OPINION
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If you have a burning question about the quirks or intricacies of economics send it to liam.dann@nzherald.co.nz or leave a message in the comments section.
Q: “Why can’t there be a controlled reduction in GDP and GDP per capita where we increase the quality but decrease the quantity of our spending without the world going into a panic?
The trade-off would be improved mental health, quality of life and reduced impact on the planet ...
Take fashion for example. Oscar Wilde once said that fashion is a form of ugliness so extreme that it needs to be changed every six months.
So, what say we all just wore our clothes until they actually started to wear out and made quality replacement purchases like Dr Martens instead of cheap shoes and we also got them resoled when needed? What if we dined at home instead of dining out, made our next vehicle a lean hybrid instead of an SUV?
Perhaps we could start a virtuous cycle of contraction.” - John C
A: This sounds great in theory. In fact, in some respects, it is what the economy is going through right now.
The Reserve Bank has lifted interest rates to restrict the money supply. The idea is that higher rates incentivise saving and discourage borrowing. So the net effect is less spending activity, which causes economic activity to slow and even contract (go into recession).
Of course, this is happening at a macro level. We don’t share the pain evenly. Young people with big mortgages will feel things worse than the mortgage-free.
And those who lose their jobs may feel it worst of all.
Meanwhile, some individuals have different circumstances that may allow them to keep spending regardless. Nobody is being forced to do anything other than by the economic conditions they face (and even then some people seem good at ignoring those).
You’d have to have a good deal more faith in humanity than I do to try and engineer a co-ordinated reduction in consumption in the way you describe.
I’d note that this question was delivered through the Herald’s comment section, which is its special kind of reminder of how hard it is to get people to agree on anything. Good luck getting them to stop buying new shoes!
But it is an interesting thought experiment.
Another reason I’d be wary of this kind of managed contraction – even if we could all agree – is the risk of deflation. If the economy contracts for an extended period, prices can actually start falling. That sounds great. But it isn’t.
So why are falling prices bad for economies?
Everyone wants to pay less for things. So, intuitively, it can be hard to understand why deflation is just as bad, if not worse, than inflation.
First, it is worth remembering that all this talk of reducing inflation is about reducing the rate at which prices rise (which is called disinflation), not bringing them down (which is deflation).
The Reserve Bank (RBNZ) is only trying to get inflation back to about 2 per cent a year. It doesn’t actually want prices to start falling.
Inflation is a bit like the salt in our diet: too much will probably kill us over time. None at all definitely will.
Not long ago, deflation was enemy No 1 in economics. Between 2010 and 2020, we worried a lot more about it than inflation. Central banks had to keep interest rates extremely low to stop deflation from taking hold. The United States dropped the cash rate to zero and some countries – like Japan, Switzerland and Denmark – dropped it into negative territory.
That was as weird as it sounds (in theory, it means banks have to pay you to borrow their money). Japan lifted its official cash rate into positive territory only last week.
A recent article by the Associated Press (AP), run in the Herald, looked at the issues around deflation and warned we should be careful what we wish for.
The biggest issue is that deflation, like inflation, tends to spiral and become self-perpetuating.
Falling prices tend to discourage consumers from spending. People think, why buy now if you can purchase what you want – cars, furniture, appliances, vacations – at a lower price later?
But as prices fall, business margins are squeezed, production falls and businesses contract. Jobs are lost and new jobs are not created. Wages fall and people are poorer so they can afford to spend even less.
An inflationary spiral erodes trust in currency and adds extra zeros to everything. If wages rose in tandem, the net effect would be negligible. But of course it never works that way.
Deflation is much the same. It is not necessarily a wild freefall like the market meltdown of the GFC. Economies will not collapse overnight.
We can look to Japan for a plausible example of what the world might face: stagnation, low growth and regular dips into recession.
As AP puts it: “The reality is that the economy’s health depends on steady consumer purchases. In the United States, household spending accounts for around 70 per cent of the entire economy. If consumers were to pull back, en masse, to await lower prices, businesses would face intense pressure to cut prices, even more, to try to jump-start sales.”
Without growth and momentum, opportunity is removed from the economy. And opportunity is one of capitalism’s most powerful drivers.
Winning the war on inflation
Ok, before we start worrying about deflation, most of us just want our grocery bills to stop inflating.
The good news is that food is one area where we are winning the war on inflation.
The Financial Times reports that food inflation across rich nations has dropped to its lowest level since before Russia’s full-scale invasion of Ukraine.
“Food prices surged in 2022 due to rising energy costs and lower trade caused by the war in Ukraine, while larger-than-expected droughts and Covid-related supply chain disruptions also took a toll,” the FT says.
The annual change in consumer food prices across 38 industrialised countries eased to 5.3 per cent in February, down from 6.2 per cent in the previous month and well below a peak of 16.2 per cent in November 2022, according to the latest OECD data.
