On The Dubious Wisdom Of Raising Interest Rates

During the last half of the 1990s, the first flickering signs of economic growth would cause then-Reserve Bank governor Don Brash to hike up interest rates and stamp them out. The fear back then was that if left unchecked, the embers of economic activity might cause the same inflationary fires to come roaring back to life that the West had experienced in the late 1970s. At the time, Brash would justify raising interest rates on the grounds that as RB governor, he always needed to be looking 18 months ahead, and judging where things might go by then, if he didn’t act now.

All so different these days. In its monetary statements, the Reserve Bank keeps on saying that in two year’s time the current price noises around inflation will have subsided, and inflation will have fallen back into the middle of the target range. To quote from the RB’s most recent monetary statement: “Headline CPI inflation is expected to measure above 5 percent in the near term before returning towards the 2 percent midpoint over the next two years.”

Interesting, right? In taking the exact opposite approach to Brash, RB governor Adrian Orr is saying that he has to act on the basis of how things are currently, and not on the basis of the conditions that he expects to prevail in 18-24 months. The risk remains the same though as it was with Brash: By raising interest rates now, is the central bank doing as much harm as good? After all… How exactly, will raising the cost of borrowing assist firms to innovate and invest in the technology required to boost productivity? Answer: It won’t.

So… What has the RB been citing as the main causes of the current spike in inflation? In no particular order, they include: supply chain bottlenecks; rising oil prices; rising transport costs; booming prices for our farm exports; high house prices; labour shortages etc. Ask yourself: how many of the items on that list would be significantly affected – or affected at all - by raising interest rates in small steps over the next few months? Not many, if any. This is not simply a reflection of the inadequacy of the basket of items deemed worthy of measure by the Consumer Price Index. Instead, what we seem to have right now are several inflation drivers that are strictly pandemic-related, and not subject to the normal CPI cycles and interest rate responses.

Timing is everything

Also, the gradual RB rate hikes are kicking in just as many of the government supports and stimulus measures that have been underpinning the Covid economy are being withdrawn. That seems quite risky. Shouldn’t we have waited a while longer, and observed what impact this dialling back of government/RB assistance will have on economic activity? Especially since we don’t know whether the removal of almost all the Covid lockdown restrictions will see a surge in Covid infections, which would make consumers a lot less keen to shop and dine out. Not to mention the impact of Omicron. And those are merely the known unknowns.

In sum, there’s an argument that says our economic recovery could well be far more fragile than (a) the initial Covid recovery this time last year, and (b) what was indicated by the last quarter’s numbers. Yet the RB is raising the official cash rate, mortgage rates are already on the rise and more rate hikes are promised. This prospect can only further reduce the amounts of disposable income that households will have available to spend in the shops and cafes that have been pining for customers with open wallets. True, the rate hikes and tougher lending measures do seem to be taking the edge off house prices, but is that worth the risk of helping to send the wider economy into a tailspin?

The late 70s inflation bogey

With or without interest rate hikes, no sane person was expecting to see the return of the double digit inflation we saw in the late 1970s and early 1980s. In that bygone age, employers had expected inflation to continue unchecked forever, and so they gaily passed on price rises and wage increases, thereby creating the dreaded wage/price spiral. Yet in front of a Parliamentary select committee this week… Outgoing deputy RB governor Geoff Bascand claimed that there are no fears at the RB that a wage/price spiral is on the cards this time around.

Yes, that seems a pretty safe bet. After all, the ANZ economist Finn Robinson recently pointed to findings that wages are not rising at the same pace as prices. So…. To all intents we are raising interest rates to head off a mythical wage/price spiral in a climate where the value of real wages has actually been falling, relative to prices. To repeat: Many of those price hikes are pandemic related, and not subject to the normal business cycle. So…. I all looks rather like kabuki economics: the make believe stuff you do because you hope to make people believe you’re onto it. Otherwise they might panic (or revolt) and business confidence might falter. And we know that business confidence is such a fragile flower.

