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.

"This Is New."

Game Changer: Labour's finance spokesperson, David Parker, has come up with a credible solution to the many problems associated with New Zealand's Reserve Bank Act mandated monetary policy. Labour now has a more convincing economic story to pitch to the voters than National. Game on!

 

KEYNESIANISM by other means. That’s what David Parker’s new monetary policy offers voters – and they should take it.

 

The measures announced by Parker on Tuesday morning constitute the long-awaited framework upon which the detail of Labour’s manifesto can now be hung. Indeed, without Parker’s proposed changes to the Reserve Bank Act and the Kiwisaver scheme, Labour’s promise to resuscitate the manufacturing export sector and create thousands of new jobs would’ve been empty. But now that Parker has provided the party with an economic skeleton to articulate its redistributive muscle, well: “Dem bones, dem bones gonna walk around!”

 

And it’s all Parker’s doing. Political observers have long dismissed the man behind Labour’s economic programme as an earnest, rather rumpled provincial lawyer and “policy wonk”. There’ll be a lot less of that now. For the first time in more than 40 years, Labour has developed a joined-up economic policy that is all its own.

 

Parker confirmed this himself when journalists demanded to know which other countries were running their monetary policy in the way he’s suggesting. “No one,” replied the Shadow Finance Minister with obvious pride, “this is new.”

 

That’s true – as far as it goes – but a close study of the way the Singaporean government has manipulated its superannuation and public housing schemes over recent decades might suggest that Parker is not alone in recognising the powerful monetary impact of raising and lowering the level of compulsory contributions to citizens’ savings funds. What really sets Parker’s plan apart is the way in which he has grafted what are, in effect, Keynesian demand management imperatives onto that most monetarist of institutions – the Reserve Bank of New Zealand.

 

“We propose an important new tool – varying the employee contribution rate for work based savings”, Parker informed his breakfasting business audience. “The variable savings rate mechanism – or VSR – would allow the raising or lowering of savings rates, rather than interest rates, to reduce or boost local consumption.”

 

Not only is Parker’s scheme sound economics (a judgement with which even the business community, however grudgingly, was forced to concur) but it is also spectacularly good politics.

 

A lower exchange rate bodes well for manufactured export and import substitution industries alike and that, in turn, points to job growth. Real job growth, that is: the sort that generates full-time, densely unionised, high-skill, high-wage employment.

 

And Parker’s story just gets better with the telling.

 

By utilising the VSR, rather than the Official Cash Rate (OCR) to take the heat out of the economy, the Reserve Bank Governor will be able to protect mortgage-holders from the sort of continuous income-squeeze they are currently undergoing. The VSR is unlikely to be wheeled out every six weeks in the manner of the OCR, and its wider application will almost certainly reduce each individual’s contribution. What’s more, the money being withdrawn from circulation will remain in New Zealand. The average Kiwi’s economic nationalist nerve cannot help but be stimulated by the knowledge that the big Aussie banks’ ability to turn New Zealand’s misery into Australia’s profit will be patriotically curtailed.

 

The question now for Parker and his boss, David Cunliffe, is how to bring the good news from Labour’s “war-room” to the party’s electoral base. Tuesday’s announcement has had the effect of binding Labour’s message into a single, coherent narrative – but it is not a story that can be told in a ten-second sound-bite. Social media can help in this respect, but Facebook and YouTube can only take this sort of story so far. Good news is best delivered in person.

 

The ideal vector for this type of message is the nationwide political tour. Cunliffe painting the picture of a kinder, gentler, more inclusive and economically productive New Zealand, while Parker details precisely how Labour proposes to take us from problem to solution.

 



Today He'd Use PowerPoint: In the election year of 1975 Rob Muldoon took his charts and graphs and tables on a nationwide tour to discredit Labour's economic policies - especially its NZ Superannuation scheme.

 

There would be an additional measure of delicious political irony in such a road-trip. Forty years ago Labour’s original superannuation scheme was systematically undermined by Rob Muldoon’s travelling roadshow. From town to town and on into the main centres the pint-sized “economic wizard” advanced with his charts and graphs and tables, and with every stop on his exhaustive itinerary the crowds grew larger and more convinced that Labour’s scheme (which today would be worth $260 billion!) was a bad idea.

 

How satisfying it would be to reverse the process.

 

This essay was originally published in The Waikato Times, The Taranaki Daily News, The Timaru Herald, The Otago Daily Times and The Greymouth Star of Friday, 2 May 2014.

