This is a re-post of an article originally published on pundit.co.nz. It is here with permission.
Much policy discussion reminds one of the story of the New Zealand navy ship arriving in a US port who are invited to a game of football by the locals.
The day before, the sailors are told it is American football, so they get a briefing on how to play the unfamiliar game. After the explanation of the various phases and the blocking and tackling and so on, the instructor says ‘We better have a trial practice; where’s the ball?’ One of the New Zealanders replies, ‘Bugger the ball, let’s get on with the game’. No doubt he became a politician or a commentator: ‘Bugger the analysis, let’s get on with the policy’.
Thus it was with the budget. Everyone gets overwhelmed with the details of the policy changes. But the analysis of what is happening to the economy whose evolution underpins the policy development, is usually ignored. It is much too boring, even if it is fundamental.
So what does Treasury, whose forecasts underpin the recent budget, think? Importantly, the Treasury forecasts are made by one of our biggest economic forecasting teams. They are made independently of its Minister of Finance, who may disagree with a forecast – in the past some have done so publicly. Their forecasts include government policies which Treasury may have advised against, as you would expect from every unbiased forecaster.
The forecasts in the May 2022 Budget Economic and Fiscal Update (BEFU) involve major changes compared to those in the December 2021 Half Year Economic and Fiscal Update (HEFU). There were two unanticipated shocks. Omicron Covid proved much more overwhelming than expected and no one anticipated Putin’s invasion of Ukraine with its international impacts, especially (for us) on the prices of hydrocarbons and grains. There are no quarterly figures but the current year ending in June 2022 was a year of two halves.
What swung the game around was the consumer price shock driven by the external events. That it mainly happened in the second half (this year) warns those cheering in the stands that the price rises cannot simply be because of government spending and the Reserve Bank’s monetary stance. Those policies were in place earlier.
As a result of the price shock, Treasury expects per capita private consumption to have fallen in the June Year Ending 2022 (2021/2) compared to JYE2021 (2022/3). (Details in the appendix below.) Any average disguises wide variations so the forecasts are consistent with the conclusion that many people are struggling.
Treasury by mid-March must have observed this was going to happen. They were not alone. At the time I was involved in serious – if a little speculative – discussions around the likelihood of recession (fall in economic activity) towards the end of this 2022 year. Apparently, the government decided in March to inject around $2b into private incomes, although the precise package – the $350 for adults with incomes below $70,000 last year and not in receipt of the winter energy supplement – was probably decided later.
So Treasury thinks that private consumption will grow in the 2022/3 year, although it will not grow as rapidly as it did before the Covid pandemic.
The pattern for spending growth of public consumption spending (which does not include transfers or investment) is the opposite to private consumption. In the years before 2019/20 government spending grew slower that GDP (private consumption grew faster). But in the last three years it has grown much faster, partly to deal with the Covid shock, but also because one of the key political differences between Labour and National is their different philosophies about the balance between public and private consumption. However, the unwinding of the Covid spending – cross fingers there is no new Covid shock – means that under current (Labour) policies, public consumption spending is projected to stagnate after this year.
The Treasury thinks that inflation has been mainly driven by domestic demand – probably at tolerable levels but with the dangers of an inflation burst if it gets out of control. Additionally, there has been a boost from global factors, so we are experiencing an extra price shock, not the beginning of stagflation – ongoing price rises and high unemployment. It thinks price increases will remain high in 2022/3 but settle down in the 2-3% p.a. range thereafter.
However, their expectation is that economic growth will be sluggish after 2022/3. (This is an issue for another column – when I have worked out what is going on.) Unemployment increases from about 3 percent to 4½ percent. There is a bit of stimulation from export growth (I was surprised that they are expecting import prices to rise faster than export prices in the medium term). Investment is gangbusters next year but stagnates at that higher level after.
