Steven Joyce: Overheated economy about to burn borrowers

You must have some sympathy for those who entered the housing market in the last year or so. Photo / 123RF

OPINION:

It is becoming clear that the economic response to the Covid-19 pandemic has been overdone.

As a result of massive fiscal expansion and the loosest monetary policy in living memory, the country is awash in both borrowed and printed money. And our unusually constrained economy can't expand fast enough to absorb all that cash. We are overheating.

Inflation is already running at an annual rate of 3.3 per cent; and most price growth has happened in the last six months. If the second half of this year runs like the first, we are heading to 4 per cent plus inflation by the end of the year.

Unemployment is at 4 per cent which normally would be considered unambiguously good news. But this time round it is more evidence of severe capacity constraints.

Because of our largely closed borders, plus a government which is philosophically determined to keep skilled workers out under almost any circumstances, our workforce is growing at nothing like it has in the past. Add a bit of demand-side growth, and businesses, hospitals and the like quickly run out of people to hire.

The rapid re-emergence of inflationary pressures seems to have surprised many people, including the Reserve Bank Governor. As late as the end of May, the Bank was telling everyone it would maintain its current stimulatory settings in order to meet its policy goals.

That's despite many people, including this writer, warning as far back as February that inflation was likely re-emerging. The Governor is supposed to be ahead of the curve, not behind it.

No reasonable person could be too critical of the initial pandemic response by either Grant Robertson or Adrian Orr. With the country plunged into level 4 lockdown, fiscal support for suddenly curtailed businesses was crucial. And dropping interest rates and releasing more cash was a sensible macro-economic response. The main problem has been the period since Christmas.

The Governor and his Monetary Policy Committee have stuck to their "least regrets" expansionary policies all year, despite clear signals they needed to be cut back to limit inflation and soaring house prices.

It was only three weeks ago that they bowed to the obvious and announced the end of large-scale bond purchases (what we know as quantitative easing). Inexplicably they still haven't stopped lending printed money to the banks at tiny interest rates to "keep borrowing costs down" at the same time.

All this means interest rate rises are now going to have to be sharper and greater than they would have been if the brakes had been tapped a few months ago. The big banks are pricing an increase of up to 1.5 per cent over the next 18 months. If that happens, it's going to hurt borrowers, especially people with large mortgages.

You must have some sympathy for those who entered the housing market in the last year or so. One of the deliberate effects of ultra-low interest rates is to boost asset prices, so people who own those assets feel wealthier and spend more than they otherwise would. It also means first-home buyers take on more debt to get into a house which costs significantly more than it otherwise would.

Then, once they are in the house, interest rates are going to hike up because inflation and house prices have gone up too much. Those unfortunate first home buyers will get whacked both ways.

But it's not just the Reserve Bank Governor who should be questioned over the timing of his decisions. The Finance Minister is taking a far too passive approach to the country's changing economic circumstances.

Reserve Bank Governor Adrian Orr and Finance Minister Grant Robertson. Photo / Mark Mitchell

Only this week he was in the media washing his hands of our pending interest rate hikes, along the lines of "we do what we do and the bank will do what it does". Not so fast.

His first problem is that the Government has just kept on spending, despite strong signs the economy is recovering. And the quality of that spending has dropped dramatically in the last nine months.

It's one thing to support people's livelihoods during a government-imposed set of public health restrictions. It's an entirely different thing to spend a bunch of borrowed cash you've put aside for future possible lockdowns on all sorts of "nice to haves" that have nothing to do with the pandemic.

This year's Budget was a doozy, with $20 billion in extra spending over four years, despite it being clear by Budget Day we are having a better pandemic economically than most other countries.

That's pump-priming on a grand scale; which in turn stokes inflation and the need for interest rate increases. The more the Finance Minister spends, the more the Governor will have to take away the proverbial punch bowl.

The Finance Minister's other problem is the negative impact the government's wider policies are having on both inflation and economic capacity. The Government is at least partially culpable for the increase in electricity costs, wage inflation (through its big hikes to the minimum wage and increased leave entitlements), and our impossibly restrictive labour market. All these make the Reserve Bank Governor's job harder, and New Zealand an outlier in the inflation stakes amongst developed countries.

Belatedly, and possibly with the help of a poll or two, the Government is showing signs of waking up to its simultaneous strangling and overheating of the New Zealand economy.

This week we are told RSE workers from Covid-free pacific islands won't have to quarantine any more; that the totemically wasteful Auckland bike bridge is probably toast; and the Government is, possibly, maybe, going to take some steps to improve the ability of businesses to get crucial workers through the mess that is MIQ. But it is all incredibly late.

These steps and other corrective actions could have been taken months ago; and the spending on the bike bridge along with a stack of other low priority items could have been nixed before they were announced.

There are plenty of things that are not of the Government's or Reserve Bank's making that are helping boost inflation. They have no control over Opec, or Joe Biden's profligate spending in the US, or indeed the world's logistics logjam.

But they can see them all happening, and alter their own response accordingly.

That would be a true "least regrets policy". Unfortunately it looks more like we've had a "set and forget" policy, and borrowers are about to feel the sharp end of that.

- Steven Joyce is a former National MP and Minister of Finance.