By Geoff Bertram*
Economists working on macroeconomic policy – things like taxes and spending, interest rates and border controls on flows of trade and money – often refer to a set of key relationships governments can influence. In the textbooks, each of those relationships is drawn as a curve in a graph.
First is the IS (“investment–saving”) curve. This says that if everything else stays the same, the Reserve Bank can increase economic output and employment by lowering the interest rate. Or it can cause a recession by raising the interest rate. (For simplicity’s sake, the curves here are depicted as straight lines.)
Second comes the Phillips Curve, which is usually drawn sloping upwards to suggest that if everything else stays the same, inflation will rise during economic booms and fall in recessions. In other words, the Reserve Bank or the government can apparently bring inflation down by causing a recession.
Third comes the trade balance – the current account of the balance of payments (investment income and traded goods and services between New Zealand and the rest of the world).
If everything else stays the same here, as the exchange rate of the dollar falls, the current account strengthens by moving towards or expanding a surplus. If the exchange rate rises, the current account weakens: exports fall and imports increase.
However, it’s a mistake to suppose each of these relationships will stay where it is while the government and Reserve Bank each tinker with their own policy settings. So, what could go wrong?
The effect of austerity
Start with the IS curve – the way output and employment are affected by interest rates, assuming the government makes no big budgetary changes. But what if the government embarks on an austerity program, slashing its spending and cancelling projects, which shrinks the economy?
At any given interest rate, output and employment will be lower, shifting the whole curve “leftwards” towards lower economic activity (see above).
Even if the Reserve Bank lowers the interest rate, that won’t expand the economy because the government’s fiscal policy is killing off its expansionary effect. The recession created by the austerity program rolls on.
Along the way, it increases costs to government from unemployment, paying other benefits, and lower tax revenue. If the government responds with further austerity, we enter a downward self-reinforcing spiral.
Wages and inflation
Second, take the Phillips Curve and ask what happens if inflation isn’t, in fact, sensitive to how the economy is doing.
In this case, driving the economy into recession has no effect on the inflation rate. When the Reserve Bank changes the interest rate, inflation just stays where it is because the Phillips Curve is flat, not upward-sloping. Reducing inflation requires completely different policy interventions.
Back when the Phillips Curve was invented, it was reasonable to think inflation fell during recessions because workers could get higher wage increases in booms than in slumps.
Bringing on a recession would reduce the bargaining power of workers, result in slower wage growth, and thereby tame inflation (given that wages are an important part of the costs of production).
But workers today have lost the bargaining power they used to have when unions were strong and welfare-state thinking prevailed.
In a paper fellow economist Bill Rosenberg and I published this year, we show the bargaining power of labour was killed off in 1991 by the Employment Contracts Act and has not recovered since. Wages no longer drive inflation in contemporary New Zealand.
Interest rates and inflation
Could the Phillips Curve work because producers of goods and services push up prices and profits faster in booms and cut their margins in recessions?
It’s possible: there’s plenty of evidence of big companies using their market power to price-gouge consumers. But it’s not clear this exercise of market power is greater in booms and lesser in slumps.
In fact, the opposite could be true. Small businesses are most likely to be driven out of the market in recessions, leaving big companies with increased market share and less competitive pressure on their margins.
Forces both locally and in international markets have clearly been pushing the Phillips Curve down, producing lower inflation. Local forces include the current government’s abrupt cancellation of major construction activities, dismissal of public servants, the constant negative messaging on the state of the economy, and rising outward migration as a consequence of all these.
International markets, including falling prices for imports such as oil, have also clearly been pushing the Phillips Curve down. While the Reserve Bank will claim credit, it’s not at all clear the bank’s interest rate policy has made that much difference.
Finally, what about the international balance of payments? One thing the Reserve Bank can do by changing the interest rate is change the exchange rate between the New Zealand dollar and other currencies.
If New Zealand’s interest rates increase relative to elsewhere in the world, short-term money flows in to take advantage of the higher rates. This raises the exchange rate, and in turn weakens the external balance by cutting the return on exports and increasing the volume of cheaper imports.
Producers of goods and services that face international competition are squeezed. Meanwhile, what used to be called the “sheltered” or “non-tradeable” industries – including the big banks, insurance companies, electricity suppliers, supermarkets, consultancies – are unscathed.
