Editorial: Dr Brash's warning pre-emptive strike

At this time, we need cool heads and rational thinking, not extravagant claims or counter-claims. So said Don Brash yesterday in a speech to the American Chamber of Commerce. The Reserve Bank Governor was referring to the tumbling dollar. Equally, however, he might have been thinking of the reaction to his warning, 24 hours earlier, of the risk that New Zealand could be pitched on to the economic rocks of stagflation. The response to this concern was about as calm as the histrionics of a primitive tribe confronted by a lunar eclipse.

Dr Brash could at least take comfort that his message was finally commanding attention. It was not the first time he had delivered the warning. Two months ago, he cautioned that wage increases, the potential fruit of workplace law changes that swing the balance of power to trade unions, would force him to raise interest rates. In response, the unions muttered about payback and seemed to take little notice. Certainly, the junior doctors were not dissuaded from seeking, and winning, a substantial pay rise, nor firefighters and nurses from lodging big claims.

On Wednesday, Dr Brash repeated his concerns, but also made it clear they were directed not just at unions but also at inflation-fuelling prices set by companies and the self-employed. His target was not price increases which were the direct result of the dollar's fall or the surge in the cost of oil, the impact of which are becoming apparent on supermarket shelves. The Reserve Bank can look through the immediate effect of one-off price shocks in its fight against inflation. Rather, Dr Brash had his sights set on attempts by businesses to re-establish margins or push up prices in compensation for wage increases which exceed productivity gains. As with his earlier warning to wage-setters, this was in the nature of a pre-emptive strike. Competition and a fragile demand has so far restrained such urges.

In referring to stagflation, Dr Brash was also warning of a potential threat - that of a combination of high inflation and weak economic growth. It is the worst of all worlds and places any central bank in the most unenviable of situations. The logical counter is higher interest rates, the disagreeable impact of which is to further dampen economic growth. Dr Brash was clear, however, that this was simply one of the directions in which the economy could travel. And he had good reason for acknowledging the threat. There are obvious parallels to the 1970s, when stagflation emerged as the natural rate of unemployment rose with strong wage pressure. But, as Dr Brash pointed out yesterday, it is not the most likely scenario. World economic growth shows no signs of flagging and the low exchange rate is stimulating an export sector that will funnel its profits throughout the economy.

Any cool-headed assessment of the economy would, therefore, be rosier than the gnashing of teeth which greeted the mention of stagflation. Certainly, there would have been none of the scaremongering that tied the dollar's fall below 40USc to the Governor's warning. The subsequent recovery in the exchange rate confirmed that the weakness in the dollar owed little, if anything, to Dr Brash and everything to the Australian Reserve Bank's decision not to raise interest rates.

However, no matter the remoteness of stagflation, Dr Brash was right to warn of the risk. After a period of stability, it has become all too easy to make light of the ravages of inflation, to forget that all suffer from the erosion of savings, the unreliability of prices and the undermining of competitiveness. The wage demands about which Dr Brash rightly worries seem likely to drive inflation above the Reserve Bank's 3 per cent target ceiling, but they will hardly reproduce double-digit inflation. Nonetheless, the certainty which is the key benefit of a low-inflation environment would be eroded.

To warn of such a threat is not, as the Council of Trade Unions had it, provocative or unhelpful. It is common sense to warn of a potential outcome if unions and companies do not show restraint in setting prices and wages. And if they do not appear to be getting the message, it may be necessary to come up with an attention-grabber. The mention of stagflation has done that. How much more comforting, however, if the message were seen for what it was and acted upon, rather than prompting delirium of dire proportions.