Video | Agriculture | Confidence | Economy | Energy | Employment | Finance | Media | Property | RBNZ | Science | SOEs | Tax | Technology | Telecoms | Tourism | Transport | Search


Inflation Debate Going Off the Rails

19 December 2005

Inflation Debate Going Off the Rails

The public debate about inflation seems at serious risk of going off the rails. Confusion abounds at several levels.

First, the Reserve Bank’s action to raise interest rates is widely interpreted as reflecting a desire to slow the economy after a period of solid growth.

But isn’t the government’s stated aim to raise the rate of economic growth in order to lift per capita incomes into the top half of the OECD rankings?

Clearly the Bank isn’t wanting to sabotage the government’s “top priority” objective. It has correctly argued many times that low inflation and growth are not inconsistent – indeed that the best contribution monetary policy can make to economic growth is to keep prices stable. So shouldn’t it and the government be focusing on what is needed in other policy areas to encourage sustained non-inflationary growth? Next, the Reserve Bank argued when increasing interest rates last week that “overall demand continues to outstrip available capacity”.

But how can New Zealand demand outstrip the world’s capacity to supply? And even if New Zealand demand were limited to New Zealand goods and services, the proposition is tenuous. As David Ranson, a former assistant to the secretary of the US Treasury, has written, “Skeptics rightly question how demand could constantly outstrip supply. Surely, demand must originate from purchasing power, purchasing power from wealth, wealth from income, and income from the ability to produce (and hence supply) goods and services.”

‘Demand pull’ and ‘cost push’ explanations of inflation have fallen by the wayside in economics. The Philips Curve was discredited by the stagflation of the 1970s. There is no consistent relationship between inflation and unemployment, capacity utilisation and GDP growth.

Inflation is not caused by electricity price rises, the actions of ‘monopoly’ businesses, union wage claims or dearer oil. One price or several prices rising is not inflation. Inflation is a sustained and ongoing increase in the general level of prices.

The Reserve Bank should not be brow-beating consumers, home owners and banks about irrational behaviour. Even if it existed it could not cause inflation; commercial banks are likely to know more about managing their risks than the Reserve Bank; and the Bank’s own reports indicate that the New Zealand financial system is in good shape.

Milton Friedman long ago won the debate with the demand-pull, cost-push Keynesians. As he famously said, “Inflation is always and everywhere a monetary phenomenon, in the sense that it cannot occur without a more rapid increase in the quantity of money than in output.” In other words, the inflation buck stops with the Reserve Bank, full stop.

Recently, US economist Walter Williams nicely illustrated the point with a simple parable.

“Pretend several of us gather to play a standard Monopoly game that contains $15,140 worth of money. The player who owns Boardwalk or any other property is free to sell it for any price he wishes. Given the money supply in the game, a general price level will emerge for all trades. If some property prices rise, others will fall, thereby maintaining that level. Suppose unbeknownst to other players, I counterfeit $5,000 and introduce it into the game. Initially, that gives me tremendous purchasing power, whereby I can bid up property prices. After my $5,000 has circulated through the game, there will be a general rise in the prices – something that would have been impossible before I slipped money into the game. My example is a highly simplistic example of a real economy, but it permits us to make some basic assessments of inflation.” Only the Reserve Bank can print money. It alone should be held accountable for inflation and inflationary expectations.

Does this mean that monetary policy can operate satisfactorily regardless of other policies the government is following? No. Monetary policy needs mates.

An anti-inflationary monetary policy running up against large increases in government spending, high local government rate increases, costincreasing employment law changes, excessive business regulations and the like can produce severe strains and imbalances (particularly for exporters and those competing with imports), as we are seeing at the present time.

What it does mean, however, is that the Reserve Bank should not be confusing public debate with defunct economics and misplaced accusations.

In respect of the housing market, for example, it should be highlighting the cost increases arising out of misguided ‘smart growth’ urban planning policies and excessive and poorly administered building regulations. Talk of direct interventions in the home lending and foreign exchange markets is worrying. It could take us back to the days of Muldoonist financial controls when governments wanted both lower interest rates and slower growth in lending. Trying to control price and quantity independently is sheer folly.

The problem with bad ideas and bad analysis is that they can give rise to bad policies.

Roger Kerr is the executive director of the New Zealand Business Roundtable

© Scoop Media

Business Headlines | Sci-Tech Headlines


BusinessDesk: Body massages and Uber are in, DVDs are out, says Stats NZ

Statistics New Zealand has rejigged the consumers price index basket in its latest three-year review, adding body massages, Airbnb and Uber and removing DVD and Blu-Ray players…More>>


StuffMe: Commerce Commission Welcomes Dismissal Of Merger Appeal

In a summary of their judgment released today, Justice Dobson and lay member Professor Martin Richardson dismissed the appellants’ process criticisms and found the Commission was entitled to place significant weight on the prospect of reduced quality of the products produced by the merged entity. More>>


Digital Futures: New Chief Technology Officer Role Created

Communications Minister Clare Curran has called for expressions of interest for the new role of Chief Technology Officer position to help drive a forward-looking digital agenda for New Zealand. More>>

Real Estate: NZ house sales slump in December but prices still firm

The number of property sales across New Zealand slumped 10 percent in December from a year earlier but prices continued to lift, according to the Real Estate Institute. More >>


Dry: Beef + Lamb Launches Drought Resources

The resources include a fact sheet outlining strategies to manage and mitigate the effects of drought, coping with stress on the farm and advice on feed requirements and animal welfare during the dry period. More>>


InternetNZ: Net Neutrality Failure In US "Will Hurt All Users"

InternetNZ Chief Executive Jordan Carter has condemned the decision by the United States communications regulator to undo 2015 open Internet rules, warning that all Internet users will end up worse off as a result. More>>