In New Zealand, we’re doing better than this. Overall food price inflation was just 2.1 per cent for the year to February, the lowest it has been since the year to May 2021. Meat, poultry, and fish prices increased just 0.2 per cent. Fruit and vege prices fell 9.3 per cent.
Unfortunately, we’ve still got sticky inflation around things like eating out. But at least we have some discretion about that.
We get new food price inflation data this Friday, and next Wednesday we’ll get the full consumer price inflation figures for the first quarter of the year.
A fresh round of supply shocks is being blamed for the latest spike in oil prices. It is the last thing we need in the inflation fight and a reminder that central banks can’t afford to relax yet. Brent Crude oil hit a six-month high this week, although readers might have noticed the pain at the petrol pump more last week as the price surge coincided with a low point in the value of the New Zealand dollar. A bit of a rebound from the kiwi this week has softened the blow. Hopefully, the oil price will plateau for a while now... touch wood.
Q: Hi Liam,
I’ve been reading your Herald contributions and would get your book for my early-20s kids if only they’d read it. Today I’ve been watching the Herald commentary on kids taking the day off school to protest for a climate change focus from the Government.
While I’m all for caring for the environment, I understand that right now New Zealand does not have money for everything. If we are forced to choose, which with our current level of debt I think we are, I’d rather see people in homes, kids in school, a focus on reducing child poverty and violence, and those who need it receiving timely, quality healthcare, than see investment in climate change initiatives.
How do we encourage kids to engage in our economy in a way that allows them to explore a holistic understanding of choice and consequence?
Given the time kids spend on games and tech these days, could someone please build an app that enables young people to model economic choice and consequence, i.e. with a certain set of economic inputs (debt, immigration, GDP, inflation, tax take etc) what are the budget options and what are the consequences of those options? - Kerry B
A: Great idea. Yes, I wrote a book on economics and I don’t hold out much hope my kids will read it – at least, not any time soon.
I’ve noticed over the years that most people start to get interested in economics as the issues become more pressing in their lives. So I get a steady stream of new readers from people entering their 30s and 40s.
Trying to make it all hip and fun for really young people can be a thankless task. But yes, a video game (or an app that made it all look like one) would be great. I think online share trading platforms have that kind of appeal for young people and can be great learning tools – as long as the stakes stay low.
There are also some epic world-building video games that require players to get to grips with economics. Website thegamer.com recommends the likes of Rimworld, Sim City and Offworld Trading Company. Those games require a lot of commitment and effort to master in my experience (reading the Business Herald is a lot easier), but perhaps readers can suggest other games and apps that might get kids engaged with the realities of money and economics.
Last week, an item about the decline of cash sparked a good deal of reader concern. I picked up on the plight of “cash-in-transit” workers. As the number of ATMs declines, we’ve seen consolidation in that part of the security industry.
There is “significant excess capacity within the New Zealand cash logistics services infrastructure”, as Evergreen, the company behind the industry consolidation, put it.
Is this the beginning of the end for cash? I asked.
Many readers were quick to point out just how crucial cash can be in a crisis, with Cyclone Gabrielle being a recent example of when it was invaluable to keep the economy ticking over.
But with banking increasingly online, how are we supposed to get the stuff?
It is reassuring to see that the RBNZ has identified and is working on the problem.
As part of its broader Future of Money project, the central bank has been researching the use of cash.
The results of a Cash Use Survey in 2021 found that ”63 per cent of New Zealanders used cash sometimes to pay for everyday things (such as groceries, petrol, lunch, a bus or train ticket) or to pay their regular bills”.
This was a significant decline from 96 per cent in both 2017 and 2019. About 40 per cent of people who use cash do so less than twice a week. The proportion of heavy cash users declined to 2 per cent in 2021 from 5 per cent in 2017.
“We know that New Zealanders, particularly in rural areas, still often rely on cash and value the certainty and convenience it provides, including when electronic options aren’t available or are off-line, as we saw for large parts of the country during Cyclone Gabrielle,” said Ian Woolford, the RBNZ’s director of money and cash.
The bank is currently funding “Community cash service trials – He whakamātautau i te pūnaha moni a-rohe”, which will start later this year in several communities.
The trials are expected to start between September 2024 and February 2025 in about six to nine communities, likely to be in two or three clusters in different parts of the country.
The trials will test new ways for people, including retailers, to withdraw and deposit cash, including change and takings, at little or no cost to them.
“This research project recognises the important role of retailers in the cash system and will test ways of ensuring that cash remains easy to get, spend, give as change, and bank,” Woolford said.
Those who think their community needs this support or want to get involved can register their interest here.
If you have a burning question about the quirks or intricacies of economics send it to liam.dann@nzherald.co.nz ... or leave a message in the comments section.
Liam Dann is business editor-at-large for the New Zealand Herald. He is a senior writer and columnist. He also presents and produces videos and podcasts and is the author of the best-selling book BBQ Economics. He joined the Herald in 2003.
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