“Monetary policy operates with long and variable lags. Accordingly, monetary policy in New Zealand is focused on the medium-term inflation outlook,” said Dr John McDermott, assistant governor and head of economics with the Reserve Bank in October, 2016.
According to the bank’s November monetary policy statement: “The supply of goods and services will improve over the medium term. Supply-chain bottlenecks will continue to ease, and migration’s resumption will bolster the labour supply… Over 2023 and 2024, headline inflation is projected to decline. And return to the top of the 1 to 3 per cent target band by late 2024. And 2 per cent by 2025.”
So, should the Reserve Bank keep increasing the official cash rate (OCR) next year? Thus increasing unemployment and “engineering a recession” when primary causes of inflation are likely to ease in the medium term anyway?
A recent Herald survey had 74 per cent cite wealth inequality as the most significant factor in declining social cohesion and 70 per cent cite access to housing as a growing cause of division.
Low interest rates have wreaked havoc on the housing market, putting home ownership out of reach for many, especially the young.
Is it time to rethink OCR and inflation targets?
The average inflation from 2011 to 2020 was only 1.5 per cent (the previous decade, 2.5 per cent).
“Low inflation has been a common challenge globally”, Christian Hawkesby, assistant governor of RBNZ told the Bank of International Settlements Forum in 2019. He said “the challenge now is to lift inflation, not bring it down”.
A pandemic later, the shoe is on the other foot. Is it just a pandemic-induced blip?
Grant Spencer, then RBNZ governor, expanded on reasons for low inflation to the Institute of Directors in 2017. “The expansion of global supply chains led to outsourcing labour-intensive production stages to cheaper emerging economies. This placed downward pressure on the wages of lower-skilled jobs in advanced economies, translating to less inflationary pressure in developed countries.
“The massive scale and growth of China’s economy had a profound effect, with capacity expansion restraining prices of industrial materials and a wide range of manufactured goods. The rise of the digital economy – the cost of information, communications and technology (ICT) goods and services have fallen worldwide as unit costs fell and supply expanded. New digital distribution channels lowered barriers to entry across a range of markets.
“Online sales are growing market share in retailing, financial services, travel services, education and health services, increasing competition and downward pressure on both input and output prices.
“The relationship between unemployment and inflation has weakened, and international and domestic factors played an important role. Increasing inward migration contributed to higher production capacity, moderating emerging excess demand for labour. We have looked closely at the role of expectations in price-setting behaviour.
“In an environment where inflation has been low for some time, businesses have placed greater weight on past inflation in setting prices”.
Other factors, both long and short-term, have contributed to low inflation.
Subdued wage inflation due to defanging unions and manufacturing jobs being replaced by lower-paid retail and tourism jobs. Strength of the NZ dollar and low commodity prices.
While some of these global and domestic factors may be changing, it’s difficult to imagine a dramatic medium-term reversal of the low inflationary environment of the past three decades.
The RBNZ has little control over most of these factors. Forty-four per cent of the Consumer Price Index (CPI) is tradeable inflation, caused mainly by global factors, over which the bank has almost no influence.
The primary economic problem over this period was asset price inflation, especially house prices worsened by low-interest rates. Why keep money in the bank earning low interest when you can make near double-digit returns by investing in housing?
There will be some changes impacting future inflation.
Costs in China are increasing with the country’s growing affluence. While some manufacturing will shift to other low-cost countries, China will be dominant in the medium term due to its scale.
Post-Covid calls for resilience could lead to an increase in higher-cost local manufacturing. Labour market dynamics could change depending on the political environment and immigration settings.
We could have a new reality of slightly higher inflation, higher wage costs and lower asset prices, which is probably a good thing overall.
What can the Government do to ease the pain of the people?
While the RBNZ has a narrow remit, the Government has broad responsibility for the welfare of its citizens.
Many European countries, like Greece, Spain, Poland and Ireland, are assisting first-home buyers and vulnerable homeowners. Germany has taxed windfall profits using it to pay the December gas bills of all households. A super profits tax can relieve low- and middle-income earners with little inflationary impact.
No one is saying the RBNZ should do nothing to constrict inflation. But does it have to be shock therapy which can cause “all kinds of trouble”, in the words of Douglas Diamond, Nobel Prize-winning economist?
Perhaps a more measured approach will result in better medium-term economic and social outcomes.
RBNZ Governor Adrian Orr admitted households were paying the price because monetary policy was too stimulatory and too long, an RBNZ mistake.
Perhaps it’s time for some humility and soul-searching before he plunges the economy into a recession and throws tens of thousands out of work.
- Kushlan Sugathapala is a researcher and writer on social justice issues.