Thanks to shipping delays, labour shortages and trillions of dollars of central bank money, Covid-19 has delivered the biggest inflation shock the world has seen in more than a decade.
In New Zealand, the Consumers Price Index data shows inflation at an annual rate of 3.3 per cent – outside the Reserve Bank’s target range.
But how urgently the bank needs to move against the trend by lifting interest rates is hotly debated.
It’s an issue dividing economists around the world. Some argue the inflation spike won’t last, and that central banks should look through the price rises. Others, however, fear it is a structural shift that could take us back to the bad old high-inflation days of the 1970s and 1980s if we don’t act fast.
Drawing inspiration from a New York Times survey of US economists, we asked some of their leading New Zealand counterparts how worried they are about inflation taking hold.
The answers suggest – thankfully – that we are less politicised here than in the US. While there are a range of viewpoints on offer, a consensus might be that there is cause for some concern, some need for central bank action … but no need to panic.
Brad Olsen – Principal economist, Infometrics
Current inflationary pressures are a combination of both high demand (people have money, and they want to spend it) and constrained supply (supply chain issues and skills shortages limiting the economy’s ability to respond and resource this growth).
With more money in the system, there’s more heat on businesses to compete for resources, with cost pressures passed on to consumers.
The economy is still a little tentative and will need support to keep the recovery rolling; just not as much support as it’s getting now.
Let’s wean New Zealand off the morphine and onto the Panadol. Balancing the pace of change (and the enduring pace of inflation) will be key to New Zealand’s monetary policy settings.
Our current view is that inflationary pressures will trend higher over at least the next two years before eventually resuming a more usual, but higher, track upwards.
There’s a word of caution over raising interest rates too fast, given that the two times New Zealand attempted to unwind accommodative monetary policy in the post-GFC era, rates had to be cut again quickly as inflationary pressures failed to eventuate.
But inflationary pressures are already here, so part of that equation is fulfilled this time.
Jarrod Kerr – Kiwibank chief economist
I’m not worried. Sure, inflation has risen significantly. Wages are finally rising. But remember, this follows one of the greatest economic disruptions of a generation.
In the post-GFC decade, we’ve seen inflation rates well below central bank mandates.
Central banks have failed on the downside since 2008. In fact, inflation has been steadily declining since the 1980s, when the RBNZ was the first to start targeting it.
The structural decline in potential growth rates and inflation has been driven by ageing demographics. These tectonic demographic forces only intensify from here.
The post-war baby boom was the largest in human history. The boomers are now retiring. Their influence on interest rates is profound, and understated.
Technology will continue to streamline, automate and disrupt. A TV cost less today than it did 10 years ago, and includes “smart” technology. A mobile phone is now a little more than just a phone. I don’t need a clunky camera anymore, or a wallet.
There is no denying the significant impact of companies like Apple, Google, Facebook and Amazon.
Amazon alone was found to have lowered global inflation, by streamlining supply chains and putting consumers directly in front of manufacturers, cutting out traditional retailers.
Any inflation beast we see ahead of us, it’s only a distant cousin of the massive beasts seen in the 70s and 80s.
I think of the Game of Thrones dragons that grew into little pups whilst in captivity. Our inflation has been captive for decades. I’m not worried medium term.
Christina Leung – NZIER principal economist
At this stage I don’t think we need to be too worried.
We have come out a period of very low inflation, supply chain disruptions have played a key role in rising cost pressures, and now strong demand means businesses are more able to pass this on to customers by raising prices.
Should this start to drive up longer-term inflation expectations materially and we start to see further flow-on effects to strong wage growth and a persistent increase in CPI, then we should start to worry about an inflationary spiral.
This does not look to be the case in the New Zealand economy.
Whether it is a structural increase in inflation depends on whether longer-term inflation expectations increases materially above the inflation target mid-point of 2 per cent.
I don’t consider the underlying structure of the NZ economy as having changed materially to change the inflation drivers.
Interest rates are already too low and have been too low for too long in my opinion. We have seen the effects of loose monetary policy on asset price inflation, particularly with the surge in house prices in NZ.
The Reserve Bank faces some tough tradeoffs in circumstances where there are few lessons from the past to draw on.
