Tuesday 17 March 2015

Inflation Is Defeated - But At Whose Expense?

Inflation Buster: As Governor of the Reserve Bank of New Zealand from 1988 until 2002, Dr Don Brash oversaw the anti-inflation programme of the new neoliberal order he had played such a vital role in unleashing upon New Zealand. The financial sector and the ticket-clipping classes were delighted by his success, workers and borrowers paid with stagnating real wages and diminished expectations. And now, an even more frightening spectre looms: Deflation.
THE PROSPECT of zero inflation is difficult for many New Zealanders to grasp. Those of us over fifty will recall the years when the annual inflation rate was this country’s most contentious political issue. Hardly surprising, when rates of up to 18 percent were recorded. A nation experiencing that sort of monetary pressure has reason to be concerned.
But, persistent high inflation affects different groups in different ways. Like most human creations, it produces both winners and losers.
In a country where most wage-workers belonged to a trade union, and there were powerful political incentives for the annual round of wage negotiations to produce results roughly reflective of increases in the cost of living, inflation was more of an irritant than a danger. If a worker’s union was strong, he and his family could keep ahead of inflation. The members of the weaker unions, however, were forever playing catch-up.
If those workers were the recipient of a 3 percent (!) State Advances loan, however, inflation was their friend. Every year that high inflation persisted, young couples could pay off the mortgage on their first home with dollars that were, in real terms, worth less than when the debt was originally incurred. Persistent levels of high inflation were a huge boon to borrowers.
Between 1965 and 1985, governments of both the left and the right were content to see inflation lift tens-of-thousands of young baby-boomers onto the lower rungs of the property ladder. Indeed, it is possible to argue that the creation and maintenance of National’s “property-owning democracy” would have been all-but-impossible without a persistently high rate of inflation.
Persistent high inflation was also of crucial assistance to running an effective welfare state. Thanks to the phenomenon known as “fiscal drag”, inflation-driven increases in wages and salaries were constantly lifting workers into higher tax-brackets, allowing the government’s own revenue needs to be met without recourse to more regular, explicit, and, therefore, politically unpopular, tax adjustments.
Persistent high inflation’s biggest losers, obviously, were those whose loans were being repaid at a fixed rate of interest in devalued dollars, along with people attempting to live on incomes that could not easily be adjusted for the effects of inflation. Returns on investment; the real value of private pensions, annuities and legacies; all tended to fall in circumstances of persistent high inflation.
It is never a good idea for politicians to antagonise those who control their nation’s financial system. Equally unwise is a government that even looks like it is prepared to beggar the social class most dependent on legacies, annuities, private pensions and the income generated from investments. That persistent high inflation, with its beneficial impacts on workers, borrowers and social-democratic politicians, would, by the end of the 1970s, convince bankers, rentiers, and other sundry members of the ticket-clipping classes that some pretty major reforms were long overdue, was entirely predictable.
That a constant theme, running through all of the dramatic economic changes of the next 30 years, would be “driving inflation out of the economy”, was equally foreseeable. Nor should we be surprised that these reforms neatly reversed the position of winners and losers. That the banks and the ticket-clipping classes would benefit disproportionately from their anti-inflationary crusade was really the whole point of the exercise.
And who, now, can say that inflation isn’t beaten? With the inflation rate hovering tantalisingly above zero - nobody. The costs, however, have been substantial.
The radical reduction of trade union power by the Employment Contracts Act shattered the mechanisms that had allowed workers and their families to keep pace with inflation. Despite improvements in workforce productivity, the purchasing power of New Zealand workers’ wages has stagnated or declined.
Politicians, too, lost their ability to turn monetary policy to the advantage of workers and borrowers. The moment controlling inflation became the Reserve Bank’s first (and some would say only) priority, the old social-democratic goals of full-employment, home ownership for all, and a generous welfare state funded through progressive taxation, became inoperative.
There’s a paradox here. As New Zealand’s inflation rate declines towards zero, the Reserve Bank must confront the possibility of deflation. But, persistently declining prices are a reflection of declining demand, which is, in its turn, a reflection of oversupply and a market that cannot clear itself except by selling below cost. Deflation is, therefore, the sign of an economy that’s slowing down. It is the harbinger of busts, slumps, recessions and (God forbid!) another Great Depression.
Some economists argue that inflation allowed the Free World to pay-off World War II in record time. Others affirm that it underpinned the great post-war boom. Is it pure coincidence then, that at the peak of the boom, inflation was suddenly branded Public Enemy No. 1?
If zero inflation is a triumph, then perhaps we should ask: “For whom?”
This essay was originally published in The Press of Tuesday, 17 March 2015.


