ANZ economists are warning of the dangers that the country may begin 'indexing' wage rises to the previous year's level of inflation.
If that happens, they say, then beating inflation will likely require a sustained period of higher interest rates and slower economic growth.
In an NZ Insight publication, ANZ economist Finn Robinson and chief economist Sharon Zollner have taken a deep dive into how we got where we are, with inflation having hit an annual 7.3% as of the June quarter. The economists will be following up this publication later with an outline of their new inflation forecasts and where they see the balance of risks from here.
But in terms of how we got to where we are, and applying the benefits of hindsight, the economists say inflation pressures "have now spread into every nook and cranny of this overheated economy", including the labour market.
They note that private sector wage growth hit 7.0% year-on-year in the June quarter, with extremely low unemployment, overstimulated demand, and the rising cost of living "creating the perfect backdrop for a potential wage price spiral".
"Wage growth is expected to exceed inflation imminently, sending real wage growth back into positive territory."
Robinson and Zollner say rising wages are not inflationary if they reflect rising productivity.
"But the challenge for businesses is that while they’re paying much higher labour costs (and other input cost as well), on balance Covid has been a negative productivity shock, for example due to worker illness or social distancing and cleaning requirements.
"So firms are paying more for workers and other inputs to production, but are not getting a commensurate increase in output (similar to the productivity impacts of climate change). And that means that at some point those higher costs have to be passed on to consumers (ie generating more inflation)."
This "cycle" of high inflation driving high wages driving high inflation can be hard to break, particularly as firms and workers realise "which way the wind is blowing" in a tight labour market and change their behaviour accordingly, the economists say.
"This results in things like indexation of wages to previous years’ inflation, which might seem only fair and reasonable, but which builds more persistence (‘stickiness’) into the inflation process.
"If that kind of dynamic gets entrenched, beating inflation will likely require a sustained period of higher interest rates and slower economic growth."
The Reserve Bank (RBNZ) began hiking the Official Cash Rate in October last year from the emergency Covid setting of 0.25% and now, after a serious of four consecutive 50 point hikes the OCR is standing at 3.0%, with the general expectation in the market place that if will hit 4.0% by the end of this year.
Robinson and Zollner say the economy has been hit by a sequence of "extraordinary" supply shocks (Covid, war, and ongoing intensification of climate change impacts), while demand has been overstimulated by a policy response to Covid that "with 20/20 hindsight", was too powerful.
"That’s an incredibly inflationary mix of factors," they say.
"In over-simplified terms, we’ve been hit by a perfect storm of supply-side constraints largely relating to the pandemic, while demand has been overstimulated by what in hindsight was an overly powerful policy response."
They say there are many competing explanations for high inflation, including Covid, global supply disruptions, geopolitical tensions, high government spending, tight labour markets (partly related to the closed border), and central bank policy stimulus.
"All of these explanations have a part to play, and there is no one single factor that can explain the inflation that we now see."
36 Comments
Don't worry, the government is hell-bent on not indexing wages for even the core workers on its payroll.
Those on public payroll such as police officers, teachers and correction officers have only received a 2-4% pay increase this year as their pay bands won't be adjusted until July 2023.
Those receiving capitation funding such as GPs have been given only a 3% increase for the current financial year.
Let's make lives miserable for the skills we desperately need and then blame resulting shortages on Kiwis leaving the workforce or the country altogether.
Higher wages are a problem ? Don't think so Why would we keep New Zealand as a low income country as economic policy.
Perhaps the economists would be better to look at outsize profits from our larger overseas owned industries and reduce those to combat inflation. Banks/Energy/Builiding Supplies. Or is that too sacred.
Labour has submitted to the will of lobby groups on the median wage threshold for importing workers, allowing low-wage sectors 2-yrs to transition to the median wage threshold.
By then, we will have Luxon or his successor running the show who will drop the requirement altogether to ensure a steady stream of low-paid workers flow into NZ and bumper profits flow out in the name of economic growth.
