Dan Bidois: Inflation myths and how to bring it down

Reserve Bank of New Zealand Governor Adrian Orr. Photo / Mike Scott

Opinion

OPINION:

News out this morning that annual inflation has reached 7.3 per cent is no comfort for Kiwi families struggling with New Zealand's cost of living crisis.

Our annual inflation rate is now the highest it's been in over 32 years. Thankfully public debate has moved on from simply finger pointing who's to blame for the current inflation environment we are in (it's both foreign and domestic!).

However, I've watched on as a few myths seem to have gained ground publicly about what will bring inflation down.

The first myth is that we can bring inflation down without going into recession. This is simply not true when we consider economic history.

According to Larry Summers, former US Treasury Secretary and president of Harvard, "if you look at [US] history, there has never been a moment where inflation is above 4 per cent and unemployment is below 5 per cent where we did not have a recession within the next two years".

Summers was one of the first who forewarned that all the fiscal and monetary stimulus from dealing with Covid-19 would lead to higher inflation. Now he is warning of a "hard landing" for the US economy as the country seeks to rein it in. This means further hikes in interest rates, a recession and rising unemployment.

America's history with inflation has parallels to our own in New Zealand. Since 1980, our economy has experienced four periods of inflation higher than 6 per cent and in all these cases a technical recession followed within two years.

Politicians and central bankers prefer not to mention this hard landing solution to lower inflation. However, there may be no other clear way to bring inflation under control.

When will our economy go into recession? Even though we experienced negative growth in the first quarter of 2022, it is possible we have escaped another quarter of negative growth and therefore a technical recession when the latest GDP data comes out in September. Recession risks will be more likely as we head into 2023.

The second myth is that governments can bring down inflation. Again, when we look at economic history, this is simply not accurate.

As Milton Friedman famously said, "inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output".

Aside from rapid and deep cuts to total Crown spending, government policies toward inflation have at best a marginal effect in the short-term and can put upward pressure on inflation.

Take Labour's $350 cost of living payment for example. By increasing government spending, aggregate demand in the economy will increase, stoking inflation pressures further. Tax relief policies too, although wildly popular to ease cost of living pressures, can have a similar impact on increasing inflation.

Let me be clear, governments have a role to play in bringing inflation down. However, it is a supporting role only to the main star of the inflation show: the Reserve Bank of New Zealand.

Here are two specific ways in which our government can play that supporting role:

The first is helping to lower inflation expectations among the public.

Expectations drive future inflation.

If Kiwi businesses and workers expect higher inflation in the future, this may flow through to higher prices and wage requests, contributing to yet higher inflation.

This is where our government can help, by being clear with the public that it will do whatever it takes to get inflation under control. This must include serious commitments to fiscal restraint and reducing wasteful government spending.

Instead, Labour's Finance Minister Grant Robertson is continuing his spending spree. We are now in the third consecutive year of budget deficits and current Treasury forecasts don't have the books returning to surplus until 2025.

Labour needs to cut back its spending. Large projects that don't add any measurable value to front line services (like Auckland's light rail, the Three Waters reforms, and the health reforms) contribute to inflationary pressures and should be shelved.

Fiscal restraint needs to be restored across all government departments and ministries. There are more examples of wasteful government spending than there are orange road cones in our country, and all compound on cost-of-living pressures.

Second, the government should restore the sole mandate of the RBNZ to fight inflation.

In 2019, Labour made a disastrous change to the RBNZ Act, widening its mandate to include maximum sustainable employment. However well-intentioned this change may have been, it has undermined the strength of New Zealand's monetary policy framework and led to a decline in the RBNZ's credibility when fighting inflation.

Restoring inflation targeting as the only goal of our central bank is necessary to ensure cost of living pressures ease over the medium to long term. All other worthy goals should be left to politicians in the Beehive or Parliament.

- Dan Bidois is managing director of Bidois Strategy Group and a former National Party MP.