Economist Brian Easton takes a government-eye view of the 'cost of living crisis'

This is a re-post of an article originally published on pundit.co.nz. It is here with permission.

A conversation between a minister and advisor.

Come in, Sit down.

Thankyou Minister.

We have to deal with the current crisis. You know what a crisis is?

No, actually I don’t, Minister. I looked it up in a dictionary. None of its answers matched the way the term is used in public.

Exactly. It’s about perception rather than reality. It’s a term used when something is going on which people don’t understand but they think something should be done. Now, about the current crisis.

Which one Minister?

What do you mean which one?

The public is fickle and jumps from crisis to crisis. Some describe any incident as a ‘crisis’, proposing exactly the same policies. I made a list of current crises. There are thirty-one on it.

Well, the one at the top of the list.

The list is alphabetical order, so at the top is ‘avocados; shortage of.’ ‘Apprenticeships’ are further down in the ‘Megapolytech merger’ crisis.

I mean the ‘cost of living’.

It’s there on the list, Minister, in with other ‘C’s like ‘co-governance’ and ‘climate change’. The trouble is that there is no rigorous notion of ‘cost of living’.

Don’t economists have one?

No. When I was trained, I was taught to avoid the term like the plague. That is why the notion is so popular; it can mean anything. Like much public discussion it is a slogan to justify some public policy like income tax cuts, or capital gains and wealth taxes, or cutting government spending, or increasing government spending.

Whatever you were taught, the public thinks there is a problem and expects me to deal with it.

But what is the problem, Minister?

That’s what I have advisers for.

As far as we can assess Minister there is a confusion of three issues. Some people think their incomes are too low compared to their purchasing power.

Everyone does.

Yes. Some shout louder than others. Those who shout least tend to be the least well-off – which is why, I suppose, nobody addresses their concerns. A second group are not getting their usual real income increases because the economy is growing more slowly. A third group are experiencing cuts in their purchasing power.

I thought everyone was in the third group.

That’s the way the public rhetoric tries to present it, especially if it is trying to promote some policy or promote self-interest, but it can’t be true.

Well, how many are in the third group?

We don’t know. The data base does not exist and even if it did, it would be out of date. Distributional economics is quite tricky which is why everyone depends on anecdotes, like the shortage of avocados, even if the poorest never buy them.

But some key voters do. Who do you think are in the third group?

There seem to be two main categories. First there are those whose incomes have not been rising as fast as consumer inflation and second there are those who are facing higher interest rates on their house mortgages.

So it is rising consumer prices and debt servicing? That sounds like it is the Reserve Bank’s responsibility.

That was the idea behind the 1989 Reserve Bank Act, especially as it shifted responsibility for inflation from the politicians to the RBNZ Governor. But the public never bought that one, so you remain in the gun, Minister. In any case the economic theory on which it was based was never very robust.

Why did economists not tell us at the time?

Some did but they were shouted down. The public loves a theory which is simple, direct and wrong. The current inflationary pressures are quite different from those the theory was about.

Should we not be dealing with the pressures?

If we can. But we don’t control the weather, we don’t control international supply chains, we don’t have much influence over our import prices, and international interest rates are rising too. We did not start the invasion of Ukraine.

Tell me. I hope this does not seem a stupid question, but how do we expect the Reserve Bank, to deal with these pressures over which it has no control?

I told you it was not a very good theory. What the Bank is actually trying to do, is make sure these pressures do not trigger a permanent inflationary regime.

But I still don’t get it. There are a group they think are worse off. The Bank has said it wants them to have even lower incomes.

It’s a kind of ‘the flogging will continue until morale improves’.

Even so, we have households – voters actually – suffering from higher interest rates. So we are increasing their debt servicing further.

It’s partly because world interest rates are rising and we cannot lag too far behind. They are rising as everyone unwinds the massive borrowing we did as a part of the fight against Covid. But it is also because it is the only policy instrument the Reserve Bank really has.

Does that mean we should use other policy instruments.

You can try, Minister.

So I cut taxes?

How are you going to pay for the loss of revenue?

Cutting government spending?

But what? That’s handwaving that opposition parties do – never any specifics of course; not enough to cover the gap from the tax cuts. Every budget cycle, the government goes through a detailed, onerous review of government spending which identifies areas which can be cut – useful gains but never enough. Of course you could abandon some of your big projects; they can make a difference. We no longer have your media-merger on the crisis list, Minister.    

We could borrow.

We did that as a part of the fiscal package to deal with Covid. Borrowing can be kicking the can down the road, loading costs to haunt future generations. The Covid cans are haunting us at the moment. They add to the risk the country faces if there is another global financial crisis – a real crisis.

Will there be another one?                                                     

That’s a question which haunts your economic advisers. We hope one will not happen soon. But it is fifteen years since the last one.

Well we have to do something. Our political discourse requires the government to deal with crises. If we are not seen to be doing anything, the other side gets elected.

And they will be equally as effective.

I have a speech on the cost of living crisis next week for a business breakfast for avocado growers. Will you get me a draft setting out what we have just decided?

Yes Minister.

*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.