Increasing productivity will be dependent on NZ management investment in both technologies & higher skilled (=paid) staff to run it. Not much sign of that over the last 30 years while successive Govts both left & right have facilitated the employers race to the bottom with excessive immigration.
One thing that was not mentioned was another way of minimising inflation in an environment of rapidly increasing wages was to reduce profit taking by the business owners rather than passing the costs directly on to the customers. Maybe the profit margins are so tight already that this is not possible. Maybe the current business models of many businesses are not ‘fit for purpose’ in this environment. If inflation is the great threat it is purported to be then the pain should be shared by business owners, not just workers and customers.
Jeez, this shallow analysis and reliance on broken reckonomics models does my head in.
Median earnings in NZ increased by 1.4% in the last 6 months (from $1,153 to $1,168). Earnings for lower wage employees have flatlined over the same period. How can this be you ask?
Firstly, the increase in earnings quoted in this article happened at the end of 2021 when there was a surge back after a slump. In other words, over the last 6 months we have seen very little growth whilst the bank economists have been screaming about the immiment doom of wage inflation. The annual wage inflation indicators use mid-2021 as a baseline (obviously), meaning they tell you more about what was happening in mid-2021 than they do about what is happening now! Use the latest data ffs!
Secondly, what the ANZ economists (and just about everyone else) are missing is that it is total take home pay that drives demand in the economy - not how much people get paid per hour. If you believe that increased demand drives inflation, this is really important. You might ask how earnings can flatline whilst hourly rates increase? Simple. Whilst some companies are, under pressure from employees, paying a bit more per hour, they are also reducing opening hours and focusing on profitable work only. There is also a major trend in employing teenagers on casual shifts to reduce wage pressures. Capitalism is very innovative at reducing the costs of labour to protect profits, which are at record highs lest we forget.
This is ugly and the result of poor communication and economic management.
In comparison Australia has 6% inflation a 3.3% wage indexation and a new government communicating that wages cannot be allowed to increase at the rate of inflation. Australia is currently pulling all levers to find people to fill jobs (allowing pensioners to work, increasing migration, paying student fees) to hold wages growth back.
Why - because once inflation becomes embedded it cant be easily reversed without employees taking a "real wage cut" ie your salary moves from 60K to 55K. This is compared to transitionary inflation ie what is happening with petrol - the price increase is reversible as oil prices fall then the price of petrol falls and we get deflation.
The short term sugar hit of wages matching inflation does mean that central banks must raise interest rates - often making it harder for those with a mortgage to keep up with additional costs (especially in a country with a large number of million dollar mortgages). That sugar hit rapidly becomes a sour taste
The other outcome of embedded inflation - which is the economy's greatest fear ie businesses go broke trying to keep labour and pay them more and more - eventually running out of cashflow ( as wages increase they must pas on the costs to consumers and in turn they need for consumers to accept the price increases - hard to do when your mortgage payments are skyrocketing) and the business goes into liquidation.
If lots of businesses fail , this pushed up unemployment and this creates a recession - simialr to the late 1970's and early 1990's recessions.
The government plays a role in communicating on wages and inflation - Australia's prepared to stand up and draw a line in the sand, NZ must do the same
Actually they are doing the opposite - if they can keep inflation transitionary and not embed it
- then in the long run inflation will deflate as commodity prices return to normal
- interest rates will not be as high- making housing more affordable and giving people more disposable income
- There will be a lower likelihood of a recession (meaning people may have slightly lower wages (relative to NZ - but at least they will have a wage)
- People on fixed/ low incomes feel inflation more than the wealthy - so low inflation will mean less pain for those on low incomes.
"Robinson and Zollner say rising wages are not inflationary if they reflect rising productivity"
How does that work for interest rates and margins. Or is that different?
Edit.
Is it just me or is it really hard not to throw personal abuse at these people for their overpaid double standards.
Of course, housing inflation is not included, so in reality wages are lagging far behind.
And that is why until a far lower median income to house price multiple is restored, we are far worse off than in the past.
It's not all about ONLY wage growth, or ONLY house price falls, but the relative ratio between the two.
To restore the balance, wages need to rise some more, and house prices need to fall some more.
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