The Reserve Bank's actions this week in lifting the official cash rate to 2 per cent — and signalling it could go as high as 4 per cent — is tacit acknowledgement that their monetary response to the pandemic went too far.
Not that you'll hear that from governor Adrian Orr. We don't need to worry, they've got this. Things are unfolding more or less as intended in the best little advanced economy in the world.
Orr is fond of "least regrets" decisions. It was least regrets back at the beginning of the pandemic to go further on quantitative easing and unconventional monetary policy tools than most other countries, and now, having belatedly accepted that inflation is a thing, it's a least regrets decision to hike interest rates as quickly as possible.
The trouble is, there will be quite a few people and businesses who do have regrets.
Those that responded to his explicit signals to borrow and spend as asset prices surged will have plenty of time to regret following that lead as they find themselves in straitened times now.
We have moved from "there is nothing to see here, inflation is transitory" to "there is nothing to see here — I'm whacking up rates fast and will deal with it" in record time. Perhaps a "stitch in time saves nine" might have been a better strategy to observe earlier in this inflationary cycle.
Of course, our Reserve Bank doesn't have this issue on its own. Central banks the world over have been pulling 180-degree handbrake turns on their long-suffering citizens, despite plenty of warnings this time would come. It's just a pity our current governor was not as willing to buck central bank fashion a year or more ago the way his predecessor was during the GFC.
The governor was also too polite in his nevertheless correct observation that government spending is boosting inflation. He suggested the extra demand created by government spending was "small beer" relative to everything else going on.
His sanguinity appears to rest on Grant Robertson's protestations that spending increases will drop to 2 or 3 per cent a year from next year onwards. This is despite Robertson's track record since 2018 of hiking spending, excluding Covid, by an average in excess of 10 per cent a year, as pointed out this week by Cameron Bagrie.
We now have two arms of government acting against each other. A spending bonfire stoked by Robertson up against a fire extinguisher wielded by governor Orr. But that's not all.
In his comments this week Orr was quick to identify supply constraints as a big contributor to inflation. As he said, our economy can't grow fast enough to absorb the demand that's out there, and that's why he has to crank up interest rates.
Some of those supply issues are beyond New Zealand's control. We can't do much about the Ukraine war or Chinese Covid lockdowns. But he did identify the highly restricted New Zealand labour market as a key internal constraint. And he's clearly right.
Signs of the labour market affecting our ability to grow are everywhere. Fruit is rotting on the ground (again), hospitality venues are running on restricted hours, everyone is poaching staff from each other by inflating wages. It's all on. Having a hermetically sealed border for two years will do that. With the pool of workers we currently have, we simply can't grow as much as we need to. That is making inflation worse.
Having passed up the opportunity to constrain expenditure in the Budget, the smartest thing the Government could do now is put out the welcome mat to new workers, and fast.
We need high-skilled workers, yes. But we also need medium-skilled workers, RSE workers and working holiday workers. We need students willing to work between lectures, we need people willing to work in rest homes, on dairy farms and picking fruit. We need to counter a net outflow of migration which risks only getting worse in the year ahead. And we need all this to happen now.
Other countries which closed their borders during the pandemic have shown real urgency in opening up again to attract people willing to work and help grow their economies.
There is an acknowledgement that they have a real job to do to attract people back. Some are even doing things like waiving visa fees to encourage students back. But not here.
With its immigration reset, the Government is being very picky about who they might deem worthy of letting in.
Certain occupations are favoured, others not so much. Nurses and teachers can come in to work, but some can't stay on, because they might, horror upon horror, change jobs and work somewhere else. The Government is also ramping up the salaries that migrant workers must earn, which carries the unfortunate impression they are reserving lower paid jobs for Kiwis, surely not the policy intention.
Ministers seem to believe that despite the past two years of barricaded borders and forced family separations, people will be queueing up to enter this country, and we have to be ever-vigilant or we will be swamped. However all the early evidence is that this isn't the case. In any event, the immigration service is patently not ready to process them.
A small and isolated country needs a practical, more open migration policy if it is to get ahead and grow for its citizens. Fortress New Zealand forces economic stagnation and excessive inflation. And that only hurts the people who live here.
So here we are in an economic straitjacket. Loose monetary policy, excessive government spending and an artificially constrained labour market have combined with external factors to stoke inflation to the highest levels in more than a generation. Without controlling government expenditure (reducing demand), or expanding the labour market (increasing supply), the only solution is to put up interest rates, and fast.
This in turn creates other risks. If interest rates go up too rapidly, higher mortgage repayments join higher prices in reducing household spending. Asset prices, too, can crater. Already, share markets are well down and house prices are coming down. If houses stop selling and residential building stops, we will have another big problem.
Our recession clock is steadily moving closer to midnight. Yet the government band plays merrily on.
- Steven Joyce is a former National Minister of Finance. He is director at Joyce Advisory.