Worse than recession – have we hit stagflation? – Liam Dann

The stagflation of the 1970s – when both unemployment and inflation were high – was widely seen as discrediting the idea of a Phillips curve. Illustration / Anna Crichton

THREE KEY FACTS:

• New Zealand’s economy contracted by 0.1 per cent in the December quarter. GDP figures for the March quarter are due out on June 20.
• Inflation (the Consumers Price Index) was 4.0 per cent in the year to March.
• The country’s largest recruitment website Seek has recorded a 30 per cent drop in job ads across the past year. It saw a 5 per cent drop in job ads for May alone.

Liam Dann is business editor-at-large for the New Zealand Herald. He is a senior writer and columnist, and also presents and produces videos and podcasts. He joined the Herald in 2003.

OPINION

We might technically be out of recession already. Economists are divided on whether the economy grew or shrank in the first quarter of this year.

We’ll find out next Thursday when GDP figures are released. The difference will be marginal either way. A small expansion will hardly be a cause for celebration.

The economy is in the doldrums however you cut it. It is expected to stay there until inflation falls below 3 per cent and the Reserve Bank lowers interest rates.

That will take the rest of this year at least. So everyone is just holding on. Survive to ‘25 has become a catchphrase.

But what if it takes longer? What if the last sticky per cent or so of high inflation refuses to budge?

Are we at risk of getting stuck in this low-growth, high-inflation trap?

That’s called stagflation... and it’s not a place we want to be for long.

Stagflation is the horrible combination of low growth, high unemployment and high inflation.

According to classical economic theory, it’s not really supposed to exist - at least not for long.

A miserable economy should cause higher unemployment and restrict the money supply, cancelling out inflation.

But, as we found out in the 1970s, economies can get stuck – like a scratched record – in an awkward spot... the worst of both worlds.

It’s a grim prospect but one already being debated in Australia and the US - neither of which have actually been in recession yet.

In the end, the “R” word – for all its headline-grabbing potential – doesn’t matter as much to our lives as we make out.

When economies grow, we create more opportunity and when they shrink, opportunity is diminished.

But GDP – the scoresheet for recessions and booms – is an aggregate measure. It captures an economy’s total output.

On a personal level, it is still possible to be poor in an economic boom or get wealthy in a downturn.

What matters more in people’s daily lives are two statistics with a more immediate impact: inflation and unemployment.

Inflation erodes the value of our dollars and means we can afford less. Unemployment is a measure of labour market health. Even if you don’t actually lose your job, high unemployment means there is less opportunity to change jobs and less leverage to bargain for better pay.

High unemployment also means more people in the economy can’t afford to buy things, causing business profits to fall, leading to more job losses.

The Phillips Curve – developed in the 1950s by legendary Kiwi economist Bill Phillips – tells us there is an inverse correlation between unemployment and inflation.

When one falls the other rises and vice versa.

That broke down in the 1970s when loose monetary policy and excessive government spending, combined with some energy price shocks, delivered a painful period of stagflation.

There have been plenty of comparisons made between the current economy and the 1970s stagflation.

Until now, the one statistic we have looked to for comfort has been unemployment.

Unemployment has been at historical lows, but the trend is not good. Photo / Depositphotos

It has been at historical lows below 4 per cent until the start of the year. The current rate of 4.3 per cent remains below the long-term average of 5.5 per cent.

But the trend is not good.

We’re bombarded daily with fresh news of public service job cuts – now more than 6000.

And, the latest data from New Zealand’s largest recruitment website Seek shows job advertisements dropping at an alarming rate.

Seek has recorded a 30 per cent drop in job ads across the past year.

It saw a 5 per cent drop in job ads for May alone, suggesting the trend is getting worse.

It’s true we’re coming off a low base and economists expect unemployment will peak at 5.5 per cent.

However, the dramatic shift in gears the labour market is going through creates an outsized impact on the lives of those losing their jobs and looking for work.

To all intents and purposes, it feels very much like we’re in stagflation right now.

Hopefully, this is just a transition, an overlapping of painful trends as the tide turns but it is a reminder of how important it is that we don’t get stuck here.

The idea that this cycle will come to a tidy conclusion next year and normal service resumes is predicated on central banks winning the war on inflation.

I still think we will get there.

Latest price data from Stats NZ was heartening – showing food price growth has returned to normal. Even rents and travel costs were heading in the right direction

But the last vestiges of inflation are taking a worryingly long time to move as price increases are passed through the service sector.

If there is cause for confidence we won’t get stuck in stagflation it is underpinned by the determination of central banks to hold the line on interest rates.

The Reserve Bank’s focus on ensuring the fires of inflation are fully extinguished can seem cruel.

Its forecast that we’ll be waiting until September next year for rate relief is painfully conservative.

But it sends a message. Hopefully, that tough message will get us to the inflation race finish line much sooner.