Stagflation spectre in economic outlook

Alasdair Thompson

Rising prices and falling economic growth can result in stagflation, warns the CEO of a leading employers' group.

The warning comes from Alasdair Thompson, chief executive of the Employers & Manufacturers Association (Northern).

"Finance Minister Dr Cullen is calling for restraint on wage rises", said Mr Thompson.

"We would be unwise to let factors driven to a large degree from overseas to add to wage pressures," he added.

"We can't simply award ourselves higher wages to compensate for high oil prices, or the lower exchange rate which is pushing up the price of imported goods.

"While inflation is marching towards four per cent per annum due to these factors, along with higher power prices and ongoing skill shortages, the rate of GDP growth has fallen and is expected to stay low for the next year.

"Growth has dropped from its 3.5 per cent per annum average and is expected to fall to just one per cent", he said.

"Rising prices and lower growth sets the scene for stagflation - rising prices without real growth - which hurts everyone."

Mr Thompson said the spectre of stagflation is hanging over us.

"The drop in the NZ dollar is a consequence of the rest of the world seeing that we have spent far more than earned. Overseas investors in effect are saying: 'Your higher import costs and reliance on borrowing means you are poorer so we are marking down the value of your currency.'"

* SO, WHAT IS STAGFLATION?

According to web-based reference source Wikipedia, "Stagflation is a term in macroeconomics used to describe a period characteristic of high inflation combined with economic stagnation, unemployment, or economic recession.

Stagflation is thought to occur when there is an adverse shock (a sudden increase, say in the price of oil) in a country's aggregate supply curve. The effects of rising inflation and unemployment are especially hard to counteract for the central bank.

The bank has one of two choices to make, each with negative outcomes.

First, the bank can choose to pursue a loose money policy to stimulate the economy and create jobs by increasing the money supply (by lowering interest rates) and exacerbate the inflation problem further.

Or second, pursue a tight money policy (by increasing interest rates) to try and rein in inflation at the cost of perhaps increasing unemployment further." SOURCE: Wikipedia