'Sobering': Govt books sink further into the red than expectedhttps://t.co/zA1iDQGpcu
— Newstalk ZB (@NewstalkZB) October 10, 2024
Deeper recession
The Reserve Bank may not have much effect on inflation, but it can certainly affect the structure of the economy. Using the interest rate as the weapon against inflation squeezes manufacturers, tourism and farmers, but leaves non-tradables largely untouched.
Right now in New Zealand, the IS curve is remorselessly shifting left as the economy plunges into a deeper recession exacerbated by government austerity – an ideologically driven quest for instant fiscal surpluses, low public debt and a shrinking public sector relative to GDP.
Falling interest rates will struggle to make expansionary headway against that austerity.
Meanwhile, corporate profiteering and rising government charges continue to put upward pressure on the Phillips Curve, and the balance of payments is weakening. This means the country as a whole is piling up increasing debts to the rest of the world (largely through the Australian-owned banks).
The question is, does the current government understand where its policies are taking us?
*Geoff Bertram, Visiting Scholar, School of History, Philosophy, Political Science and International Relations, Te Herenga Waka — Victoria University of Wellington
This article is republished from The Conversation under a Creative Commons license. Read the original article.
30 Comments
Wages would have pales in comparison to the increase in government spending and mainly, the level of private debt magicked out of thin air by banks via residential mortgage lending. Cant hate on people for actually getting a wage they deserve, given the system is built to hold wages down.
The current NZ government is doing part of what is necessary to correct the financial mess the previous government left us. On the other hand, the Left believes governments can indefinitely stimulate the economy through borrowing and "Printing" money. It works fine for a short time but then results in the sort of inflation we have just experienced. Ultimately it leads to the kind of mess Venezuela and Argentina have experience.
If NZ gets a left government again in two years time, they will continue to borrow and spend, also bring in a wealth tax which will result in many people who invest in creating small businesses and professional people leaving for Australia.
With you on that, k-o;
https://writingtips.org/theres-none-so-blind/
And it doesn't help that the government drives their ideology as if 'a stick that must be used', or we're done for.
We have had an economy largely reliant on soaring house prices and massive population growth via immigration.
As house prices rise and punters think they're rich, imports surge as they buy new furnishings, cars, toys, etc.
Private debt has soared as it was the fuel for rising house prices. The tax take from this process made the governments books look good.
As this process goes into reverse, Government debt soars as the tax take reduces and other automatic stabilizers like benefits increase. NZ is not alone in this process and it will eventually have to end in default of some type as these debts are too large to repay. Also, there is not enough planet/ net energy left to facilitate the economic growth required to ever pay it back.
A great book on the subject is This Time Is Different by Reinhart and Rogoff that traces debt and default over 800 years. Once upon a time if a King ran up enormous and unrepayable debts, he would call in the creditor and have their heads removed, thereby cancelling the debt. This way out is obviously not practical at this point in time.
its not even a matter of paying it back... Simply servicing it is becoming near impossible.
We need to add more Debt, and we need more Debt to keep employment / consumption going. Thats the wheel we are on
But the game is now stuck between lowering interest rates to facilitate more Debt .... and raising interest rates to avoid inflation of all that new debt
And we stumble ever closer to the point where something will break
You are, well... talking sense!!!
NZ is already in a debilitating depression which would be painfully obvious to all of us if our bureaucrats didn't manipulate all of the data, using nominal figures and flat-out bare-faced lies, all of which is interlaced with fairy tales based solely on hopium.
Another word for our current situation is 'stagflation' - we are already technically insolvent with total debt (this includes unfunded liabilities) of well over 600% of GDP.
This doesn't even allow for the fact that our real GDP is plummeting as our economy becomes increasingly financialised. None of the political gamut has a single clue about this vital distinction between the real economy and the blatantly parasitic financial economy.
From Investopedia...
- "Stagflation is the simultaneous appearance in an economy of slow growth, high unemployment, and rising prices.
- Once thought by economists to be impossible, stagflation has occurred repeatedly in the developed world since the 1970s.
- Policy solutions for slow growth tend to worsen inflation, and vice versa. That makes stagflation hard to fight."
We don't appear to have disastrous unemployment rates... YET - but this situation has been masked largely by the fact that during the corporate-sponsored plandemic, we killed and maimed a significant percentage of the population.
Many who are not already dead have been permanently taken out of the workforce and now require considerable financial and human resources to care for them. Unless we undertake dramatic financial reform, our true GDP:Total Debt ratio will only go from extremely bad to worse.
