Labour is betting that inflation has peaked.
Panicked by the cost of living, the Government has introduced a temporary three-month cost of living package for 2.1 million adults that will cost $814 million. About 82 per cent of the population will be receiving their income in full or part from the government.
Every cent of the package will have to be borrowed.
It is unsustainable. Politically, it is a huge risk.
The granting of a benefit is rarely appreciated. After all, the Budget produced no jump in the polls. However, the withdrawal of a benefit always produces an angry response.
Unless the Government can point to inflation having dropped dramatically, Labour will anger 2.1 million voters.
Will inflation rapidly fall?
The increasing track for the official cash rate (OCR), the Reserve Bank believes, "will confidently bring consumer price inflation to within the target range".
Annual CPI inflation "is expected to have peaked in the first half of 2022", the bank says.
The bank's new economist, Paul Conway, is even more optimistic.
"We're aiming to get inflation back into its box, while engineering a soft landing," he says. "It's entirely possible, feasible, that the OCR doesn't have to go as high as we forecast."
The problem is, the Bank was just as confident last year. In May last year the bank said it would "maintain its current stimulatory monetary settings until it is confident that consumer price inflation will be sustained near the 2
per cent per annum target midpoint ..."
The Bank's claim that inflation has peaked is contradicted by its own monetary policy statement. The bank says the government's Budget is inflationary.
The "Russian invasion of Ukraine has added to the underlying global inflation pressures," says the bank. "The cost of living has risen significantly, in particular due to shortages of food and fuel".
The bank notes "supply-chain disruptions" are "adding costs". Labour shortages are predicted to increase as skilled New Zealanders migrate. It says "rising wage pressures are an expected outcome".
Against these inflationary pressures, the bank believes a 2 per cent OCR rising to 3.9 per cent will roll back inflation to 2 per cent. It is not credible.
Economists cite the Taylor Rule for calculating what the OCR must be to neutralise inflation. In simple terms, the OCR should be the difference between the target rate of inflation, 2 per cent, and the present rate of inflation, 6.9 per cent. The required rate to defeat inflation is 5 per cent.
In the 1980s, in order to defeat inflation interest rates were in double digits for years. Even then it required a recession after the 1987 sharemarket crash to finally defeat inflation.
The Reserve Bank's claims that it can gently defeat inflation without a significant contraction have caused the Reserve Bank governor who did return New Zealand to low inflation - Dr Don Brash - to write this on his website, Bassett, Brash and Hide: "When the OCR goes up, borrowing becomes more expensive … But let's not pretend that that process is painless: it certainly isn't. Some people find they can no longer service their mortgage … jobs are lost, wages and salary increases are less than expected, some companies fail."
Professor Robert McCulloch, on his blog, Down to Earth Kiwi, says the real reason we have inflation is not President Putin but the Reserve Bank printing $50 billion. The MI money supply "increased from $90b in March 2020 to $140b in March 2022", he notes. The Reserve Bank's plan to reduce its balance sheet will leave much of that $50b in the economy, driving up inflation.
We can see inflation every time we go to the supermarket or fill up the car. My lawyers last week increased their fees by 10-12 per cent. I have a new gas stove hob. If it was not illegal and dangerous, I could plug it in myself. The gas-fitter has quoted $689.52. Such is the shortage of tradesmen that I was pleased even to get a quote.
By October it will be clear whether inflation is falling. Even if it has, people will notice the loss of $27 a week just before Christmas.
If inflation is still elevated, then removing the income support will be one of the most unpopular decisions by any government. Overseas, people riot for less. It will be electoral suicide.
But deciding to continue the income support, having just 18 per cent of the population supporting the other 82 per cent, will shred whatever economic credibility Labour has.
The only way to avoid having to cancel or extend the income support package would be for Labour to find an excuse to call a snap election.
- Richard Prebble is a former leader of the Act Party and former member of the Labour Party.