OPINION: The government could not print money even if it wanted to and the system has worked. Until now.
Adrian Orr should have refused to sign the Policy Target Agreement presented to him by Grant Robertson. He didn’t and in that single act we know all we need to about our new Reserve Bank governor.
This forecasts dark economic times ahead but also an opportunity for those who are prepared. But first: some history.
In 1958 Kiwi economist William Phillips discovered high inflation and low unemployment were co-related. Some apparatchiks concluded the government could use inflation to reduce unemployment. Like homoeopathy or a Warrior’s premiership the idea has been debunked but refuses to die.
Milton Friedman demonstrated that it was unexpected inflation, not inflation, which created a few temporary jobs by tricking firms into thinking that higher prices reflect an increase in demand. It never lasts and the public wised up. By the 1980s we were stuck with high inflation and high unemployment.
The state needed to convince the public it was out of the money-printing business so in 1990 New Zealand led the way by enshrining the independence of the central bank through the Reserve Bank Act. Section 8 states that the primary function of the bank is price stability.
This is what Messrs Orr and Robertson have undermined.
Section 9 allows the governor and the minister of finance to agree on the level of inflation but not to add in additional objectives, like low unemployment or the re-election of the current administration. The government could not print money even if it wanted to and the system has worked.
Until now.
Mr Orr has agreed to conduct monetary policy to maintain stable prices “… and contribute to maximum employment …” The key word is ‘and’. It doesn’t say ‘subject to,’ or ‘with regards to’. The wording is unambiguous.
It’s ominous because Mr Orr can do just that. We’ve raised a generation of business owners, workers and journalists who think thinking inflation went out with the 5¼ inch floppy. A little inflation will be unexpected and firms will think a rise in prices means an increase in demand. They will hire staff and invest; only to find they have been tricked.
Like interest-free student loans, this will create a massive headache for future governments but who cares about long-term economic vandalism when another three years of access to Crown limos is at stake?
Helen Clark didn’t. No reason to think her progeny will either.
Given the buoyant economic waters it’s easy to be seduced by the ‘Don’t panic’ message conveyed by Oliver Hartwich of the NZ Initiative, writing in NBR last week. This would be a mistake. We are a decade into an economic expansion fuelled by low interest rates and expanding sovereign debt. It will come to an end and when it does Mr Orr will be the governor and, scandals aside, Mr Robertson will be the minister of finance.
Compounding the threat are rising US interest rates that will create a stronger US dollar and imported inflation. Previously, this has been countered by matching rises in the official cash rate; usually at the cost of rising unemployment but increasing the value of the kiwi and reducing the cost of imports. We know what Don Brash would do in that situation but how will Mr Orr respond given his commitment to contribute to maximum employment?
We have been living in a low inflation environment for so long we’ve forgotten about indexation. We’ve got long-term contracts with no or poorly defined CPI adjustments terms. This will increase the benefits of debtors in delaying payment and restrict the cashflow of firms with long-term supply contracts. Leases with long periods between rent reviews are a perfect example.
We have wage earners used to 2% annual pay rises. Businesses that can increase prices quickly while giving staff annual pay rises will find themselves doing well even as their staff find their standard of living mysteriously declining.
Inflation rewards the delinquent and punishes the prudent. It undermines longer-term economic growth and destroys savings but, most importantly, done with sufficient stealth it can provide a temporary economic boost when a government struggling to win re-election needs it the most.
Dr Hartwich, being a man of honour and integrity, would never impugn the integrity of those in high office. I, however, have no such qualities or qualms.
This is supplied content and not commissioned or paid for by NBR.