Yet for argument’s sake… What is the purpose of steadily raising interest rates right now? At best, it looks like a shot across the bow of mistaken inflationary attitudes that might otherwise bed in and prolong the spike of inflation a bit longer than would be desirable. In other words… Many of us are going to be paying significantly more on our mortgages lest some corporate chieftains think the late 1970s are coming back again, and that another wage/price spiral is imminent – even though the wages part of that spiral staircase happens to be almost entirely missing.

Oh, and there’s the other thing. Interest rate hikes are part of the meagre toolkit that the RB has at its disposal to try and temper the nation’s house price increases. Again though, because it is attitudes – not realities – that are the main problem here, maybe more of the government and RB rhetoric should have gone into actively painting the inflation tiger as being largely illusory, and/or only temporary. Stay the course etc. Until around August of this year, the RB did try to hold the logical line that its fellow central bankers in the US and Europe were promoting, that Covid-inspired inflation will only be temporary. Since then however, the RBNZ’s faith in Team Temporary has apparently collapsed.

This has happened, one imagines, largely for political reasons – the RB and the government have got to be seen to be doing something about rising prices - than for strictly economic ones. Sure, price stability is part of the RB’s mandate, but where’s the logical connection between the ailment and this form of treatment? The cure is just as likely to damage a recovery that’s already in some peril.

Could Team Temporary have held the line? Maybe. This would have required stimulus and wage supports to be more carefully tapered off, until such time as the price blip had begun to subside. Extra relief could also have been given via immigration policy, to allow in more of the skilled workers currently in short supply. This would have taken some steam out of the relatively few areas where labour shortages are creating wage pressures. None of this would have resulted in a wage/price spiral.

To repeat: Prices will continue to rise in the short term, because many of the factors driving them upwards have little to do with the ready access to borrowed money. But the rate hikes will hurt ordinary punters with a mortgage, and the retail/hospo outlets that depend on then.

Footnote: Here’s a recent column by Paul Krugman explaining why he is still on Team Temporary when it comes to inflation. And here’s an even more recent column by Krugman on the same subject, and with a few more lessons from history. The issue comes down to whether you do more damage by going too early with rate hikes, than you do by going too late. Krugman believes it is easier to undo any harm that’s done by going too late.

Congrats, Germany

The home of MMP has voted in a successor to Angela Merkel, and a ruling coalition has been put together with surprising speed The new Chancellor will be 63 year old Olaf Scholz, a former vice-chancellor and Finance Minister in the fourth Merkel government. In the 1990s, Scholz was a vice-president in the International Union of Socialist Youth, the same organisation that Jacinda Ardern headed as president in 2008.

The centre-left Social Democrats and Greens have reached an agreement with the pro-business Free Democrats to pursue this list of common goals:

• Increase rail freight transport by 25% and have at least 15 million electric cars on the roads by 2030
• The phasing out of coal by 2030 and a commitment to 80% renewable energy
• Push for a European air travel surcharge like the one already in place in Germany
• Enable immigrants to apply for citizenship after five years and allowed dual citizenship, a potential big change for thousands of ethnic Turks, many of whom remain foreign nationals after decades in Germany
• Increase the minimum wage to €12
• Legalize the regulated sale of cannabis
• Build 400,000 new apartments a year to fight a housing crisis,
• Lower the voting age to 16

The new Cabinet will be gender equal. The Greens co-leader Annalena Baerbock will be Germany’s first ever female Foreign Minister. As the price of his participation, Free Democrats leader Christian Lindner has won a sizeable number of concessions from the centre-left:

At the Free Democrats’ insistence, the prospective partners have said they won’t raise taxes or loosen curbs on running up debt. Lindner is set to become Germany's new finance minister, and the party also will get the transport, justice and education ministries.

Team Bartees

Bartees Strange is a singular talent. A black indie rock musician from Mustang, Oklahoma, his output to date has followed no discernible pattern. He’s as likely to do an experimental noise single like “Mustang” as he is to do cover versions of his favourite cuts by the National. This new track “Weights” comes from the deluxe edition of his recent live album.

And here from the Pitchfork concert stage earlier this year, is a terrific live version of “ Boomer”

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