Brian Fallow: Who's really to blame for domestic inflation?

Finance Minister Grant Robertson. Photo / Mark Mitchell

OPINION:

The political battle lines over the cost of living crisis are already clear.

The Labour Government's line is that the current inflation is largely a global phenomenon beyond the control of anyone in New Zealand — and to the extent that there is a problem with excess domestic demand, well, it's the Reserve Bank's job to deal with that and they have every confidence it will.

National and Act say that is a cop-out, that consumers are suffering the fruits of undisciplined government spending and that what is needed is a much tighter hold on the purse-strings than Labour can be trusted to provide.

If that is what the politicians say, what do last week's inflation numbers say?

When the statisticians split the 650 items in the consumers price index between tradable (imported) and non-tradable (domestic) prices, the two groups had an almost equal impact on the overall 6.9 per cent annual increase, which is the highest since 1990.

This is radically different from the normal pattern. Between 2002 and 2020, tradables, which currently comprise 40 per cent of the CPI, rose an average 0.4 per cent a year, significantly offsetting non-tradables inflation which averaged 3.1 per cent.

In the latest year, tradables inflation has climbed to 8.5 per cent and non-tradables to 6 per cent. A year ago they were 0.5 and 2.1 per cent respectively.

If the most conspicuous rises are excluded — vehicle fuels from tradables and residential construction costs from non-tradables — the inflation rate would be one third lower than it is. But it would still be 4.6 per cent.

All the measures of core inflation have been climbing.

Price rises have become more widespread, with 63 per cent of the items in the CPI, by number, and 77 per cent by expenditure weight rising in the March quarter.

That makes it ominous that the NZIER's latest quarterly survey of business opinion found a net 77 per cent of respondent firms say they expect to increase their prices in the next three months, up from 65 per cent in the December survey.

Ominous and surprising, given the increasing strains evident on household finances.
Real incomes are falling for most wage and salary-earners, which should see spending retreat from nice-to-have things to the need-to-haves.

Mortgage rates are rising and the REINZ national house price index has fallen for four months in a row, turning off any wealth effect from house price inflation.

And then there is Covid, currently killing more Kiwis per week than it did altogether in the first two years of the pandemic. You would expect that to have some chilling effect on consumer confidence and behaviour. And indeed, Westpac's survey of consumer sentiment is back at GFC levels.

But at the moment it would seem the thousands of people who actually set consumer prices are more concerned about the bottom line than the top line. The question is how long that lasts and whether it takes a recession to change it.

The message we can expect to hear from the Reserve Bank to price-setters next month will be stern: We know your costs are rising and naturally you want to pass that on. Well, we can't have that, not on this scale. We know how to drain demand from the economy and we will continue to do so. Bear that in mind before raising your prices.

As the saying goes, monetary policy needs mates.

You can see governor Adrian Orr's statement to that effect when talking to the International Monetary Fund last week either as a rhetorical missile aimed at the Government, or alternatively as an innocuous statement of the obvious: having one side of Bowen St flooring the accelerator while the other side is hitting the brakes will not do the vehicle any good.

How much the Reserve Bank tightens the interest rate screws next month will depend a lot on how expansionary or contractionary the Budget Grant Robertson delivers a week earlier looks.

He would not need to be reminded of that. It is the law of the land — written into the Public Finance Act in Bill English's day — that one of the principles the Government must have regard to when formulating fiscal policy is the interaction between it and monetary policy.

But if Robertson were in the dock, accused of fuelling inflation with a spendthrift approach to government spending, the first witness for the defence should be that very Sir William English.

During English's first four years as Finance Minister — to be precise, the fiscal years immediately following his first four Budgets — government spending (core Crown expenses) measured against the size of the economy averaged 32.1 per cent of gross domestic product.

Four years in, the equivalent number for Robertson is 32.3 per cent. It's essentially the same number.

In the early years of Finance Minister Bill English, government spending as a proportion of GDP was much the same as it has been under Grant Robertson. Photo / Mark Mitchell

Inevitably when making comparisons like this, there are all sorts of things which make a difference between then and now. But the similarities are striking too. English had the global financial crisis to deal with; Robertson has a pandemic. Both had the benefit of inheriting relatively low levels of government debt.

So the idea — now an article of faith on the political right — that there is some deep difference between the two main parties' DNA in how they approach fiscal policy is empirically challenged, to put it politely.

The Opposition invites us to be alarmed by the outsized $6 billion operating allowance, or pot of new spending, the Government has foreshadowed for next month's Budget.
Much of that is likely to be earmarked to clean up the accumulated deficits of district health boards as part of the restructure of the health system.

That would not be an inflationary fillip to demand in the way that, say, tax cuts would be.
In any case, the Opposition does not mention that the half-year economic and fiscal update released last December has core Crown expenses falling $8b to $120b in the coming fiscal year. Not going up, but down.

And the deficit is forecast to shrink from $20b this year to less than $1b next year before returning to surplus in the out years.

Those forecasts predate Omicron and the war in Ukraine and will have to be revised. But as an indicator of fiscal intent, they are at odds with the image of a fiscally undisciplined Government that National and Act are keen to embed.

In the end, though, the Government is not the main driver of domestic demand.

Household consumption is three times as big a component of domestic demand as government consumption.

But we are not likely to hear politicians wagging an admonishing finger at consumers/voters and saying: "Cut out that low-grade, undisciplined spending on marginal things like long blacks and Lotto tickets. We need that money to pay nurses and keep the lights on in police stations."

Easier to blame the Government.