Sharechat Logo

What goes up?

By Donal Curtin

Wednesday 29th June 2005

Text too small?
Talk to the person in the street and you'll get two radically different takes on New Zealand's inflation rate.

One is that we are overreacting to an illusionary inflation problem we don't actually face, and there's no good reason for mortgages to be as expensive as they are: our inflation rate is low, and there's no call for our interest rates to be so out of whack with other countries'.

And the other reaction is exactly the opposite: folks point to the official inflation rate (a rise of 2.8% over the 12 months to the March quarter) and say they're baffled where the low official figure comes from: their household bills seem to be going up a lot faster than that.

The truth is that we do, indeed, have an issue. Our inflation rate is already a bit higher than many countries we compare ourselves with - Australia's rate is 2%, as is the Eurozone's, while the US's is 1.7% and Britain's 1.1% - and that's despite the effect the strong Kiwi dollar has had in keeping our inflation rate down. Without that windfall benefit, we'd be looking downright bad by current international standards.

That can be seen from the 'tradables' and 'non tradables' numbers that Statistics New Zealand calculate. Tradables inflation captures things that benefit from the high dollar: over the past year, tradables inflation is a piffling 0.8% (and prices actually fell in the March quarter). The sharply falling prices of consumer gadgetry such as digital cameras have also helped: household appliances and equipment now cost 4.6% less than they did a year ago.

Look at non tradables, however, which cover a lot of the domestic economy, and inflation is a rather more alarming 4.2%. This helps to explain the scepticism of many households about the official 2.8% inflation rate. If the bulk of your recent spending has been on the likes of school fees, health, the electricity bill, or anything to do with the housing trades, then for you inflation has indeed been closer to 5% (not helped by central and local government charges, which are up 4.6% over the past year).

On the face of it, this strong domestically sourced inflation is bad news: we can do without a swathe of domestic prices rising by 4% or 5%. At the same time, when you look at what has been causing this rise in domestic prices, you find something quite positive about the way our economy works these days.

Grab any recent monetary policy statement by the Reserve Bank, and you'll find a graph which explains what's been going on. The graph links domestic, non-tradables inflation to whether the economy, at any point in time, is growing faster or slower than usual (where 'usual' is measured by our longer-term average rate of economic growth). There's a lag - domestic inflation reacts to unusually fast or unusually slow economic growth with a lag of about six months - but otherwise the link between the two is very close indeed. Our current high level of domestic inflation largely reflects the strong economic growth of 2004, as the economy hit capacity bottlenecks of one kind and another (notably the availability of staff, as unemployment dropped to 3.6% despite substantially more people entering the labour force).

Where's the positive side to this? It's that the relationship is symmetric: our domestic inflation goes up when we're growing rapidly, but equally it falls when the economy is growing more slowly than usual. In late 1998 and early 1999, for example, the economy hit a weak patch in the wake of the Asian crisis: GDP growth in the year to March 1999 was only 0.5%. Non-tradable inflation dropped to almost zero.

What this shows is that the economy has become considerably more flexible; prices of all kinds are more responsive to demand and supply conditions than they used to be. And that's a change for the better from the economy of the 1970s and 1980s. Then, inflation was embedded and structural. It didn't get better when the economy cooled: it was permanent, sustained by fiscal and monetary indiscipline and by the rigid goods and labour markets of the time.

That's the good news - the bad news is that the head of steam that the economy built up in 2004, and which is likely to have carried over at least into the first quarter of this year, means that, with its usual lag, the domestic inflation rate will remain high for the rest of this year. And that's without factoring in any additional unpleasantness should the Kiwi dollar go pear-shaped. Those folks who reckon that the Reserve Bank is starting at shadows need to think again: it's got a real issue on its hands.

  General Finance Advertising    

Comments from our readers

No comments yet

Add your comment:
Your name:
Your email:
Not displayed to the public
Comment:
Comments to Sharechat go through an approval process. Comments which are defamatory, abusive or in some way deemed inappropriate will not be approved. It is allowable to use some form of non-de-plume for your name, however we recommend real email addresses are used. Comments from free email addresses such as Gmail, Yahoo, Hotmail, etc may not be approved.

Related News:

NZ dollar holds gains on improved dairy, bank capital outlook
MARKET CLOSE: NZ shares gain; banks rally on Reserve Bank capital decision
NZ dollar rises; bank capital rules less harsh than expected
RBNZ relaxes capital requirements, allows preference shares, extends phase-in
NZ dollar extends gain amid mixed US data, possible trade progress
MARKET CLOSE: NZ shares dip on eve of major regulatory decisions
NZ dollar sees off global headwinds, holds above 65 US cents
NZ dollar holds above 65 US cents; dairy auction prices mixed
Dairy index falls on weaker butter, milk fat demand
MARKET CLOSE: NZ shares join global decline; US tariff move weighs on exporters

IRG See IRG research reports