By Alison Brook*
After three decades of low inflation, most people could be forgiven for dismissing the idea of stagflation as an historical anomaly from the 1970s. However, fears are rising that this unwelcome prospect could soon be back.
Stagflation occurs when there is high inflation, low or negative real economic growth and increasing unemployment, a particularly traumatic trio for the economy. Periods of stagflation tend to overlap with recessions and often occur together with supply shocks (like oil price shocks) and are preceded by a period of loose monetary policy.
According to Phillip Braun of the Kellogg School of Management the primary cause of stagflation is not the oil shock but monetary policy response. In other words the root cause is when central banks do not adequately forecast how inflation and the real economy will respond to monetary tightening.
Monetary tightening and rising interest rates lead to households reducing spending and companies investing less. The aim is to rein in inflation and cool an overheated economy. Unemployment, economic growth and inflation do not respond immediately to a change in monetary policy and the effects are often not felt for two to three years. Inflation can, in particular, be sticky and continue to rise for up to three years as firms cut back on staff levels to meet reduced demand.
The question is how fast monetary contraction brings down inflation relative to causing economic growth to slow and unemployment to rise. It is a tricky balance with pandemic-induced supply chain issues running into the Russia-Ukraine war. Both of which are inherently inflationary.
Avoiding a hard landing
In New Zealand the Reserve Bank has indicated they will follow “the path of least regrets” progressively increasing the OCR in 2022 in higher increments than they had indicated earlier. Handled well, the central bank would account for the lag between rate hikes and declining inflation and start cutting rates again before it shows up in inflation figures.
Unfortunately, the odds of this happening are not great and the risks of a hard landing increase with each rate hike. According to Capital Economics since the late 1970s the US, UK and Europe have gone through sixteen tightening cycles and thirteen have resulted in a recession.
The war in Ukraine has made the situation even more fraught as it is likely to push inflation even higher but has also raised the risks to economic activity already weakened by the pandemic. As a result, “the path for a soft landing is narrow.”
On Monday, Bridgewater Associate’s Ray Dalio warned the US was heading back to a period of 1970s-style stagflation. Ronald Reagan only brought the double-digit inflation of the time under control after sweeping into power in 1980 with a controversial economic policy platform of reduced government spending, cuts to taxes and regulations, and tightened monetary supply.
NZ’s high levels of household debt make things even trickier
The IMF in its preliminary “Article IV” report raised concerns about high levels of (largely housing) debt leaving New Zealand particularly vulnerable to raising interest rates. Housing debt has risen alarmingly and is up by 29% since 2018 according to Stats NZ. This sensitivity means rates rises are more likely to slam consumer demand and set the foundations in place for stagflation. Capital Economics research found New Zealand was vulnerable to “even a modest rise” in interest rates.
The rates hikes may be short-lived, however. In January 2022 Ben Udy, Capital Economics Australia and New Zealand economist predicted falling house prices will mean the Reserve Bank will begin cutting rates again from next year.
As at December 2021 unemployment in New Zealand had dropped to 3.2%, its lowest rate ever. However, May will be a critical month in New Zealand when employment stats are released for the first quarter of 2022. The risks for stagnation are clearly high no matter how buoyant the labour market is right now. The economy held up remarkably well in 2021 but the forward-looking indicators suggest a gloomier outlook for the road ahead.
*Alison Brook is from the Knowledge Exchange Hub at the Massey University campus at Albany, Auckland. She is on the GDPLive team. This article is a post from the GDPLive blog, and is here with permission. The New Zealand GDPLive resource can also be accessed here.
71 Comments
Good article.
my prediction of the OCR not going above 1.75, which will probably be wrong, was predicated on the housing market and economy weakening massively by the time the OCR gets to that point.
And hence the RBNZ stopping the hiking to prevent a total capitulation of the economy.
while my number will almost certainly be wrong, I still back the spirit of my prediction. Which is that the OCR won’t go nearly as high as most are predicting.
Interest rate swap rates are determined mainly by the rates on NZ government bonds, which RBNZ has always influenced through open market operations. If RBNZ wanted to take a firm control of market rates, they could simply offer to buy all bonds at a floor price (which corresponds to a target yield or rate). This is what RBNZ did with QE - and it is what Japan has done for decades of course. Note that simply offering to buy anything at a given floor level creates an anchor for the rates - central banks often only have to say that they will step-in to get the market to follow their lead.