Sharon Zollner – ANZ chief economist
Rising inflation matters to the extent that it’s going to stick around unless central banks do something about it.
In New Zealand, with the economy performing strongly, the RBNZ is in a position where it can recognise the risks that the current spike, while containing temporary components, could become self-sustaining.
Inflation expectations and, anecdotally, wage growth, are strong and rising. That’s the sort of inflation that doesn’t go away if you ignore it, at least not without a recession.
In countries where inflation is high but the growth outlook is still very iffy because of the Covid situation, central banks are naturally not keen to raise rates before labour markets in particular are healed.
I think globally the risks skew to central banks moving too late. They simply don’t want to believe they are facing a tradeoff between stabilising growth and jobs or stabilising inflation.
That’s a horrible choice. So they deny it exists.
Here in New Zealand, strong growth and lower Covid risks means we can react “normally”.
But I think it’s pretty clear that a policy mistake has been made: both monetary and fiscal policy overdid it.
Again, I’d underline that I’m not throwing stones; we all got it wrong and understandably so, given the extreme uncertainty at the time.
We didn’t dare dream we could eliminate Covid; that’s a big part of it.
We also all underestimated the cost shock, and assumed a more persistent hit to both business and household sentiment than eventuated.
Policymakers now need to acknowledge the situation and move quickly to try to bring demand and supply more into line.
Because at the moment we’re digging the next recession deeper (whenever that might be) in order to make today’s boom bigger, and that’s the opposite of what monetary policy is supposed to do.
Stephen Toplis, BNZ head of research
Is this transitory or not is really the wrong question.
Ultimately, while central banks are charged with keeping inflation in check, any spike in inflation should prove relatively transitory.
And yes, the supply shocks that we are experiencing will eventually come to an end too.
The more interesting questions are: how long will inflation remain above target; will inflation feed into elevated inflation expectations; how much work will central banks have to do to contain the spread of current inflationary pressures into more protracted inflation; and what will the new norm look like once the inflation “blip” is behind us?
I would argue that even if the majority of the current inflationary pulse is “transitory”, why would inflation not normalise (at say 2 per cent) and thus require a normalisation in interest rates?
You can pick a number, any number, for the appropriate level for the neutral rate, but I doubt it would be the 0.25 per cent we now have.
The RBNZ says the current neutral rate is around 1.9 per cent. That says to me this should be a base target for medium-term rate forecasts.
It is true technological change and price discovery have permanently changed the way the world works. Such advances should mean major gains in productivity (and competition), resulting in lower inflation.
On this basis, people should have been more comfortable with lower inflation than was the case.
Surely, it doesn’t make sense for central banks to lower interest rates to compensate for reduced price pressure due to efficiency gains?
That said, Covid is currently acting to offset many of these benefits, as supply chains break and demand for technology outstrips supply.
In my opinion, the risks are very much skewed towards central banks being too late.
Michael Gordon – Westpac chief economist
There are many good reasons to think that we won’t see a return to the double-digit inflation of the 1970s, but the biggest one is that central banks don’t have the same leeway that they did back then.
Sustained inflation is more a question of the strength of demand, which central banks do have some sway over.
In New Zealand, you can make a case that demand is now running too hot.
We’ve ended up with the best-case scenario for domestic activity, at the same time that the RBNZ and the Government have been running worst-case-scenario polices to stimulate demand.
So it’s now time to start withdrawing some of that stimulus. (I do want to point out that my “conversion” to rate hikes over the last couple of months has been about recognising the strength of demand, not about the scale of the near-term inflation spike.)
As for what the RBNZ should do: hiking in August or waiting until November would make very little difference in terms of economic outcomes.
What I question is how an early move fits with the RBNZ’s self-proclaimed “least regrets” approach.
No-one claims that our border system is perfect, and it’s perhaps only a matter of time before a case of Delta slips through.
If that were to happen when we’re still some way from completing our vaccination programme, then – as we’re seeing in Sydney – it would be very difficult to keep in check with anything less than a Level 4 lockdown.
So I think there’s a high risk of tightening now only to have to reverse course soon afterward. That said, it would be more of a reputational cost than an economic one.
Mark Cox, BERL principal consultant
How worried should we be about rising inflation? Moderately worried.