Treasury forecasts include upside and downside scenarios reflecting the uncertainty around their judgements about future events. In the upside scenario, disruptions from Covid and the Russian invasion of Ukraine are assumed to recede more quickly, resulting in less persistent inflation, so that monetary policy is tightened less aggressively in response, so that the impact on the real economy is smaller. Unemployment increases only a little and economic growth is slightly faster.
In the downside scenario, more persistent price pressures necessitate a sharper rise in interest rates, weakening GDP growth and pushing up the unemployment rate. The 90-day bill rate almost doubles for a short time and unemployment is up 1½ percentage points – say 40,000 plus workers. The scenario even expects a mild recession in 2022/3 and 2023/4. (The 2023 General Election would be slap in the middle of it.)
In the difficult circumstances we face, the central forecast does not look too bad. I have one reservation. The basic rule is that during a downward shock some have to suffer. Currently it is those hit by the price spike. However, the forecast suggests that should be over soon but the recovery is achieved by charging the future.
Net overseas borrowing rises dramatically. For this year and next it is about 6½ percent of GDP, over double the 3 percent level of the previous decade. In the medium term the borrowing drops back to 4 percent of GDP, still higher than the past level. The Net International Investment Position (roughly net overseas debt) increases from 45 percent of GDP in 2021 to 55 percent in 2026. We have eased the burden of living today by adding to the burden of those living in the future.
I reported that Treasury has carefully considered strategies for the government’s debt. Surely we need to be as thoughtful about the nation’s (public and private) debt.
Appendix. Annual Growth Rates (Per Capita)
Private Public GDP
June Years Consumption Consumption
2011/2-2018/9 2.6% 0.7% 1.9%
2019/0-2021/2 0.5% 7.9% 0.7%
2022/3-2025/6 1.2% -0.3% 1.1%
Source: BEFU 2022, pg 158 (adjusted to per capita)
*Brian Easton, an independent scholar, is an economist, social statistician, public policy analyst and historian. He was the Listener economic columnist from 1978 to 2014. This is a re-post of an article originally published on pundit.co.nz. It is here with permission.
32 Comments
Yes, that's my armchair analysis if inflation is truly "supply-side" and "international". In that case, things are just getting more expensive and we either need to buy less and/or become more productive. In this scenario, the RBNZ raising interest rates is just shooting us in the foot.
However it's pretty clear that there's also a strong element of monetary inflation from the money printers over the past two years. That's the proverbial chickens coming home to roost, and RBNZ hiking rates is the expected response (to their own silly actions).
If both are true, which I think is the case, then there's little an individual can do but batten down the hatches.
Yes, the line that it's all temporary supply chain problems and thus we shouldn't change rates has a few problems.
One is that the inflation feeds through naturally from 'imported' to 'domestic' inflation, ignoring any conceptual distinction you want to make.
Another is that international ports have actually serviced *more* throughput in the last year than any year previous. This would suggest that the demand spike is the real problem - the supply chain is struggling because of increased demand more than decreased capacity (though obviously there are real problems in eg Chinese ports.)
Another is that we've had massive nominal gains in the value of real estate and equities - non-productive assets. No one has explained to me how those gains can possibly be realised without causing a bout of inflation.
Anyway, it sounds like Treasury's forecasts are hopelessly optimistic. Probably because they share the ridiculous belief that handing rich people a million each in yearly capital gains is not inflationary, while hiking minimum wage is.
"Raising interest rates to fight inflation is pointless"
If this statement is true, so then would be "dropping interest rates to fight deflation is pointless".
Do you agree? And if so, are you happy that we've created debt/asset bubbles by dropping interest rates to zero to offset the imported deflation we've had the last 20-30 years? (from globalisation/cheap labour from asian countries).
What I've learnt from the era of super-low rates:
-When rates are high, capitalists benefit because they can get high risk-free returns while contributing little actual production. Boo!
-But when rates are super low, asset-holders benefit because they have collateral and can use it as leverage. They can get high risk-free returns while contributing little actual production. Boo!
