Finance Minister Michael Cullen was among the movers and shakers who became uneasy when the annual inflation rate – driven mainly by the high price of fuel – rose to four percent in the June quarter while the unemployment rate declined to record 3.6 percent, creating obvious shortages of skilled staff. “The immediate outlook does not appear so rosy,’’ he said in speech in Tauranga. “Inflation pressures remain uncomfortably strong.’’
Dr Cullen’s concerns were reflected in rise in inflation expectations. Reserve Bank survey showed one-year expectations rising from 3.2 percent to 3.5 percent and two-year expectations lifting from 2.7 percent to 2.9 percent.
National Bank business survey respondents reported similar expectations and net 37.5 percent of firms reported they expected to hike prices in the coming three months.
“The recent fall in domestic petrol prices should provide some respite,” the National Bank reported in its August Business Outlook. Even so, the message across an array of gauges – producer output and input prices (+5.6 and 7.8 percent respectively), house prices (+12 percent) and so on – meant that inflation pressures remained “uncomfortably high”.
On the other hand, signs of slower economic growth showed up in firms’ own activity expectations in the National Bank survey. These had fallen to +6, the lowest level in five months, and levels below +10 typically foreshadow very weak growth.
Commenting on those survey findings, Bank of New Zealand economists said firms’ rising inflation expectations while activity expectations deteriorated created an extremely uncomfortable set of circumstances for monetary policy managers at the Reserve Bank. The overall outlook “reeks of the New Zealand economy’s stagflationary problems”.
New Zealand has not been alone in becoming uneasy about rising inflation. In Australia early in September, Treasurer Peter Costello said the government would be concerned if inflation and wages were driven higher by increased fuel costs. The annual inflation rate there was four percent, too, in the June quarter, five-year high. It was the first time in more than three years it had breached the central bank’s target of two-to-three percent.
“The important thing is to keep inflation low,’’ Costello counselled. “It would be concern to us if we had generalised price rises or generalised wage rises off the back of petrol increases.’’
In Britain, newspaper headlines declared: “Bank of England Faces Inflation Dilemma”. These told of survey from the Chartered Institute of Purchasing and Supply, which showed growth in the UK’s dominant service sector slowing for the fourth straight month to its weakest since last November, but inflationary pressures were mounting.
But let’s put things in perspective. An annual inflation rate of four percent and expectations of it remaining above three percent for year or so were causing disquiet largely because this would put it above the top of the one-to-three percent band decreed by the Government to be the target for monetary policy management purposes.
Let’s not forget that inflation rates in 1987 climbed as high as 18.9 percent. Mortgage rates then exceeded 20 percent and the 30-day bill rate (which averaged 7.4 percent in August) was just under 30 percent in April that year.
Our inflation rate is not out of whack with international trends: consumer prices on average rose by 3.1 percent in OECD countries in the year to July and by 4.1 percent in the United States.
Newsweek columnist Robert J. Samuelson helps put things further into perspective, albeit in an article he wrote two years ago. Over the past four decades, he noted then, the rise and fall of double-digit inflation had been the most significant force affecting the American economy.
Inflation rose from below two percent in 1960 to 13 percent in 1979 and then gradually descended to little less than two percent in 2003.
Going up, inflation generally harmed the economy, causing harsh recessions, stagnant stock market and lacklustre gains in living standards. Coming down, inflation generally helped the economy, leading to longer expansions, stock market boom and stronger gains in living standards.
The gains from purging double-digit inflation were “a great untold story”, Samuelson enthused. The benefits from the Federal Reserve’s staunch anti-inflationary policies – not from President Ronald Reagan’s tax cuts or President Bill Clinton’s budget policies – “mostly explain the [American] economy’s fabulous performance in the 1990s”.
“The economy must now move ahead without the powerful afterburners of soaring stocks or rapidly falling interest rates,” Samuelson advised. “These were the final chapters of the Age of Inflation. It’s over.”
Mind you, he concluded: “What comes next is anyone’s guess.”
Bob Edlin is regular contributor to Management.
