Keith Rankin: The Big S-Word
Don Brash said it for the first time since 1982. Stagflation. Sounds like a rush of male deer. But it's a case of mixed metaphors. Dr Brash has scared the horses.
So are we moving into a period of both recession and inflation?
The latest real GDP (gross domestic product = value-added production) figures were released last week. They indicated, provisionally, that seasonally-adjusted GDP was down in the June 2000 quarter. More importantly, the actual non-adjusted GDP statistic was 4.4% up on the June 1999 quarter. Hardly stagnation.
The truth is that we have post America's Cup depression. It's a traumatic stress disorder akin to the depression Olympic gold-medallists often go through in the year after their events. The artificial highs of GDP from July 1999 to March 2000 give the illusion of stagnation today. It's a depression of the mind.
We may be heading, anyway, for a minor downturn in 2001, as part of the normal business cycle. We run a very real danger of linking a regular cyclical slowdown with our current national psychosis, thereby creating the economic crisis we seek to avoid. Even more so if Dr Brash acts out his threats to pour fuel on the fires that drive our pessimism.
As yet, we have nor actual stagnation; only perceived stagnation. What about inflation? Yes we can expect some, on account of the lower value of the New Zealand dollar. But we shouldn't exaggerate this. Many countries have had manageable inflation despite falling currency values. The dangers are that of the self-fulfilling prophecy. The more we act on our belief that the falling dollar is a problem, the more the dollar will fall, and the more inflation we will get.
Normally, stagflation is depicted as "too many dollars chasing TOO FEW GOODS", whereas normal (demand) inflation is depicted as "TOO MANY DOLLARS chasing too few goods". That is, stagflation is a cost inflation, or a supply-side inflation.
New Zealand has never had a demand inflation since 1973. Despite this, we passed the Reserve Bank Act in 1989 on the assumption that all inflations are demand inflations. What is now scaring the horses is that Dr Brash is suggesting we may have cost-inflation while at the same time is threatening to treat it as if it was demand inflation. That's a bit like prescribing whisky as a treatment for alcoholism.
Genuine cost-inflations occur when resource costs increase, thereby raising the real costs of production in most industries. Cost-inflations may occur if ubiquitous raw materials (eg oil) become more expensive. But we shouldn't overemphasise this, because we can always choose to use oil less; use more of other forms of energy, or use less energy.
Cost-inflations may occur if labour claims an increased share of the national income; that's the classical textbook example. But they also occur when interest rates increase. After all, interest rates are simply the "wages of capital" as distinct from the "wages of labour". High interest rates significantly reduce firms' willingness to supply goods and services. Hence our dollars chase fewer goods than they would chase if interest rates were at more appropriate levels. That's why Dr Brash's threat to raise interest rates is singularly inappropriate.
In the bad old days before the Great Depression of the 1930s, a slowdown in the economy would lead to a lower tax take. As a consequences, politicians would "retrench", meaning to cut government spending so as to keep the budget in balance, even in a depression. All this did was to aggravate the pessimism; aggravate the depression.
In the 1930s, J.M Keynes said we should to the exact opposite. Governments should spend more, not less. They should offset rather than aggravate a depression, by running a budget deficit that, as the depression ended, would prove to be self-eliminating.
Keynes claimed that depressions and recessions were crises of confidence; especially business confidence but also consumer confidence. So he suggested that government should step in quickly, before a recession took hold. The government would spend more in order to prevent a crisis of confidence from becoming a recession.
We cannot follow Keynes' prescription in New Zealand. Ruth Richardson's 1994 Fiscal Responsibility Act prevents this. And as Deutsche Bank chief economist Ulf Schoefisch notes in yesterday's Business Herald, Michael Cullen's pension scheme, which must be funded by budget surpluses, also inhibits government-led expansion.
So we look to monetary policy - to Dr Brash - to bring confidence to an economy that stands on the precipice of stagnation. Unfortunately, like the retrenchers of old, Brash only offers to push us over the precipice.
To make matters worse, the inflation we face is not a true cost-inflation. It is an inflation driven by perceptions of New Zealand and not by rising resource costs. If Dr Brash's brinkmanship acts to further erode confidence in New Zealand then he will precipitate the unmentionable combination of inflation and stagnation that is his worst nightmare.