-Low interest rates encourage speculation in absolute garbage because people hate holding cash. We're seeing trillions in crypto garbage evaporate, trillions in 'tech' garbage (unprofitable websites pretending to be innovation), and a lot more yet to come.
-Thirty years of tut-tutting about Japan's inability to raise rates and clean out zombie companies is exposed as gruesomely hypocritical.
In summary, the poor get screwed either way, and the words of central banks and governments are only ever cover for protecting the prices of assets held by their own social class. C'est la vie.
Well , Brian : you're sitting in your car , the engine is running ... and you've got one foot hard on the accelerator , and the other ( presuming you only have two of them ) jamming down on the brakes ...
... what happens ? ... because , that's what we have in NZ ... with Robbo on a batshit crazy spending spree ... and Adrian hiking up the OCR ... where do we get to , with two diametrically opposed efforts ...
This piece TOTALLY omits the real predicament.
Avoids? Or is ignorant of?
Treasury are equally blind, of course, for the same reason; alle same alchemy. We are into a new era now; one where disruptions are the norm, and on the increase. As an astute commentator said yesterday:
https://www.rnz.co.nz/national/programmes/sunday/audio/2018843837/from-…
"growth of globalism is over" - towards the end. The reason, not explained or asked, is that we are overshooting the planet's ability to supply.
"We have eased the burden of living today by adding to the burden of those living in the future."
Debt is everywhere. Modern society, as we know it today, cannot do without it. So long as it does not exceed that of the US, UK and EU, its viable.
Just pause for a moment and look at Japan or try opaque China.
Prior to Covid the world was in a deflationary economic environment. We couldn't get inflation no matter how hard we tried. The global response to Covid was loose monetary policy - remember the slashing of interest rates, the dropping of LVR restrictions in NZ, the quantitative easing programmes pretty much everywhere- combined with stimulatory fiscal policy (unlike post GFC which had austerity fiscal responses). It was this combination which switched the world economy from a deflationary to inflationary cycle - that made the economies much more vulnerable to economic shocks - such as Chinese Covid lockdowns which affects supply chains and the Ukraine war which affects, food and fuel commodity prices. This has changed inflation expectations causing second order affects that the RBNZ (and the government - I agree with Mr Gummy on this) need to counter to avoid a permanent 1970s type stagflation economic environment (high unemployment, high inflation).
Agreeing with that persona almost guarantees incorrectitute.
And in this case, does.
The 1970's were the first example of our need for energy, and in hindsight, the first indication that economics, as preached, was shy of a few facts.
The 1967 Arab embargo had no impact; the 1973 one, did. Kissinger worked it out; most got hung up on those economic terms. North Sea and Prudhoe Bay kicked the can, as US fracking has this last decade. There is no remaining swing-producer, certainly not of light sweet crude. We are carrying a never-bigger collection of debt; extracting from a never-worse-quality remaining stock of resources, and well down the remaining energy stocks.
In terms of 'financial' impact, there will be scarcity/demand-driven inflation. Then there will be either a failure of belief in debt-repayable-ness, or continued ignorance and debt-issuance. The former may well precipitate a collapse; the latter - after a period of inevitable stagflation - deflation. The overlooked difference this time, is that it is a permanent state; this is no 'cycle' of fixable hiccup.
I see that the cost of renewables replacing fossil fuels has come down and in many places solar and wind costs including battery storage costs are less than the so-called gas tranisition fuel.
The Energy required to obtain energy - from any source - is rising exponentially. We have passed the bottoming-out. If you are running with an accounting system which doesn't include that fact, be very unsure. There is a lot of hype around, and a lot of regurgitation of said hype:
https://player.fm/series/nine-to-noon/decarbonising-heavy-transport-wit…
No solar panel is made using solar panels, no windmill either, nor yet any battery. All are reliant on fossil energy/feedstock.
We should be counting joules and tons-depleted; all else is false accounting.
Sit23 and PDK are both talking nonsense. Solar and wind are net producers of energy. They produce way more energy than it costs to make them. Not only that they are getting more productive year after year. The latest generation are larger producers of energy than older models.