So, RBNZ controls the OCR, and it can also control the rates on Govt bonds. RBNZ also sets other key anchor rates - e.g. the amount paid on the balances in settlement accounts. Thus, RBNZ can set market rates in NZ pretty much wherever it wants them.
If RBNZ wanted to take a firm control of market rates, they could simply offer to buy all bonds at a floor price (which corresponds to a target yield or rate). This is what RBNZ did with QE - and it is what Japan has done for decades of course.
I don't believe the RBNZ could pull off what the BOJ has done. Mainly because Japan is still a net creditor nation and while it may sound crazy to say, they live within their means.
Of course I could be wrong because NZ has never monetized debt on a scale like Japan.
QE isn't a silver bullet. LSAP had limits on how much of the bond market the RBNZ was prepared to own, since eventually it gets to the point where you don't have a bond market anymore, you just have a bunch of money chasing its own tail. At that point you lose the ability to participate in international bond markets, lose the ability to borrow money, and risk bankrupting your country.
Japan is far different to NZ. They are the world's third largest economy, and have enjoyed the benefits of a strong manufacturing sector which for decades has been selling into the largest global consumer boom in history. Their situation is incomparable to New Zealand's.
It is not 'QE' that is the silver bullet - it is the central bank taking a firm position and being prepared to follow through on that commitment. Just about every central bank in the world has done this for the last two years - Japan just provides the longest and most extreme use case. That is not to say that yield curve control like this needs to be used to hold interest rates near zero - if RBNZ decided, for example, to track 50bps above or below the rates in the US they could achieve this quite easily by nudging the market with open market operations (as they probably have done in the past)
As for 'losing the ability to borrow money' - that makes no sense at all. Govt doesn't go into debt when bonds are sold - that happens when Govt credits the settlement accounts of commercial banks (i.e. when Govt pays for things). Credit in commercial bank settlement accounts is Govt debt. Commercial banks can swap this credit for bonds, but this just changes the form of Govt debt - from liabilities in settlement accounts to liabilities in the form of bonds. Around $40bn of NZ Govt debt is currently in the form of settlement account balances - and RBNZ pay OCR on this balance to the account holders. There would be no drama if RBNZ decided to hold a greater proportion of its debt in settlement account balances (or in short-term securities) instead of bonds. The main reason they don't is because the financial sector needs bonds as collateral. This is the primary reason that bonds exist - not because sovereign Govts need to 'borrow'.
Governments issue bonds in order to raise money. If those bonds are not offering a high enough yield, investors will not buy them.
What you're implying is that we have a centrally controlled economy, where the central bank simply dictates the cost of money to everyone else. Not only is this nonsense, it's a dangerous misconception. It gives people a false sense of the risk involved when taking on debt.
What you're implying is that we have a centrally controlled economy, where the central bank simply dictates the cost of money to everyone else. Not only is this nonsense, it's a dangerous misconception. It gives people a false sense of the risk involved when taking on debt.
Correct. The MMTers are quite comfortable with this. I think Jfoe is one but not completely sure. Apologies in advance if I'm wrong.
Govts do not issue debts to raise money - look at the evidence of the last two years, that is a complete nonsense. Most NZ Govt issued debt is sat in settlement accounts (with the wholly govt owned rbnz holding nearly $60bn in of the bonds)!
But, I am not implying that we have a centrally controlled economy, I am saying that our central bank has the ability to control the cost of credit, and the value of NZD denominated govt liabilities. That is not contentious. It is just uncomfortable for those with a market fetish
This is not 100% correct. The RBNZ bought the bonds during QE on the secundairy market, from our main banks, leaving the treasury with a possible 5.1 billion$ bill because they have to pay the higher interest on the settlement accounts. Those accounts will be settled when the RBNZ winds down their government bonds assets and for that time they have to pay the market rate which is higher than the face value rate of those bonds.
As said in some of the other comments, the RBNZ can only buy directly from the Treasury if you do not have a current account deficit. Japan has a positive current account so they can do this to keep interest rates low and New Zealand not. New Zealand need to start saving big time to achieve that and stop increasing the household mortgage debt. (You have to pay the mortgage regardless what your equity is!)That only serve the Australian banks and create an even bigger current account deficit.
Ok so what's your prediction on the currency?
The US housing market is still strong and they are likely to hike rates for longer. Surely this means our currency will fall if we stop hiking, introducing new inflation pressures from imports, and therefore the need to keep rates high.