Well what do you know - here was I thinking that honest non-shill economists in the Western world are about as common as unicorns, and then along comes Geoff with this epic article!
Qouted... "While the Reserve Bank will claim credit, it’s not at all clear the bank’s interest rate policy has made that much difference." - it about as clear as mud!!! - here's why...
As I tried to explain in my eCONomics sequel interest rates are a lagging indicator...
..."interest rate hikes are not an effective monetary tool to address inflation – on the contrary, they instantly feed inflation just as hikes in energy prices do – you do not even require the most basic economic nouse to understand this principle – it should be self-evident to anyone with an IQ even approaching room temperature."
https://globalsouth.co/2024/03/12/economics-part-iv-interest-rates-mani…
As Professor Richard Werner (another very courageous unicorn) points out, it is not interest rates, but bank credit that determines economic growth, simply because ~97% of the money supply in our Western fiat currencies is created out of thin air by privately owned commercial banks.
There is zero basis for the official narrative that higher interest rates lead to lower growth and that low interest rates lead to high growth.
As with most aspects of eCONomics the quickest way to get straight to the truth is to simply assume the 180˚ polar opposite of the official narratives.
Interest rate manipulation are simply not useful as a monetary policy tool – PERIOD!
Bravo to Geoff, and of course to interest.co.nz, for giving these home truths some air
Colin Maxwell
As long as we allow the private banking cartels to create money more than 90% of the money supply out of thin air, and charge us interest on it, then we will continue down this debt-trap vortex.
As I explained in the link below, the solutions are incredibly simple. However the road to get there is not - neither is the local financial/political architecture available just yet - I can see only two possible roads to achieve the necessary major monetary and fiscal reform...
#1 A total systemic Western financial meltdown, at least on the scale of the 1930s Great Depression, where the populace finally demands complete financial reform - including sound money and money creation mechanisms.
#2 The success of an alternative financial/security bloc like BRICS which offers a system that is divorced from the Western fiat system, is based on sound money, on banking operated as a public utility (the PBS), and demonstrates the fact that a country can transition away technical insolvency into financial sovereignty and long term wealth in as little as one term of government.
https://globalsouth.co/2024/02/09/solutions-to-the-western-train-wreck/
There is light at the end of the tunnel - economic history is riddled with examples of solutions that could release society from its perpetual debt bondage.
Cheers to all
Colin Maxwell
Get rid of the debt and you get rid of the standard of living we are used to ... its the debt that has allowed this complex pillaging of every corner of the globe to keep rolling and growing. Thats the big hurdle which no one will willingly choose to approach
You need an (output) surplus in an economy in order to have consumption. And we have long since substituted DEBT for growth in real output surplus ...
... and lamingtons ... isn't it truly amazing how some folk are in total denial of how close the Labour government came to bankrupting us as a nation ...
We have a small narrow based economy , we cannot afford to service the enormous debts that northern hemisphere countries can do ... Robbo was lucky Labour got a pummeling in the 2023 election , he got out before the sheer enormity of his profligate spending came to light ...
"We have a small narrow based economy , we cannot afford to service the enormous debts that northern hemisphere countries can do."
No Gummy Bear, those countries you refer to are technically insolvent too - NZ's total debt:GDP ratio is well over 600% even when we use horse shite data - inflation adjusted figures and sound GDP measurement would make this picture far more bleak.
Last time I checked, the biggy Western economies ranged from 600% up to a mind-numbing 1200%. The only major econmmy I could find that was not technically insolvent was Australia - which from memory was languishing at around the 250% mark.
That figure is around one third of the average for major Western economies. That too is inexcuseable, given their vast mineral reserves along and relatively modest population base.
If Aus had kept their CBA PBS model, they could have been far and away the most wealthy nation on the planet.
https:/www.facebook.com/colin.maxwell.129/posts/pfbid02uyCHsox57AVaPrfvtKAgLJS…
With respect Kiwi, none of this is about the colours of the political gamut.
At the end of the day, the dominant NZ parties are all neoliberal grovelers who serve the plutocratic status quo. They all have vested interests in the bankster's perpetual pump-and-dump cycles, and the blowing of monumental asset bubbles.
What National has done to date, in their current term, is the equivalent of fiddling with the breakfast menu font on board the Titanic during its inaugural dash across the Atlantic.
