David Seymour and Nicola Willis question whether the Reserve Bank is downplaying the inflationary impact of Government spending

Parliament’s Finance and Expenditure Committee has challenged the Reserve Bank of New Zealand over its view that Government spending won’t make inflation worse.

The central bank’s Monetary Policy Statement, released on Wednesday, lifted the official cash rate to 5.5% and said that level was expected to be high enough to halt inflation. 

This was a surprise to economists and financial markets which thought extra spending in Budget 2023 and high migration would require higher interest rates, closer to 6%. 

In a press conference on Wednesday, Governor Adrian Orr said fiscal policy was “more friend than foe” to the goal of bringing annual inflation back to 2%.

On Thursday at a meeting of Parliament’s Finance and Expenditure Committee, ACT party leader David Seymour took issue with that comment.

He said it was difficult to square that view with the $10 billion of borrowing Labour has planned over the next two years in Budget 2023. 

Orr said the central bank looked at the fiscal impulse across the forecast period, which shows a decrease in real spending levels over the next few years. 

“The level of government spending is rising, it just isn’t rising as fast as inflation and we are predicting it will fall by 5% over the prediction period as a percentage of GDP”.

The governor, who is known for his combative communication style, also criticised the media for what he saw as sensationalist reporting.

“I love the sound bites and I note that despite having produced a document that is significant on insight and effort, the one soundbite that makes it to the New Zealand Herald is ‘friend or foe’.” 

Hook, line, & thinker 

National Party deputy leader Nicola Willis said fiscal policy settings were expected to support demand and inflationary pressure in the 2023/2024 fiscal year, according to the Treasury. 

Again, Orr said the central bank was focused on a two or three year horizon during which fiscal policy, for the purposes of economic modelling, was negative.

At times, the exchange between Orr and, in particular, Seymour was almost antagonistic.

The Act Party leader said it “didn’t seem plausible” that fiscal policy could be helping to fight inflation in the next two years, and asked if the Governor had meant to say four years. 

Orr said there was net positive fiscal impulse from Government spending in the first year then a “strong net negative” for the following two years that make up the projection period. 

Monetary policy decisions take more than 18-months to take full effect in the economy, so rate changes made now are based on expectations of economic conditions in the future. 

“When we set interest rates today, the impact for inflation won't be seen for at least 18 months to two-and-a-half years ahead. So, we always have to think about what is the net expected spending two and a half years ahead,” he said. 

Seymour said government spending as a percentage of GDP was forecast to be 32.5%, 33%, and then 32.5% over the next three years.   

“And yet, you are unwilling to criticise the effects of government expenditure on inflation”. 

Orr said the bank was concerned about persistent core inflation, which was driven by spending in the local economy. 

“So domestic spending, and government spending, is a big part of the core inflation pressure — which is why we have restrictive interest rates,” he said. 

Manufacturing consent

Willis asked if it was appropriate for the Minister of Finance, Grant Robertson, to have said in an interview that the Reserve Bank would not have to lift rates as a result of Budget 2023. 

Orr said he had “utter confidence” in the bank’s operational independence and uninfluenced decision making, but didn’t comment on whether the remark was appropriate.

Chlöe Swarbrick, a Green Party MP, asked if the Reserve Bank was still “manufacturing a recession” as it had implied during a committee meeting in November last year. 

Orr reiterated that the goal of monetary policy was to bring supply and demand back into balance, which requires some slowdown in the economy.

The Reserve Bank forecasts economic activity will be flat, if not slightly negative, while Treasury forecasts it will be flat, if not slightly positive. 

“These are so within the bounds of being irrelevant — the main point is aggregate demand and spending will be flat,” he said. 

“That will feel painful for people. We love to consume. But it's necessary to take the inflation pressure out of the economy”.