Anonymous said...

Deflation can be brought about by improvements in productivity, but who would be willing to say that such improvements are not a good thing.

Anonymous said...

NZ has only had one period of high inflastion, during the 1970's, we were not alone in this. It was combined with rising unemployment and falling productivity and growth and is hardly a panacea for anyone except heavily mortgaged property owners with fixed term morgtages of 5 or more years (My father essentially got gifted 7 houses this way in the now highly desireable center of Wellington city). prior to that our inflation rate was round 2-4 % per anum much as it is now (exceptions were the korean wool boom when the economy grew at super human rates).

Deflation can be good or bad, if an economy is in a state of general glut with slack demand there will be falling prices and rising unemployment - a vicious cycle. In our case at the moment we have falling oil prices and comodity prices and a strenghtening currency all of which are driving down prices, this combined with a powerfully growing domestic economy are createing something of a panacea (I know reality hurts Chris but some times youve just got to eat it) with falling prices and a boyant labour market - long may it last.

Anonymous said...

Chris, there are larger forces at work here than just the NZ Reserve Bank. Organised labour lost its influence for two reasons, both of which are global in nature and unstoppable:

Firstly automation vastly improved industrial efficiency and reduced the need for manual labour. This process continues unabated and will impact generations to come.

Secondly when China opened up its economy it added 50% to the global workforce, undermining labour rates across the western world.

So if you're hoping for a change in local politics to halt the demise of union power, you're deluding yourself. Even if we voted in a true Left Wing government tomorrow, any attempt by it to return to the golden days of union power would snap the economy like a twig. In short order we would become the Albania of the South Pacific.

Davo Stevens said...

@Anon 7.47, Automation was supposed to make our lives easier and as you said it displaces workers. In the past those workers would be moved to the new jobs created by the development.

But in the last 40 yrs that hasn't happened, the jobs have not eventuated and the un-employed are relegated to the Dole queue and the endless struggle to survive or they get only low paid service jobs in cafe's etc.

Changing the Govt. could make a difference if the incoming party wants change it. To date no party is prepared to do so. By empowering unions again means the the profits that are currently going to one or two people and often overseas, are shared out in the economy.

In a consumer economy it is the people with some discretionary income that create new jobs not tax cuts for the wealthy. Can some-one point me to where there are any long-term jobs that were created by John Key's tax cuts?

Anonymous said...

Automation may displace manual labour but it does not follow over the economy as a whole, over time that this leads to higher unemployment (as opposed to making manual labourers unemployed in say, one business at one instant in time, when a new production line is installed). In the very recent past (i.e. pre GFC, i.e. when we've had decades of increasing embedded automation) unemployment was getting rather low again (e.g. <1000 people on the dole in Hawke's Bay, a province with 150,000 people). Employment levels still represent the outcome of macro policy choices, indeed are an instrument of them. There is also a difference between high inflation and for example low but not 2% inflation. Do not forget that the 2% target level was arbitrary. It could have been 3 or 4%, indeed much of Europe and America would be better off right now if it was. Nobody is arguing for double digit inflation. In terms of deflation, NZ is not a closed system and to the extent that we benefit importing delationary inputs from the rest of the world, that only puts us ahead to the extent that benefit continues to exceed the failing demand conditions in the rest of the world, that ultimately will impact on what we sell the world (anybody notice the dairy price auction result today?) - deflation is rarely a good thing and don't be too confident about it in our case now either.

