NZ’s barking mad reaction to inflation

By targeting interest rates with its official cash rate hikes, the Reserve Bank is trying to fight price increases by putting up a major price, writes Tim Hazledine.

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OPINION: The famous economist Joseph Stiglitz once had a dog, Woofie. Whenever a plane flew over their house, Woofie would dash around the back yard, barking at it. Then he would return to his kennel, wagging his tail; pleased with himself for scaring off the plane.

Stiglitz likens the anti-inflation hawks in central banks around the world to his old dog Woofie. The sudden burst of higher prices that was generated by Covid supply-side shocks is naturally sorting itself out. Annual consumer price index increases are most recently down to 3.7 percent in the US; 2.9 percent in the Eurozone.

Partly as a result, inflation is coming down in Aotearoa New Zealand as well – a bit more slowly, but then everything happens a bit slower in New Zealand.

But despite this, Woofie-like panic has set in at the Federal Reserve in America, and at our own Reserve Bank. Their anti-inflation weapon is partly bark, and partly real, painful, bite. There is the “tough talk” about the central bank being very serious about doing what it takes to squeeze inflation out of the system.

And then comes the actual bite which is, of course, massive increases in interest rates to pull back consumer and business spending: the squeeze in action, to be manifested most painfully in increases in unemployment.

Perhaps the failure confessed to in the Reserve Bank of New Zealand’s latest monetary policy statement is something of a blessing in disguise. 

Stiglitz and his followers, in what he calls “Team Transitory”, argue that the pain is unnecessary and perhaps in itself useless or worse; that the one-off or transitory Covid price shock is already dissipating and would do so without the administration of unpleasant monetarist medicine.

To be clear: there can be situations where inflation is demand driven – “too much money chasing too few goods” – and then action to curb spending is justified, though here fiscal policy – changes to taxes and government outlays – may be more direct and more appropriate than monetary policy action.

But if the problem comes from the supply side of the market system – first the very real logistical snarl-ups in the era of Covid shut-downs, and then the amplification of these by crafty multinational corporations seizing the moment to push up their prices and profit margins – well, that is when central banks don’t have a clue what to do, but act regardless.

Why possibly worse than useless? Two reasons. First, the interest rate is itself a price – the price of money – and as such may be the most important price for many households or businesses owing money on mortgages or other loans. That is, we are trying to fight price increases by first putting up a major price – one step backwards before hopefully advancing forwards on the inflation front.

Tim Hazledine, emeritus professor of economics at the University of Auckland Business School.
Tim Hazledine is emeritus professor of economics at the University of Auckland Business School.

Second, the whole monetarist value system should be scrutinised. Moderate price inflation is at worst a bit of a nuisance, with everyone having to divert time and energy to adjusting their own wages and prices to keep up with everyone else.

Unemployment, however, is a major tragedy for those who are thrown out of work, and for the businesses that fail when demand is deliberately screwed down. Here, Stiglitz switches metaphors. He repeats the psychologist Abraham Maslow’s old saw: “To a man with a hammer, everything looks like a nail.” And then: “Just because the Fed has a hammer [and no other tool], it shouldn’t go around smashing the economy.”

So perhaps the failure confessed to in the Reserve Bank of New Zealand’s latest monetary policy statement is something of a blessing in disguise. The Governor, Adrian Orr, admits that his high-interest rate policy has actually not succeeded in its instrumental goal of increasing unemployment and business failures. Good! But then, his response is: keep on applying the failing policy, instead of having a fundamental rethink.

What could be offered here? In this troubled world, it may be prudent to be prepared for more international supply shocks that are beyond our control. We need to be realistic in facing up to the necessary adjustment to our standard of living – perhaps this is a job for Treasury.

And then we could bring in a beefed-up Commerce Commission to make sure the pain is not unnecessarily prolonged – as has been the post-Covid recovery – by opportunists taking advantage of confused times.

Tim Hazledine is Emeritus Professor of Economics at the Business School.

This opinion piece was first published by Stuff. The opinions are those of the author and not necessarily of the University of Auckland.

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