The RBNZ should at that point slash the OCR. As a deep economic recession will kill demand.
the NZ dollar will drop markedly, but if demand is destroyed the impact of higher priced imported goods will be mitigated.
also, a much weaker dollar would be great for exporters and what should hopefully be a recovering tourism sector.
either way it won’t be pretty, but the RBNZ only has its self to blame.
Not repeat; it was a small indication only. There were 2 billion people on the planet, not many were consumers, not much of the planet had been consumed.
This is totally different; there are 8 billion people (4x more) and we've consumed about half the planet - the best half.
Atop that, we have run a belief-based, debt-issued tracking system - which hasn't tracked anything. And we've chosen to believe it. But it is coming up against the Limits to Growth, an there are no 'tools' in finance/money/economics, which can alter the physics.
Yes, they 'issued' too much 'money'. Too many forward expectations. So a lot of those are going to be worth less, even as supplies reduce. Yes, stagflation - maybe then deflation - certainly mass disbelief/angst turning to either conflict or collapse.
Two parents working 50 hours a week to barely keep your head above water is a reality for many now. I'm struggling to see my 'quality of life' there. Unless you're of those people who work at the Statistics Department who thinks we can feed our children flatscreen TVs so inflation isn't really happening.
If you think raising interest will take us to stagflation then you should also tell us what we can do to avoid this crazy inflation other than giving excuses that it is transitory or a supply chain issue.
Always remember raising prices are easy but taking it back after staying at the peak for long time is not at all desirable by any business.
Also, salaries always go up I have never seen them going down. So if the OCR stays below 3% it means we are throwing fuel to doze the flames.
Fed are still pumping their economy, buying assets/expanding their balance sheet, with negative real rates while the average person suffers the highest inflation in 40 years.
All to protect the debt bubble.
Oddly, what they do, is both saving the debt bubble, but at the same time, increasing the probability that the future will be worse for the average American.
Pain avoidance doesn't solve the issues that an individual, or a nation, need to face.
There are positives to living here but almost everything is more expensive and of lower quality compared to other countries, which results in a lower standard of living. Of course there is more to life than material things. But one cannot deny this, unless you’ve never been abroad.
So what is the solution?
Probably an understanding of what various countries are about.
Dubai for instance has many, many wonderful physical objects. Tax free income. Man made islands. Lots of Sun. But it's also the worst parts of modernity, on crack.
Expecting NZ to have a cheaper and better consumer market than much larger markets closer to each other doesn't make much sense.
Don't be ridiculous. I'm simply stating the facts.
The glass is at 50% capacity and goods and services in New Zealand are stupidly expensive compared to proper developed countries like AU, US, UK.
This translates directly to a lower standard of living.
I wasn't aware that one can only comment and say "positive" things about New Zealand.
Education. In my experience /opinion, public education is significantly better in NZ than Aus, in general, and you are more likely to have to fork out bigger $$$ in Aus for a better high school education for kids.
but I agree most financial aspects are better in Aus than NZ.
but some non- financial things are better in NZ than Aus, in my opinion.
Our son went to a public high school that was considered to be top end, it was low- mid end by Auckland standards.
our daughter goes to Baradene in Auckland, the premier Catholic girls school. After donation refunds are accounted for, we pay about 4k per annum. In Aus, a similar quality school was about 20k per annum.
Hi Albert2020,
This is a finance and economics website and unfortunately there isn't very much positive to say economically about a basket case. I did however find the South Island backcountry absolutely stunning on a recent trip there if that's what gets you moist.
I am constructing a lovely home in a lovely (and affordable) part of Australia, but I'm sure that even you could understand that building a house from scratch takes a little bit of time, so for now (if it's okay with you) I'm letting my kids enjoy having their grandparents around. Fortunately the builders aren't running around like headless chickens trying to source basic materials like plasterboard or wood like their counterparts in this dysfunctional country.
Now how long are you going to keep up this petty grudge against me because you were the fool that bought at the absolute peak of the property bubble? Is your bitterness towards me going to keep intensifying the more money that you lose?
If so, we might need to buckle up because the price drops are just getting started. When I said that only "idiots" would be buying now, I figured that even obtuse people should be able to put two-and-two together to avoid financial calamity.
You’re moving to a country that has 40% of exports (see rocks) exposed to one country (China), a country that also has an almighty property bubble and a country who still treats kiwi migrants post 2001 as second class citizens and you call NZ an economic basket case?
I’m glad you’ve decided to build a home at a point when building and labour costs have exploded. Not everyone has access to income that can be wasted so frivolously.