Loz said...

The previous anonymous commentator suggested New Zealand has a "powerfully growing domestic economy". Keynes famously once said, "When statistics do not seem to make sense, I find it generally wiser to prefer sense to statistics".

New Zealand's exports are now almost entirely basic commodities that have been either grown, chopped down or extracted from the earth. Worryingly, dairy prices have fallen dramatically over the past year with a further 8.8% drop this week alone. Knowing that the country is not developing new export industries, is dependent on high commodity prices to service debt and maintains a reliance on manufactured imports casts considerable doubt on what is fueling claims of a strong economy.

Agriculture, Horticulture and Mining only represent about 8% of New Zealand's GDP while accounting for almost all export earnings. The "growing economy" and growth in GDP is based on services being supplied within the country itself. Finance, Insurance and Business Services sectors are now the largest contributor to the nation's GDP, accounting for 28%. This indicates how GDP can grow without increasing and diversifying exports. The economy is being fuelled on Household debt and the ballooning support industries surrounding property.

Some terrifying indicators have been provided by Jesse Colombo for Forbes magazine. From 2002 - 2013 mortgage debt in New Zealand rose 165% and now has the 4th highest household debt to GDP ratio of the OECD - on par with the debt of Portugal. New Zealand Government debt has tripled since 2008.

Not to forget, Australia, our traditionally largest importer of NZ goods is economically in trouble and filled to the brim with hundreds of thousands of kiwis who will be forced to leave the country if they lose their jobs as Australia has refused to provide income support or citizenship to the workers who have relocated over the past 20 years.

New Zealand's economic outlook should be of great concern to all those who wish to look beyond the positive headlines.

Anonymous said...

It is true targeting very low inflation in all circumstances may be destructive to economic growth. Economists are now realising that and our inflation target was lifted from 0-2% to 1-3% for that reason. But high inflation can be very damaging especially in a world where capital is far more mobile than it used to be. The only economy that still resembles 1970s New Zealand's is Argentina's. When people realise cash in their hand is being subject to an invisible tax they may start investing their money into things they perceive to be unaffected by inflation like houses and sharemarkets which can lead to bubbles and crashes.

But when we talk about an inflation rate, what is the actual inflation rate? Statistics back in the old days were more honest and less sugar coated. For an example, the actual unemployment rate in the USA and Australia is currently at least 12% and much higher again if we include people working a few hours per week who can't find full time employment. The official rates are much lower because they're massaged by statisticians. Statisticians do the same treatment to inflation rates: some analysts put the USA's true rate of inflation at over 10% after the global financial crisis.

"a powerfully growing domestic economy"

Ah, but is that GDP growth or per capita GDP growth you're going by? Per capita GDP growth is what counts, so that lowers real GDP growth after you take the immigration flood into account. Then minus the insurance payouts for Christchurch, minus the chronic debt expansion, take into account most dairy farms are going broke, and together our economic situation is not improving. These are the "good" times internationally so when the global financial crisis mark II starts there'll be another sea of red ink and potentially a one way ticket to the IMF.

"New Zealand's exports are now almost entirely basic commodities that have been either grown, chopped down or extracted from the earth."

Which is partially why New Zealand's economic decline over the last 50 years has gone in hand with the population growth rate. Using immigrating to expand the number of people living in Auckland doesn't do anything to increase the number of trees, cows and tourists, but it does mean ever more people depend on the same trees, crows and tourists.

Without export diversification, a halt to debt expansion and a resolution to the housing crisis, New Zealand can't go any way but down. Unfortunately New Zealand's politicians have shown no interest beyond lip service in tackling these issues.

Chris Trotter said...