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Bernard Hickey: Inflation risk lowers growth speed limit

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The Reserve Bank says that within a year New Zealand will hit the buffers of its ability to grow without generating  inflation. Photo / Mark Mitchell
The Reserve Bank says that within a year New Zealand will hit the buffers of its ability to grow without generating inflation. Photo / Mark Mitchell

Nairu is not a nice place. It took me a while to learn that it was an economic idea, rather than an island in the South Pacific.

The Non-Accelerating Inflation Rate of Unemployment is the rate below which inflation starts to rise. It suggests that governments should stop trying to push down unemployment once it gets to a certain threshold. It seems uncharitable, but it is useful because it indicates a speed limit for the economy, beyond which any attempt to accelerate growth will simply spin into inflation.

On Thursday the Reserve Bank revealed some sobering truths. It said our potential growth rate had halved from 3 per cent in the 2000s to 1.5 per cent this year. Attempts to grow faster than at 1.5 per cent will fire up inflation.

In recent years, households and businesses have been reluctant to invest. New houses haven't been built, new machines have not been bought, and workers have not been trained with the right skills.

Households have focused on repaying debt, and businesses have also been reluctant to invest in a sputtering economy.

The result is painful. The Reserve Bank says that within a year New Zealand will hit the buffers of its ability to grow without generating inflation. It points to signs of skills shortages and wage increases in line with a time when our unemployment rate was about 4 per cent. The difficulty of finding labour is at levels last seen in 2006, when the rate was 4 per cent. Now the rate is 6.7 per cent.

Our Nairu has shifted up because we have slowed down investment in physical and human capital. Policymakers should start thinking about what a reduction in the economic speed limit means for our ability to pay the mounting healthcare and pensions bill.

The Reserve Bank's forecast says the Government's budget will be in deficit to the tune of 1.1 per cent in 2014-15, the deadline set for a surplus.

All sorts of problems crop up if we don't lift this speed limit, or if some painful choices about pensions and healthcare are not made. New Zealand's public debts will blow out beyond 100 per cent of GDP within 20-30 years.

Somehow, we need to shift the Nairu back down with a huge burst of investment. Will the Government pick up the baton? It should have done it already.

- Herald on Sunday

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