Central Banks (including the Fed and the RBNZ) appear to be relaxed about it, on the grounds that the increasing inflation we are seeing now will only be a temporary, but there is a significant risk that it will not.
The economic problems associated with inflation are varied. If the central banks respond by raising interest rates, all the debt that governments have incurred will become more expensive to manage.
There will also be a tendency for labour market unrest, as unions take action to secure wage increases.
And anything more than low level inflation protects inefficient businesses because they can get away with increasing their prices.
But the social consequences of increasing inflation are, if anything, more serious than the economic consequences.
Earners start to become grumpy because, although their wages and salaries might increase, a greater proportion of their earnings will be at higher tax rates because of bracket creep.
Anyone on a fixed income will suffer. And people on lower incomes (spending a higher proportion of income on food and living costs) tend to suffer more than most.
Price discovery via the internet helps consumers to find best buys, but the old rules still apply. Inflation is caused by more demand than supply.
Cameron Bagrie – Bagrie Economics
If I was the Government I would be really worried. The emergence of it in a sustained fashion is telling a poor story about the economic base and supply side capacity of the economy, which is essential for improving wellbeing.
Inflation will make people grumpy. Excessive inflation is a thief that steals savings.
It makes it more difficult for people to afford necessities as prices rise. This can cause families to struggle. Inflation puts pressure on interest rates to increase, which hurts borrowers.
A higher cost of capital defers investment.
Some is transitory. Technology is still deflationary too. But there are wider forces that point to some inflation persistence we need to be alert to.
Some previous structural inflation suppressants such as globalisation are showing signs of reversing. Government policy is also taking on a strong redistributive element which is inflationary.
Climate changes carries costs too. Costs are being poured on businesses. Society’s attitudes seem to be changing, supporting social issues such as higher wages, though will they be prepared to pay the higher costs is yet unanswered.
The economy has a lower potential growth rate post-Covid, so less capacity for growth without hitting capacity and inflation pressures.
At the same time, monetary policy and fiscal policy has poured a lot into the demand side of the economy.
Central banks should start turning down the heat. I think monetary policy will apply the brakes [but] the government spending will be hard to rein in.
Nick Tuffley chief economist ASB
We shouldn’t be too worried about it, but we do need to respond to it in a measured way before too much longer.
There is a growing risk of inflation sustaining for a period outside of the inflation target band and of the economy going through an unnecessary boom/bust period.
The most persistent inflation source is set to be wage growth and could last several years. It is the one that will be most influential on what the RBNZ decides to do.
Even though the unemployment rate (as reported to date) is not back to historic levels, there appears to be a mismatch between jobs, required skills and location that means labour tightness is greater than what the unemployment rate suggests.
Strong construction vs weak tourism/hospitality is an example of this.
With entry into New Zealand likely to be heavily restricted for several years, the ability to source added labour through migrants – particularly to fill skill shortages – will be very limited.
Globally, there are also labour shortages that will be difficult to fill and create added cross-border competition.
[For the RBNZ] the risks have skewed towards not moving soon enough.But OCR increases should be done judiciously.
The world has become very different in a short space of time and the impacts of tighter monetary policy may be quite different from the past, and the RBNZ needs to be mindful of that.
Oliver Hartwich, executive director NZ Initiative
My view of inflation is based on money supply rather than consumer price index.
So most people think of inflation as prices going up. For me that’s a part of inflation but not it.
Sometimes it shows up in consumer prices and sometimes in asset prices . So when people look at inflation and say it is low and has been stable for some time (even 3.3 per cent doesn’t sound like real inflation yet)..that’s all very well.
But we have inflation, it’s just happening elsewhere.
So the question is where this money ends up.
It went into property, it went into the stock market, it depressed yields on the Government bonds.
All are these are inflationary effects but the driver is the money supply.
So the Reserve Bank was right to end its bond buying programme and tighten the money supply?
This hasn’t come a day too early. I would have done that earlier before getting into this 30 per cent house price inflation territory that we’ve had the past few months.
Plus, you don’t want to make it too cheap for the MPs to borrow because you want the incentive to keep the Government finances broadly on track. You don’t want to end up like Italy or Greece where, because borrowing was so cheap for a decade, they can never get out of that.
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