ANZ's Chief Economist Richard Yetsenga on government fiscal policy, inflation and 'the climate new normal'

The economic world's a radically different place now than it was pre-Covid, with greater inflation pressures and government spending shackles broken, says ANZ Banking Group Chief Economist and Head of Research Richard Yetsenga.

Speaking to interest.co.nz during a visit to New Zealand, the Sydney-based Yetsenga notes the low inflation world we knew before the Covid-19 pandemic is gone, but this isn't necessarily all bad.

"I think the policy stance says it is gone. Clearly fiscal policy is part of it. And forecasting the path of fiscal policy is a challenge because like it or not ideas tend to be infectious," Yetsenga says.

If you thought governments were going to back off Covid-induced ramped fiscal policy, or the use of government spending and taxation to influence the economy, "you'd be scratching for evidence today," Yetsenga says. In contrast after the global financial crisis (GFC) policy makers focused on fiscal sustainability.

"I think we have broken some shackles on policies through this pandemic and they imply on average stronger nominal growth for the world over the next few years. China is going the other way, so it may be the mix of growth is a bit different from what we had pre-pandemic where China was clearly stronger than lots of other parts of the world. But I think we'll see, in places like the US and Australia, growth is stronger probably than we saw in that pre-pandemic decade because of the shift in policy," says Yetsenga.

A world with stronger economic growth and stronger inflation comes with risks.

"Recession is always a risk and we define every cycle by the recession that comes to define the end of it. So there will be a recession at some point. Do I think the central probability is we're going to have a US and global recession in the next two years? No."

"If you look at the US today there are two job vacancies for every job seeker. The economy's operating so far above potential I don't think, certainly not since the late 1970s or early 1980s, we've seen that situation," says Yetsenga.

"I think people would find the US economy and the global economy would operate more smoothly if the level of activity was actually a bit lower. Businesses wouldn't constantly feel like their supply chains can't keep up, suppliers wouldn't constantly feel like they can't deliver what their customers want. And as customers we wouldn't constantly be facing this cost of living pressure, price increases, and let's face it service is tending not to be great because businesses that provide customer service are finding it really hard to get staff that are suitably qualified."

Inflation drivers swap sides

Pre-Covid Yetsenga referred to a list of eight or nine factors he believed were pushing inflation down. Now he says at least five of those have changed side and become upward pressures on inflation.

"Globalisation has changed, we still have lots of debt, we're all still getting older and technology is still a big force. But globalisation clearly has given labour something different. I don't think deglobalisation is the right term, but certainly it's a different environment. Fiscal policy, in 2009 when the US had the Troubled Asset Relief Program I think Congress rejected it twice before it finally got accepted, whereas this time of course everyone said we just need to do what's required."

"Central banks were operating quite differently. There was a recognition finally that they had a two sided problem rather than just a one sided problem. I think after the GFC there was clear evidence people were much more cautious and wanted to keep a chunk of the liquidity they'd accumulated through the crisis. This time if you look around the world demand seems to be booming."

"We talk about lots of savings and people really seem to want to deploy those whether they're individuals or businesses. We'd just come off a commodity price super cycle, now we've had the weakest five years of commodity investment certainly we've seen in the last 20," says Yetsenga.

"And I would say the last piece is inflation. Inflation is part of business decisions now. I do more meetings with boards and executive groups than I've ever done about inflation as they just think about that as a separate element of their strategic planning."

"The Bank for International Settlements maybe has put this the most neatly where they suggest [that] as a statistical reality at low rates of inflation is price changes tend to be decorrelated. You might get airfares go up one quarter and the next quarter it's used car prices or something else. They all tend to be idiosyncratic moves. As rates of inflation pick up you find everything tends to be rising. Something might rise a bit more than something else, but actually that change story is quite different," Yetsenga says.

'The climate new normal'

In terms of efforts to mitigate climate change, and in New Zealand's case striving to reduce net emissions of greenhouse gases to zero by 2050, requires a big shift in resource use, Yetsenga says. This is likely to be inflationary.

"There need to be large relative price movements, and the fact is there's an enormous investment task suggests that it should make prices go up. And in a world where policy is a bit more front footed and bit more stimulatory than it used to be, then that's likely to add to the inflation story which is around." 

"It's clear there's a large public and private investment need and part of the funding for that needs to be the investment dollars which everyone talks about. But part of the funding for that also needs to be the commodities you need, the skilled labour you need, the expertise you need, the management time you need," says Yetsenga.

"A world that's generating inflation implies we're utilising the world's resources pretty fully already, [so] we've got to do less of something else to fund that. It's hard to see that that's the government sector because they're clearly a part of that investment story, and they don't seem particularly willing to retrench spending back to where it was."

"So you're left with private consumption. Now consumers don't consume less just because. They need some sort of price signal to do that. Part of that can be interest rates, which we're seeing everywhere. Part of that can be relative price movements. Most economies have seen increases in energy prices," Yetsenga says.

"The tension here is, and I feel like this is an issue where the climate rubber hits the reality road, is that that hits poorer income households the most. It's consumption that's typically price inelastic. Most governments short-term response has been to 'do something' about that and subsidise those costs in some way, which is obviously perfectly understandable. But also [it] blunts the price signal that we're getting. Which is you need to consume less of stuff here so we can have the resources and expertise to fund that transition."

"I think that tension is probably part of the climate new normal and we're going to be facing this as a constant policy choice for a reasonable period of time," says Yetsenga.

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