Im sorry your parents won’t be able to see their grandchildren routinely and your children have to move to a foreign country away from friends and family; that wasn’t a sacrifice I was willing to make and I paid a premium for that decision but I understand not everyone is as fortunate to be in my position.
I don’t hold a grudge with you Brock, I just find it amusing that everytime you comment there is not one positive thing to come from your mouth.
As for my decision to buy a forever home for my young family last year; whether or not house prices dropped or rose after purchase had absolutely no influence on my decision; why would it, we bought a house and 1200sqm section 15mins from Auckland city to live in for the next 30 years.
I haven’t lost anything as I haven’t sold our house 6 months after we bought it. Much like I didn’t lose 30% of my share portfolio during the start of the pandemic cos I didn’t panic and sell. My debt to income ratio is 2.5, I’m fortunate to have bought a house and locked in extremely cheap rates to pay my debt down aggressively for the next 3 years.
It’s time to be a lover not a hater Brock, you’ll find the change fulfilling I promise.
But...but... How would that make them feel better about their amazing decision making prowess?
I had to laugh at this
Fortunately the builders aren't running around like headless chickens trying to source basic materials like plasterboard or wood like their counterparts in this dysfunctional country.
When the Aussie media is reporting like this
Wayne Whyte has been carrying out custom renovations on properties around Brisbane for more than three decades and, with all of these factors hitting his sector simultaneously, he is now retiring early and liquidating his business.
“[The sector] is bleeding profit,” Wayne says.
He is especially concerned about the quality of work he is getting from tradies.
As labour shortages continue, his small company can only draw in less-experienced people.
"Walls have been built at the wrong height," he laments.
His final job – a two storey extension with a deck – sums up all his concerns with a sad metaphor.
"I only got a call on Friday about the toilet for this job. We can't source it for eight weeks," he says.
Wait. You expect to rock up to another country and be treated as a first class citizen when you actually aren't? Lol. I can only think of one country that's as daft as that!
Nah. Not the case. You're projecting the total basket case NZ construction situation abroad. It's nowhere near as bad.
Also not the case. For those blessed with multiple citizenships it's not even a foreign country.
You've been quite triggered since I warned in November that only idiots would be buying now. I remember your tanty about it. Talk about frivolous wastage of money!
That's cool. It must be comforting to know you're doing the same thing for the next thirty years. I try to work on five year basis.
Hey you know each time I celebrate that the kiwi mega-bubble is bursting it's actually an extremely positive thing 🎉. Its a shame you're too bitter to recognise it 😜.
... agreed , we do ... but we seem to have been " taking a cup of tea " since the 70's or 80's ... drifting along , feeling " 100 % Pure " about ourselves ... whilst the rest of the world has continued innovating , producing , progressing...
We're stuck in a time warp ... heading backwards to big central government , industry fair pay agreements , unemployment insurance ....
A lot of that 'way of life' was only possible by being small and not having that many people. Now we have double the number of people but we've done little to meet the population growth. So we're probably going backwards a lot faster than most people can appreciate.
Stagflation....I thinks it's quite likely.
Uncontrolled inflation will crush and wipe out all but the most resilient SME employers as staff demand more pay, and customers demand lower price. This will in turn create a lot of unemployment, and rolling debt defaulting as many don't manage the pressures of this balancing act. Middle class tax generating youth will continue to vote with their feet to west island. Aussie will continue to send its criminals here based on passport.
And so on and so on.
As this situation with rising interest rates and rising inflation roles on. There will be people who are fine and there will be people who are another word starting with F. The situation of the F’d people will begin to impact more and more on the people who thought they were fine. Causing some of those fine people to also become F’d. Once the F’d people outnumber the fine people. There will be a change politically and economically.
As at December 2021 unemployment in New Zealand had dropped to 3.2%, its lowest rate ever.
Seems like unemployment hovered around 1% for a good twenty years after WWII.
It's funny, the theory was that increase in interest rates makes people deposit more in the bank, thus reducing money supply, and therefore decreasing inflation.
The reality, an increase in interest rates makes mortgages cost more thus reducing disposable money supply therefore causing an economic collapse.
When exactly do the deposit rates go up?
Because you’re not meant to have pumped a debt/asset bubble prior to raising rates that prevents you from ever raising rates if inflation shows up…
The damage to the economy won’t happen when you raise rates…it’s already happened by dropping rates to zero (and issuing bad debts under the assumption that rates never go up)
Sri Lanka - what happened - is it an isolate case or other countries to follow, maybe not as bad but enough for its citizen to feel the pain ( just begun) :
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