Inflation: A Decrease In The Value Of Money?
Keith Rankin's Thursday Column
This month the latest inflation rate was announced two days before the scheduled announcement by the Reserve Bank to increase the OCR (official cash [interest] rate) to 6%. The CPI inflation rise, 0.7% for the period from mid-November to mid-February, is up on the 0.2% for the previous quarter.
Any embarrassment to the Bank this time arises not from poor inflation estimates but from a diminished ability of New Zealanders to buy into our own companies. The usual rule is that fragile equity markets require an accommodating monetary policy; a policy of easy short term credit; of low interest rates.
Two items stand out in the latest CPI increase: oil prices and tertiary study fees. Do the increases in the costs of these two items indicate that the purchasing power of money is falling?
The 1989 Reserve Bank Act is monetarist dogma. Monetarists understand all inflations as being decreases in the purchasing power of money. They say inflation is "always and everywhere a monetary phenomenon". The job of managing the price level was given to the monetary authority - the Reserve Bank - on the basis of that dogma. The Bank, the last refuge of 1980s' monetarism, regards rising tertiary education fees not offset by falling prices of other products as being a symptom of an abundance of money.
In reality, our latest inflation is caused by less crude oil being supplied to the world petroleum market, and by tertiary education becoming more costly. Neither cost has anything to do with the domestic value of money. Formerly underpriced oil - ie underpriced using environmental accounting - is now closer to its correct price. The correction in the oil market is a global solution that Dr Brash is treating as a domestic monetary problem.
Likewise, our increasingly overpriced public education system is a problem that cannot be solved by raising the cost of private sector credit.
Monetary stability exists when domestic purchasing power grows at the same rate as the supply of goods and services. A monetary remedy for inflation or deflation is only appropriate if that 'flation' is caused by monetary instability. Monetary inflations exist when goods and services experience uniform price increases that cannot be explained in any non-monetary way.
Part of the problem today is that economic policymakers - especially in macro policy which is about maintaining price stability, full employment, economic growth and a balance between foreign exchange payments and receipts - are forever fighting yesterday's wars. Thus we fought the 1930s' depression in the 1950s. In the 1980s, we fought the inflation arising from the monetary expansion linked to the Vietnam War. We are now fighting the inflation arising from the costs incurred in the 1980s when we fought the inflation of the late 1960s and early 1970s.
We now have a global economy in which productivity gains fully offset the increased demand that has accompanied global monetary growth. Those productivity gains only happened in the 1990s in countries where central banks refrained from raising interest rates. Productivity growth was much greater in Australia and the USA than in New Zealand.
Much of the inflation in New Zealand in the last 10 years has originated from government charges and from rising costs within government. This is a result of increased inefficiency in public administration; in particular the increased payments of public money to managers and consultants, and the costs of the perpetual restructurings. Another source of inflation over the last decade is the increased consumption of financial and business services by New Zealand firms, combined with the increased costs of those services. This is cost inflation and it has been specific to the government and finance sectors.
Is tertiary education now being supplied less efficiently than before? The answer is probably 'yes', but that's not the whole story. Massey University's Vice-Chancellor Dr James McWha noted on radio on Tuesday that costs were rising in tertiary education, and hence course fees had to go up (once again).
Tertiary education has been following a competitive model in the last decade. That was meant to reduce the rate of cost increases. While it meant less direct public funding per student, that is not the same thing as increased efficiency.
Universities, like manufacturing businesses, were expected to absorb internal costs and to tender more competitively when purchasing goods and services from other sectors. Universities and manufacturers both buy their inputs from the marketplace. So why should universities' costs be rising while manufacturers' costs are not? Total costs per student increased. Part of that was advertising costs, as each publicly owned tertiary education provider sought to increase its market share at the expense of the other publicly owned tertiary education providers.
What we are finding is that universities - like banks and like Telecom - are incurring increased costs in the understanding that they can pass on those costs through cost-plus pricing. The problem is a core failure in the micro reforms of the late 1980s and the 1990s.
Universities cannot be managed like baked beans' factories. The problem of rising costs in public and former public sectors is caused by inappropriate reforms, not by relaxed monetary conditions. The remedy therefore is not to impose firm monetary conditions, which impact disproportionately on manufacturing and farming which are already lean to the bone. It is not the role of monetary policy to deflate the national economy as a means of brushing under the carpet the inability of the 'reforms' to deliver efficiency or productivity gains.
Inflation in New Zealand has been low since 1990 because, despite government and finance sector costs having risen, other costs have fallen. Real wages have fallen. Now that unemployment is edging to below 6%, thanks to increases in global demand, real wages can no longer be relied upon to fall. There will be more cost-pressures on prices in the 2000s than there were in the 1990s. Inappropriate actions by the Reserve Bank, still fighting the inflations of the 1970s, will only add to the real costs of production in New Zealand. Workers and beneficiaries will not continue to bear those costs; they will not continue to collaborate in the disguising of the rising costs of doing business in New Zealand. Rising costs in New Zealand will be reflected in rising prices. The strategy of disguising domestic cost inflation by pushing up the exchange rate to engineer falls in import prices is no longer tenable.
The Reserve Bank should accept that modern cost-inflation lies outside its domain of policy competence. And they should be ultra-careful about precipitating another recession. The already-high risk of recession in 2001 and 2002 has been markedly accentuated by both the weakness of our sharemarket and by the Bank's simplistic policy stance. The small amount of inflationary pressure that we face today is not due to a decrease in the value of money.
© 2000 Keith Rankin
Thursday Column Archive (2000): http://pl.net/~keithr/thursday2000.html