the rate of inflation has just soared to 15 percent.

Pretty soon the penny will drop that this is a game they cannot win. Eventually, they will resign themselves to the bitter medicine of “sound economics”. Believing Roger Douglas’s claim that it is only by enduring “short term pain for long-term gain’ that the scourge of inflation can finally be defeated.

When you’re skint, the old saying about there being no such thing as a free lunch can sound pretty harsh. But the reason so many people consent to going hungry is because they also believe it to be true.

*Chris Trotter has been writing and commenting professionally about New Zealand politics for more than 30 years. He writes a weekly column for interest.co.nz. His work may also be found at http//:bowalleyroad.blogspot.com.