Inflation has again been in the news recently – and the news just keeps getting worse. Last Thursday’s announcement of inflation of 6.9 per cent for the year ended March 31 revealed just how far the RBNZ is behind the game. The inflation horse has well and truly bolted and the bolt is still gaining strength and speed.
The RBNZ, and most other Central Banks, had been hoping that the recent surge in global inflation wouldn’t lead to second-round effects that would start an inflation cycle. But second-round wage and price effects are already becoming widespread. The recent minimum wage increase of six per cent in New Zealand is one example. I am aware of a local organisation that recently increased the rents of its tenants by seven per cent – and got no complaints or even questions. The tenants all expected it.
If Central Banks had started to take action against the inflation surge sooner, second-round effects may have been less. But when inflation first started to rise last year, some of the Central Banks continued to add fuel to the inflation fire. Others thought words would be enough. A few, like the RBNZ, did start taking some tightening action. But it was too little and too late.
The problem goes back to the behaviour of Central Banks in the preceding years in response to their concerns about economic activity. They over-reacted and lowered interest rates to ridiculously low levels and took everybody, including themselves, into uncharted territory.
I have been asking Central Bankers for some years how they were going to get their policy settings back to ‘normal’. They never had an answer – they simply had no Plan A let alone a Plan B. If they now raise interest rates as aggressively as they should in response to inflation, they will create a financial stability problem. This dilemma could have and should have been foreseen by Central Banks as it is very similar to one of the main causes of the last global financial crisis.
The Central Banks have made their main policy tool unusable against the current inflation surge by their past behaviour. It is not a surprise therefore that Adrian Orr, the Governor of the RBNZ, now says he needs help from others to stem this inflation surge.
Second-round wage and price increases are also necessary for many people to retain their standard of living in the face of the rising prices. Some of the biggest price rises are in the areas regarded as necessities
– food, housing and transport. Central Banks seem to be saying that because inflation will fall back to their target level of around two per cent, the inflation problem is only a temporary one. They are confusing the inflation rate and the price level. The inflation rate might come back to around two per cent sometime, but even transitory inflation raises the price level permanently unless the inflation rate becomes negative for a period.
So what will happen to the price level in New Zealand over the next few years? Inflation was two per cent in 2020, 5.9 per cent in 2021, will be over seven per cent in 2022, and the RBNZ’s latest projection is 4.5 per cent for 2023. That means that the price level at the end of 2023 will be over 20 per cent higher than it was in 2020.
That is too big an increase for people to ignore. Also, it is not good policy-making to solve the problem of a price-level surge by lowering the living standards of the poorest members of our society.