The other point that often seems omitted is that while we have fossil fuel to use, surely it makes sense to use them on preparing our ability to rely increasingly on other forms of energy generation instead. The alternative is to run out those fossil fuels and then squawk "why didn't we prepare?"
Is supply side inflation also classed as reducing demand?
For example I have $30 to buy two blocks of cheese, historically I would have purchased two blocks. Now they are $20 each so I only purchase one block.
Trying to keep this as simple as I can does this mean that there is now less demand, and if so what is increasing rates adding to the equation? Apart from causing businesses to have to pass through further price increases for any increasing debt costs earlier in the chain
Could someone please explain what I am missing?
Not sure if you understand the concept of aggregate demand or not. But this video might help.
RBNZ have stated they want to raise rates to reduce aggregate demand, and hence cool inflation.
Hi IO,
I think I get the concept of aggregate demand, but still not connecting the dots, maybe I have the goal wrong?
Goal = need to decrease inflation
1) increase interest rates
2) increase prices
3) demand reduces
Increasing the interest rate (1), just multiply the effect of increasing the prices (2) with the goal of reducing demand faster (3)?
To me it looks like at the moment we are going 2 - 1 - 2 - 3, why not just let 2 - 3 play out?
The video that played straight after it (Aggregate demand | Aggregate demand and aggregate supply | Macroeconomics | Khan Academy - YouTube) helped reframe the FOREX side of things better for me though, I knew it was important for NZ but not that important
Ok, another video might help...I'm not sure if you understand the difference between cost push and demand pull inflation. Some argue we only have one, or the other at present, but I think we have a combination of both at play.
Also, note what has happened in Turkey and their inflation rate because they decided to not raise rates when inflation started rising. That is a risk for any nation that decides to ignore inflation hence why Powell (Fed) and Orr (RBNZ) are taking the steps they are taking.
Once established within an economy, inflation can become entrenched. Its psychological as people expect everything to be more expensive in the future so they change their behaviours. And businesses, instead of trying to keep prices as low as possible to be competitive, start passing costs onto customers....who then in order to survive have to ask for pay rises, which causes businesses high labour expense, which results in even high costs/prices for goods and services within the economy......that results in workers asking for even high wages.......and a doom loop that is very hard to stop has started within the economy.
Hence why many are concerned that the Fed has waited too long to act now as if inflation gets entrenched in wage increases, then businesses will have to start pushing up prices of goods and services and so on and so forth....and the only tool that central bankers have to slow that down is to reduce the aggregate demand for goods and services within the economy....and aggregate demand happens when people feel 'wealthy' and want to buy goods and services......increasing interest rates makes most people feel less wealthy so they have less desire to chase the limited quantity of goods and services within the economy.....and yes its quite likely it could cause a recession.......but if you look at the history of the relationship between inflation, the effective funds rate/OCR, and recessions.....almost every time the central bank does what it is about to do, you end up with a recession.....but that isn't a bad thing despite what many people say.....recessions are actually a very healthy thing for an economy. It gets rid of zombie companies and bad debts from the economy....and the longer you avoid doing that essential clear out, the more painful the adjustment is when it comes....we should have had this back in 2020, but we managed to dodge the bullet by increasing aggregate demand by reducing interest rates....but central banks went too far and create too much aggregate demand for the limited quantity of goods and services....so we have had too much money chasing too few goods and services....hence if you look at that on a supply demand graph in that original video...you end up with price inflation.
Hope this helps.
No problem....good to get the brain back into some of the university macro econ theory by trying to explain these types of things.
Essentially there are two paths to get out of the rock/hard place that the Fed/RBNZ has put the world into with their crazy monetary policy back in 2020....
We significantly increase the quantity of goods and services that are produced within the domestic/global economy (i.e. high productivity) so that price equilibrium can be achieved with the increased aggregate demand that has been caused from the excess easy monetary policies of the last 2 years....(if that doesn't happen, equilibrium will be at a higher price point = more inflation).