Targeting The Policy Agreement

Policy Target: The Reserve Bank Act (1989)  It was one of the Neoliberal Counter-Revolution's primary objectives: to keep the interfering hands of politicians as far away from the controlling mechanisms of monetary policy as possible. Otherwise known as strangling the economy in order to save it.

 

SOME ARE CALLING IT irresponsible meddling, others talk about the need to regain control of our destiny. Whatever it’s called, it’s attracting a lot of attention. And not a little concern.

 

For nearly thirty years both of New Zealand’s largest political parties have faithfully adhered to the doctrine that a country’s monetary policy is best determined by an independent central bank. Furthermore, that the prime focus of monetary policy must be keeping inflationary pressures under the strictest control. In practice, that’s meant keeping the interfering hands of politicians as far away from the steering-wheel as possible.

 

New Zealand embraced this monetarist view the central bank’s role with special fervour. Our current Reserve Bank Act, passed by the Fourth Labour Government in 1989, places enormous economic power in the hands of a single person, the Reserve Bank Governor. He alone is responsible for carrying out the Act’s primary function: ensuring “stability in the general level of prices”.

 

The only democratic check upon the Governor’s power comes in the form of the Policy Target Agreement (PTA) negotiated periodically with the Minister of Finance. It isn’t much of a check though, because the only real debate is over the permissible range of inflationary fluctuations. If the inflation rate goes above, or stays below, the agreed levels for too long, the Governor intervenes.

 

The mechanism he uses to do this is the Official Cash Rate (OCR). By raising or lowering the price at which the privately-owned banks can access liquid funds on a short-term basis the Reserve Bank is able to expand or contract short-term demand in the New Zealand economy and hence (at least theoretically) keep prices under control.

 

The use of this single, blunt economic instrument has fuelled repeated property booms, blown out New Zealand’s balance-of-payments, and undermined our manufacturing exporters.

 

So, why did our politicians give so much economic power to one, unelected government official? Why is something so critical to the health of our economy as setting core interest rates not the responsibility – as it once was – of the people’s elected representatives?

 

Answering that question takes us to the heart of the “Quiet Revolution” in economic management, in which the Reserve Bank Act (1989) played so important a part. Essentially, the decision to remove the management of monetary policy from the politicians’ hands was inspired by the growing fear among political and economic elites that the democratisation of economic policy formation had gotten out of hand.

 

The deadly confluence of the economic, political and social crises that characterised the 1930s, and which led to the human disaster of World War II, had largely discredited the laissez-faire economic doctrines which spawned them. Rather than go on entrusting the elites with the conduct of economic policy, the citizens of the victorious democratic powers made sure that those responsible for the big economic decisions were politicians accountable to themselves.

 

The result was a 30-year period of unprecedented economic expansion, during which, in the USA, the share of national income going to the top 1 percent of income earners plummeted to less than 10 percent (from a pre-war high of close to 20 percent). Between 1945 and 1975, thanks to successive post-war governments’ commitment to policies aimed at full-employment and wealth redistribution, and to preserving the bargaining strength of trade unions, the standard of living of ordinary working people rose steadily.

 

With their economic and political power fast eroding, the Western elites seized upon the inflationary pressures unleashed by the Vietnam War and the Arab Oil Embargo to discredit the democratic conduct of economic affairs.

 

Politicians, they argued, were unfit to determine economic policy precisely because they were prey to electoral pressures. Only when populist politicians, like New Zealand’s Sir Robert Muldoon, were legally precluded from interfering with the free play of “market forces” could the scourge of double-digit inflation be defeated. And that free play could only occur after the “market distorting” influence of high taxes and excessive government borrowing, inefficient state-owned enterprises, and the power of the “over-mighty” trade unions had been dismantled – comprehensively.

 

The imposition of what came to be called “neoliberalism” thus represented not a “revolution” in economic management but a “counter-revolution”. And absolutely crucial to its success has been the 30-year bipartisan consensus that no other economic doctrine is to be given a serious hearing anywhere. Not in the news media; not in the schools and universities; and certainly not in the two main political parties: National and Labour.

 

Hardly surprising, then, that serious disquiet is growing among those whose job it is to defend the neoliberal counter-revolution at all costs. Not only is the Reserve Bank under attack from the Greens (whose modest levels of electoral support make them more irritant than threat) but also, and most alarmingly, from Labour.

 

And once Labour’s re-democratised monetary policy – what’s next?

 

This essay was originally published in The Press of Tuesday, 8 October 2013.

Making Money

Printing Money! The knee-jerk outcry from New Zealand's politicians, journalists and right-wing economists is that Quantitative Easing is the same as "printing money". In reality, QE its a IMF-endorsed method of freeing-up the flow of credit to businesses large and small. The Greens' QE proposal was much more limited: to provide urgently needed capital for the Christchurch re-build.  Strangely, the fact that private banks "print money" every day elicits no outcry at all from the critics of QE. 

