Old foe’s threat to growth is not what it was at least for the time being
Where has inflation gone and does it have a return ticket?
Little wonder the Reserve Bank has just left interest rates on hold and the markets expect no change in the official cash rate for another year or so.
In the year to last month, inflation was 1 per cent and over the past three years it has averaged just 1.2 per cent.
It is starting to look only barely compliant with the bank's statutory price stability objective. That is defined in the policy targets agreement -- the governor's employment contract, if you like -- as keeping annual inflation as measured by the Consumers' Price Index within a 1 to 3 per cent range on average over the medium term, with a focus on achieving the mid-point of 2 per cent.
The latest low reading for inflation comes despite the fact economic growth has been running a full percentage point stronger than the bank's estimate of potential, that is, the rate the economy can sustain at full employment and without inflation.
The output gap -- an estimate of the amount of slack in the economy based on the difference between actual and potential growth -- has now closed, the bank reckons.
In the past year, the country has seen a record net inflow of permanent and long-term migrants, adding 1 per cent to the population, and migration historically has tended to boost the demand side of the economy more quickly than the supply side.
In Auckland at least, the majority of householders -- those who own the roofs over their heads -- have seen the value of their property rise by a third since 2007, the sort of increase which on past experience might have been expected to spill over into debt-fuelled consumption based on the wealth effect.
There is also a construction boom under way,with the cost of rebuilding Christchurch estimated to be equivalent to 20 per cent of a year's gross domestic product, and there is also a backlog of demand in Auckland as well as work on seismic strengthening and leaky buildings.
The key words in all that are "estimate" and "historically".
Economic forecasters do not have immutable laws of nature to rely on. Based on evidence from the past, their models quantify relationships which might strengthen or weaken, speed up or slow down.
Claims that this time it is different need to be viewed with suspicion, but that is not to say they are always wrong.
One possible reason inflation keeps undershooting the Reserve Bank's forecasts might be that the bank has underestimated the economy's potential growth rate, which is driven by growth in the workforce and in labour productivity.
It has recently revised it up to nearly 3 per cent.
Business investment in plant and machinery has grown at an average 8 per cent a year over the past four years, far stronger than the 2.8 per cent growth in household consumption. And that would not capture any gains in productivity from firms getting smarter at using the resources they have.
Meanwhile, the labour supply has benefited from a couple of things.
The labour force participation rate has remained high, and the net outflow of New Zealanders to the rest of the world has dropped to 9700 in the latest year, from 39,500 two years earlier, while the number of immigrants on work visas has risen by 30 per cent to 31,900 over the same period. Wage inflation is accordingly weak.
ANZ chief economist Cameron Bagrie is struck by the fact that credit growth is running well below growth in nominal gross domestic product and incomes.
For instance, average household income from all sources rose 6.2 per cent in the year to June, while household debt rose 5 per cent.
When you count borrowing by businesses and farmers as well, credit growth is running at 4.4 per cent, or only two-thirds the pace at which nominal GDP is expanding.
Bagrie argues that the period of widespread and virulent inflation among developed countries in the 1970s and 1980s coincided with a big build-up in leverage, and credit growth exceeding growth in nominal GDP.
"Now credit growth is a lot more contained and lo and behold you don't get a lot of inflation pressure," he said.
Bagrie believes subdued growth in household debt is evidence of a shift in households' attitudes towards borrowing and spending.
Household savings rates have gone from minus 6 per cent of income (dreadful) to plus 1 per cent (poor).
The same dynamic, he says, is behind the shortage of listings in the residential property market -- people are wary of the additional debt involved in trading up and are opting to stay put.
"Retail remains a tough gig despite house price gains over the year."
Meanwhile tradables inflation, which reflects those items whose prices are influenced by world prices and the exchange rate -- accounting for nearly half the CPI -- continues to be kept low by very weak inflation globally and the lagged effects of a rising exchange rate, which makes imports cheaper.
The latter effect will go into reverse as the exchange rate falls, but the former may prove more persistent, with oil prices falling and concerns mounting about the risk of outright deflation in the euro area.
So we are left with a situation where a construction boom is offset by a dairy bust, where the global inflation environment is benign, where the surge in net immigration this time may be boosting the supply side of the economy as much as the demand side, and where households seem to have become more provident, more sensitive to interest rate rises and less sensitive to paper gains in their housing equity.
All this reduces the chances that the current economic expansion will be cut short by the sort of inflationary surge that marked the mid-2000s boom and the monetary tightening required to combat it.
But if inflation is out on parole and seems to be going straight, its probation officer, Graeme Wheeler, will still be keeping a watchful eyeon it.