But the Fed/RBNZ have obviously decided that isn't going to happen, so its decided path two, which is to assume we won't have an increase in productivity to offset the increased aggregate demand, so instead it is going to try and reduce aggregate demand itself so that equilibrium between the money in the system and the goods and services being produced finds an equilibrium at a lower price point.....this is called disinflation (not to be confused with deflation).
So they want to reduce aggregate demand and create disinflation so that CPI reduces back to the 1-3% band.
If you were logical/rational consumer in an economic model you would still pay $30 for a reduced amount of cheese and a rational firm would sell half sized blocks of cheese to enable this. It is more likely that you will spend extra on petrol from your finite income and less on cheese. Russians and Arab elites will make more money from you and NZ farmers less. Russians will then spend the money on missiles to blow up Ukrainian apartment blocks thereby spending the extra resources on wasting the resources of other Russian speaking peoples. Fossil fuel energy will be expended on the destruction of other fossil fuel intensive structures to no-one's eventual benefit.
It's really all about the oil price. I googled Brent Crude at US $119.78 today. That's not affordable for the majority of consumers and firms in the world today. Central banks are cutting credit and increasing the cost of credit so that reduces the ability of people to pay inflated oil prices. The idea is to kill off aggregate demand.
What I am seeing is the instinctive reaction of the world's elite is to kick the weakest links of the economic chain so that things can go back to normal. Trying to enable the Russians to squash the Ukrainians so that Russia can sell their oil on the world market again. Stopping the ability of poor people to spend money on fuel so that oil demand falls away and the oil price drops back to levels that don't stop globalisation.
Today's elites are lazy and neoliberal. They don't want to spend the resources to enable the necessary change to renewable energy in a pragmatic way. They don't want a democratic Ukraine, they want the peasants just to shut up and die.
The same laziness is apparent here. The govt doesn't want to face the fact that an affordable transition to renewable energy will require the investment of the state. That the state may have to backstop the oil and gas infrastructure in the (20-30 year?) interim of this changeover in order to maintain our standard of living. That the state will have to restrict the rent seeking behaviour of large private companies and iwi elites to enable the building of geothermal and smallscale hydro, solar and wind projects by medium scale private enterprises.
These necessary changes to allow the changeover are perfectly achievable, but the elites currently in power consider them bothersome and tedious. So these changes won't happen until the elites see that they will lose their fortunes to others if they don't move. Some of the more bloody-minded ones like the Rajapaksa's and Putin will probably lose everything because of their inability to perceive that the way things are working today is not the same as the way things worked out in the past.
It is my belief that this change will happen, whether in the Ukrainian meat grinder, the Sri Lankan elite housefires, someone blowing up the Nordstream pipeline infrastructure so that Germany can't physically buy more Russian gas or the New Zealand labour govt losing elections for the next nine years because they can't get their head around the overwhelming need for practical (rather than bureaucratic and interest group agenda based) solutions.
Anecdata admittedly, but talking to three clients last week they are seeing a big drop in demand.
Client 1 makes and sells a certain category of product into big box retailers and specialist stores. Their biggest retail store (part of a nationwide change) has seen a decline in sales in this particular category/department with sales dropping from an average $7k per day to as little as $1k per day. They are getting small purchases and the big orders from cashed up buyers, but the middle - bread and butter - has dried up.
Client 2 supplies a category of product to elements of the construction industry. Sales to commercial construction remain decent, but residential construction demand (once again their bread and butter) has dried up in a short space of time. They are almost in disbelief that the residential construction sector might ever slow down. Problems arising from house builds taking too long, and their customers not being in a position to complete the work (and so have no need for the product).
Client 3 periodically exhibits at an 'open to the public' expo/show where customers can browse and buy from multiple vendors at once. Many exhibitors reporting drastically reduced sales versus last year.
Some others doing better than ever, that being said.
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