COUNTERING ANTIDOTES

The annual rate of inflation, as measured
by the consumers price index, averaged modest 3.5 percent. Inflation rose sharply from that level in the 1970s. The first blast, from 1971-73, was ignited by the general prosperity New Zealand enjoyed during worldwide commodity boom. It was followed by the 1973/74 and 1979 oil shocks, when oil prices soared.
The economy was smitten by nasty but classic dose of stagflation. This phenomenon results, typically, if there is sudden increase in the price of imported raw materials (such as oil) or when spate of hefty wage settlements is unaccompanied by increased productivity.
Annual increases in the CPI averaged 12.2 percent in the 1970s and people responded by striving to preserve their real incomes from the corrosive effects. In turn, resulting from their persistent efforts to keep their incomes rising ahead of prices, the economy developed classic inflationary spiral.
The Muldoon government reckoned it had regulatory antidote and countered with the wage-price freeze of 1982, when annual CPI inflation was growing at more than 15 percent. But the economy was overdosed with interventionist medicine and the Labour government elected in 1984 opted to harness market forces to curb inflation.
The freeze was lifted but the thaw brought fresh problems, including stampede to restore living standards that had been eroded by the freeze. In 1985, most notably, there was clamour for big wage settlements. Inflation was given spurt, too, by the introduction of the goods and services tax.
Alas, these developments were accompanied by decline in output growth and the economy endured protracted recession. Inflation in the 1980s averaged 11.2 percent, peaking at more than 18 percent in 1987 but later in the decade was slowly suppressed by tight monetary policy.
The Reserve Bank Act 1989, requiring monetary policy to be directed only towards eliminating inflation, and the Employment Contracts Act 1991, allowing employers to be more flexible with their hiring and firing arrangements, helped to change things in the 1990s. Wage costs were trimmed while the economy grew steadily, until thrown back into recession by the Asian crisis and drought effects. Inflation during the decade averaged less than two percent.
And so we come to new decade, new millennium and talk of new phenomenon. We have had another oil shock but, more generally, there has been sharp depreciation in the exchange rate. The Kiwi dollar in June was 10.3 percent lower than in June last year, commensurately raising the costs of imports. Except for oil, however, pressure on the CPI has been remarkably minor.
Sure, it increased two percent in the year to June. But if that caused any fright, it was only because of the contrast with 0.4 percent decline in the annual CPI movement in the year to June last year.
Over the near term, the Reserve Bank’s monetary policy statement in August said, some further increase in tradeables inflation is likely, because the effects of rises in petrol prices at the pump and the cigarette excise tax increase have not yet been fully recorded in the CPI and because some effects from the exchange rate’s decline have yet to pass through.
More significantly, the Reserve Bank said: “Considerable uncertainty surrounds the magnitude and dynamics of the exchange rate pass-through, whose behaviour we have noted as something of puzzle for some time.”
So how come cost pressures caused by the exchange rate in the past two years have been so weak and so delayed? Partly, it is because businesses are being burdened by higher input costs but the market is much more competitive than in the past. Businesses are reluctant to pass on these prices.
As Institute of Economic Research economist Phil Briggs acknowledged, “the non-tradeable sector is really in bit of bind”. If firms want to retain their market share overall and see their way through to better days, which they probably assume will come in the next year or so, they will be keen to keep prices down. They will gamble on clawing back their profitability when demand picks up again. Whatever is happening, BERL’s Ganesh Nana reckons “it’s new ball game Ñ the new economy, the new paradigm, you can call it what you like, but there is new relationship between the exchange rate and consumer prices”. The cost-plus mark-up mentality of the 1970s has gone.
Maybe. But let’s not forget another 1990s lesson and consult the GDP regulator. Unlike the CPI, this is measure of the average price level of all goods and services produced in New Zealand, and it took about three years before the GDP regulator showed the inflationary effects of the initial 1993 oil shock.

Bob Edlin is Wellington-based economic commentator and journalist.

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