Historically, National has always been the nemesis of any sound money or banking reform. This dates right back to the 1930s when we briefly enjoyed one of the most brilliant central bank policy blueprints on the entire planet.
Under the bankster John Key (AKA The Smiling Assasin), National basically destroyed the brilliant Kiwibank model - this was this country's most recent foray into the PBS (Public Banking Solution) - IOW, a complete no-brainer as a serious foundational step towards effective monetary reform.
But no, instead we chose to continue to pay the giant global banking cartel of trillions of dollars in unearned interest. Obviously, this in turn allows them to to buy up everything they desire - including the MIC, media narratives, Big-tech, Big-pharma, politicians, indeed entire parliaments - that includes 'NZs' too, and yet still more than 90% of our population cannot make this simple connection.
There are answers to all of this.
"The question is: "what is the right thing to do now for future generations?" The self-evident answer is to deflate the financialization bubble, defang its predatory tools, and take the lumps now rather than dump the ever-expanding destructive consequences on the next generation, or we can wait for the inevitable collapse of the bubble and then clean the nation's financial house of both the wreckage and the causes of the catastrophe, financialization. Either way, the implosion of the Everything Bubble will occur and the suffering will be great."
https://www.oftwominds.com/blogoct24/finance-economy10-24.html
Quote: "But what if the government embarks on an austerity program, slashing its spending and cancelling projects, which shrinks the economy?"
And: "... government austerity – an ideologically driven quest for instant fiscal surpluses, low public debt and a shrinking public sector relative to GDP."
This core premise of this article, is both wrong and more than a little pejorative.
Putting short term effects (a so called sugar rush) aside, reducing the amount of capital compulsorily taken away from citizens as taxes (or worse, borrowed) and spent by an administrative bureaucracy operating largely in a non-competitive paradigm, is positive for medium and long term productivity. Such reductions in non productive state activity leave capital available to be invested productively by the private sector.
The government multiplier is very low or more usually negative, whereas the private sector multiplier is much higher. Careful and thorough empirical studies have confirmed this. See, eg, Bergh and Henrekson (2011).
No, it redistributes it; government activity does not create new capital but absorbs existing capital and deploys it less productively than if citizens hadn't been taxed in the first place (during the time the state is spending that cash). State taxation and spending crowds out private investment. Spending money on endeavors that do not create an income stream (which describes most of what government does) is in aggregate inflationary - see, for instance, when he was chancellor Nigel Lawson identified prior government deficit spending, which had been almost entirely non-productive, as the key driver of inflation. Intuitively as well as empirically that is correct.
I have provided a reference. Your assertions lack basis in empirical data or rigorous studies.
You said - "No, it redistributes it; government activity does not create new capital but absorbs existing capital."
With all due respect, this is where you miss the elephant in the room, MacroView.
If NZ used half a brain, we would use the PBS model and avoid borrowing from the international private banking cartels like the plague.
In this model, well-planned Government projects don't require extra capital from anywhere - liquidity is not penalised either, neither is this capital created as debt, and no third parties extort unearnt economic rent (AKA interest) for doing precisely nothing.
Infrastructure can be built in a much more timely manner and obviously at a fraction of the cost compared to long-term borrowing from the private sector.
Neither is this economic activity inflationary - on the contrary, it greatly stimulates both money velocity and the productive economy - leaving the parasitic financial economy to find other victims to entrap.
State taxation and spending crowds out private investment. Spending money on endeavors that do not create an income stream (which describes most of what government does)
You describe our healthcare system, the Police also. Both spending that doesn't bring in a profit but brings a societal benefit in terms of longevity and deterrent and punishment for those why break, and who have broken the law. The goal and outcomes are not always is not always profit, and if supported by society, will continue to operate how they do with fiddling to find efficiencies where possible. But these are sectors that won't change in this respect unless one was to privatise the police force, or remove public healthcare outright. For clarification, I'm not arguing which of private and public spending is more productive, simply pointing out that there'll always be the need for public spending and ergo taxation to cancel this out.
Refreshing article and, good lord, I hope someone in Govt takes the time to read and understand it. I am not a big fan of the I-S stuff, but there is no denying that holding Govt spending back and RBNZ keeping their foot on the neck of credit is the world's stupidest response to a current account deficit that has blown out because of mainly non-substitutable import price rises (fuel, tech, services). It's a recipe for deepening recession.
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