ARE YOU MAKING ANY MONEY? It’s a common enough question – to which most of us reply with a rueful “Not enough!” A fortunate few (they would call themselves the ‘hard-working’ and ‘talented’ few) might venture a smug “Oh, well, I can’t complain.” But the truth of the matter is that only two things in this world “make” money: governments and banks. (If you’re ‘making’ money and you’re NOT one of those two things, then you’re a counterfeiter.)

 

The funny thing about money – given how vital it is to our lives – is that hardly anyone knows anything about how governments create their currencies, and even fewer understand why banks are allowed to ‘make’ money at all. Indeed, a recent British survey revealed that most people assume that a bank’s lending cannot exceed the value of its deposits. The idea that banks can, by means of a simple accounting entry, create hundreds of millions of dollars, tends to be greeted with considerable scepticism.

 

Take the recent kerfuffle over the Green Party’s (now abandoned) proposal to use “Quantitative Easing” (QE) to both assist the Christchurch rebuild and lower the value of the New Zealand dollar. Earthquake Recovery Bonds, to the value of 1 percent of New Zealand’s GDP (approximately $NZ2 billion) were to be purchased by the Reserve Bank.

 

Adding such a large sum to the stock of Kiwi dollars would have devalued the currency by several cents against the US dollar – making our exports more competitive on international markets. Conversely, imported goods would have become more expensive, reducing consumer demand and thereby improving the country’s balance of payments.

 

The additional $2 billion – available immediately from New Zealand institutions – rather than being drip-fed to us from the grudging hands of foreign-based reinsurance corporations – was also to have been used to kick-start Christchurch’s still sluggish reconstruction, boost the country’s economic growth, and reduce the level of unemployment.

 

A reasonable policy, you might have thought, in the light of New Zealand’s over-valued dollar and the damage it is doing to the economy. But, no. The Green co-leader’s QE proposal was decried by politicians, journalists, bloggers and bank economists, as tantamount to “printing money”.

 

Were Dr Russel Norman’s QE to be adopted, they wailed, we would very soon find ourselves in the position of Zimbabwe: facing hyperinflation and using million-dollar notes to buy a single loaf of bread.

 

Worthless Currency: Weimar Germany's hyperinflation (1920-23) was the result of its government's attempt to monetize its reparations debt to the victors of World War I. In 1938, New Zealand's first Labour Government's use of "Reserve Bank Credit" to fund its massive state house construction programme did not result in a similar inflationary surge because the money was used to create tangible assets.

 

Now, if Dr Norman’s proposal had been to monetize New Zealand’s debt by repaying her creditors with newly-printed $1,000,000-bills issued by the Reserve Bank, then the jibes of his critics would have been well deserved. But hyperinflation only occurs when the expansion of the nation’s money supply isn’t matched by an answering expansion in the value of its material assets.

 

The $2 billion Dr Norman was proposing to inject into the New Zealand economy wasn’t ear-marked for the repayment of debt, but for the reconstruction of its devastated second city, Christchurch. It would have become the steel and concrete of a reborn central business district. Transformed into the weatherboard and roofing tiles of new and refurbished homes, it would have brought desperately needed relief to Christchurch’s long-suffering earthquake victims.

 

Sadly, the cacophony of ill-informed criticism directed at Dr Norman’s QE proposal was sufficient to bring about its withdrawal.

 

As I watched the Greens back away from their perfectly reasonable and generous plans, I wondered why we have heard no similar outcry against the QE being practised by this country’s Australian-owned banks.

 

Every month, New Zealand’s privately-owned financial institutions conjure billions of dollars out of thin air in the form of mortgages. No printing presses are required to ‘make’ this money – a computer does the job in a fraction of a second. And, when the mortgage is granted on an existing property, adding nothing to the nation’s stock of material assets, is the effect inflationary?

 

You betcha! So much so, in fact, that the Reserve Bank is casting about frantically in search of some way to prevent yet another housing “bubble” from blowing up and bursting.

 

And yes, you’re right, the Global Financial Crisis was caused by banks and finance houses “making money”. And, yes, it was governments – using their power to make money – that baled them out. And, yes, you’re right again, the mechanism still being used to painstakingly reconstruct the shattered global economy is called – Quantitative Easing.

 

This essay was originally published in The Waikato Times, The Taranaki Daily News, The Timaru Herald, The Otago Daily Times and The Greymouth Star of Friday, 28 June 2013.