Liam Dann: Why low rates of inflation are bad news for us all

Business Editor at Large·NZ Herald·

18 Jul, 2016 05:00 PM3 mins to read

The CPI inflation rate remained stuck at 0.4 per cent, in the year to the June 2016 quarter. Photo / iStock

As the world's economic bogeyman low inflation has been swamped this year by global political turmoil.

But the data released yesterday shows it remains a very real and present threat.

The CPI inflation rate remained stuck at 0.4 per cent, in the year to the June 2016 quarter. That was below Reserve Bank expectations of 0.6 per cent and its targeted average mid-point of 2 per cent.

It is also despite prices for petrol and construction rising 5.3 per cent and 2.1 per cent respectively in the three months to June.

The lower than expected inflation puts more pressure on the Reserve Bank to cut interest rates further to stimulate the economy and bring the value of the Kiwi dollar down. That may pour further fuel on the already overheated housing market. The bank knows this but it has little choice as its primary responsibility is to keep inflation in the target band.

Expect more about that on Thursday morning when the central bank delivers an unplanned mid-cycle economic update.

But essentially its dilemma - to deal with inflation or the housing-bubble risk - is more acute than ever.

So what's wrong with low inflation? Well, it might not be as dramatic as a market boom and bust, but over time a lack of inflation can suck the life out of an economy.

Stagnant prices typically lead to stagnant wages and eventually job losses. Price pressure squeezes business margins and the focus goes on costs rather than expansion.

Low inflation can also prompt consumers to delay spending on big-ticket items in the expectation that prices will fall further. This further squeezes businesses.

Meanwhile, low interest rates push capital into assets like property and stocks. Soaring asset prices when prices and wages are stagnant is good for those who can afford to invest but others are locked out and we start to get growing economic inequalities.

Globally we are starting to see rising inequality generate volatile political conditions which put further pressure on an already fragile economic outlook - particularly in Europe and Britain, but also in the US.

NZ remains highly vulnerable to global shocks which further slow the world's economy. Everyone - especially dairy farmers - hopes global demand for commodities starts to rise soon. If global growth slows then commodities including dairy may stay lower longer.

NZ certainly isn't alone in facing low inflation problems. Japan and Europe have seen deflation - where prices keep falling - and have had to cut interest rates into negative territory. But there's the risk that the global economy is stuck in a vicious cycle. Central bankers' firepower declines every time it is called on.

Our rates are still relatively high at 2.25 per cent, giving room to move.

But how long this cycle lasts is anyone's guess. Some say it's a structural shift in economics as technology puts constant downward pressure on pricing. If that's the case this problem will require some lateral thinking by economists and politicians to overcome.