1/200 Economic Analysis - Beneath the Inflation Spike

In July, Statistics NZ reported that inflation had risen to an annual rate of 3.3%. Commentators all chimed in, as expected, with their feverish demands and predictions of what the government and Reserve Bank could do about it.

The Herald (paywalled) pointed to an “overheated” economy, quoting ANZ Chief Economist Sharon Zollner stating we’ve “flown past full employment” and demanding the RBNZ to “hike the OCR promptly”. RNZ had BNZ’s Head of Research Stephen Toplis calling the economy “stretched to bursting” and that we’re “at or through maximum sustainable employment”, along with fund managers imploring the RBNZ to not “sit on the sidelines”.

In response, Adrian Orr and his Monetary Policy Committee of the RBNZ were slated to lift the Official Cash Rate (OCR) on 18th August. However, an outbreak of COVID-19 in the community, and the resulting level 4 lockdown, got in the way and the OCR was held at 0.25% even though the Bank’s view is that interest rates need to rise and the economy is at “maximum sustainable employment”

So why all this concern about inflation?

If there’s one economic metric that gets the establishment in a spin more than levels of government debt, it’s inflation. Ever since the Reserve Bank Act of 1989 enshrined monetary policy independence as a key pillar of the neoliberal reforms, controlling inflation has been a key goal of the technocrats, with politicians loath to question the now iron-clad convention. Why is it so important to them? Often there are only vague references to the cost of living or fear-mongering about hyperinflation taking hold, but occasionally the reason is more plainly revealed by commentators.  The Herald, for example, were rather overt:

“While the fall in the unemployment rate is good news for workers, economists cautioned that it was now at a level which was arguably unsustainable, as businesses would be unable to grow given pressure to pay higher wages.”

Orthodox economics contends that there is a trade-off between employment and inflation. Basically, if there are too few people seeking jobs (supply of labour) from firms looking to fill them (demand for labour) this puts upward pressure on wages, and in response firms raise the prices of their products. This idea is so-called ‘wage-push inflation’, a rationale also used by corporate CEOs to oppose minimum wage increases. It’s always curious that it’s the wages of those at the bottom which are blamed for increasing prices, and not, say, massive CEO salaries, grotesque profits or shareholder dividends.

This brings us back to the concept of “maximum sustainable employment”, which all those commentators and the Reserve Bank said we’re supposedly at or past. This was added to the RBNZ’s remit by the Labour-NZ First coalition government in 2018, and although it is now one of the Bank’s two primary objectives along with keeping inflation within the 1-3% band, there is no specific target. In practice, the “maximum sustainable” level of employment seems to be whichever maximum level keeps wages low. The CTU agreed with this analysis in their Economic Bulletin last year, and when Green Party MP Chlöe Swarbrick questioned RBNZ representatives on exactly what “maximum sustainable employment” was, they couldn’t provide a convincing answer.

So keeping wage costs down is a large part of it—ensuring working people are competing with each other for jobs, rather than their bosses for better pay and conditions. Higher inflation and low interest rates also eat away at both debt and savings, meaning the balances people hold now reduce in value more quickly. Guess who this hurts more? Wealthy people with low debt and high savings.

But high inflation is associated with a growing economy. Isn’t this also what corporations and the government want?

Yes, and this is where we get into what inflation actually is, and who it impacts. When discussing inflation, we need to get away from the abstract nature of the overall inflation rate, and the dominance of ideas like “the economy being overheated”. As noted by Stats NZ, the biggest driver of the recent uptick in the June quarter was construction costs, owing to supply chain disruptions from COVID-19 and higher building demand with consents rising. Also having a big impact was rents (up 2.9% in the year to June 2021), petrol (16%), and vegetables (6.2%). When we zoom out, we can see that it’s the prices of these necessities that paint a clearer picture.

The Household living-costs price index (HLPI) is similar to the Consumer Price Index (CPI) which is the official measure of inflation, but it tells us more about the distribution effects. You can read more detail about the differences between the two measures in this piece from Newsroom, but I will skip over that here. 

What data from the HLPI reveals is that, over time, the goods that have driven up the cost of living are predominantly necessities: rent, household energy, food and transport. Prices for goods that tend to be discretionary or luxuries, such as recreation, clothing, and household appliances, haven’t really grown. Interest rates have fallen dramatically over the same period, meaning that inequality in housing costs between owner-occupiers and renters continues to surge.

As Ollie Neas’ brilliant piece for North & South magazine explains, it’s no coincidence that prices are high for these necessities and the markets for them are controlled by relatively few large companies. Economists would call these goods “relatively inelastic”, that is, the quantity of them we consume isn’t very responsive to changes in price. We need a place to live, food to eat, and power to keep the lights on regardless of the price.

This leads to a situation where the impacts of inflation are felt inequitably, with those in the bottom 20% seeing an increase in the cost of living almost double the rate of those in the top 20%. 

To make matters worse, there is a large discrepancy in home ownership for these groups. In 2020, 82% of those in the top 20% own their home, compared with 52% for the bottom 20%. This gap continues to grow.

When considering whether a booming economy (and the resulting inflation) are good or bad, we must ask the question: who is it booming for? If those at the bottom are faced with higher and higher costs of living, while those at the top keep their costs low and limit employment to restrain wages, we must ask serious questions about the entire structure.

3.3% annual inflation may send the establishment into a frenzy, and once lockdown restrictions ease, the RBNZ will doubtless tweak the settings to keep the status quo ticking. Ultimately, when we look beneath the surface of the abstract economic concepts, it means wealth continues to transfer to those at the top.