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The O'Brien Column: Retro 1970s stagflation only a possibility - not a prediction

Friday 13th October 2000

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Ah, stagflation. The word Reserve Bank governor Don Brash used last week brought back memories of days gone by.

Days when many of the current crop of financial markets' dealers and organisers of advertisements from 700 "young" New Zealanders were being toilet-trained before issuing forth into a cruel world.

Days when a young Don Brash returned to New Zealand as general manager of Broadbank, one of the early merchant banks operating after well known financial sorcerer Robert Muldoon deigned to relax the rules.

Days when New Zealand had an inflation rate of more than 10% for years, interest rates tracked the inflation rate, there was little economic growth and finance ministers regularly issued regulations setting investment ratios for financial institutions.

There was none of the current nonsense about the New Zealand currency going up and down against others and smart young people trading dollars with no reference to the state of the underlying economy.

The government set the exchange rate through re-devaluations, including a 19% devaluation in 1973 when stagflation hit.

Sharemarket investors did not have to react immediately to overseas institutions dealing in the shares of New Zealand companies. Such activity was strictly controlled and there was also little interest from the overseas people.

A nice, cosy setup, except for that stagflation. New Zealand's inflation rate was above 10% from 1972 until the end of that decade and into the 1980s, when it peaked after the economy was opened up and the one-off effect of GST was absorbed.

Inflation was 15.7% in calendar 1975 and fell slowly to 10.1% in 1978 before moving up again.

It was no coincidence there was another devaluation in 1975 of 15% (note the closeness of the inflation rate) as the then government tried to deal with the effects of imported inflation, arising mainly from substantial hikes in oil prices in 1973.

The government changed in 1975, but that was about all that changed. Economic growth was minimal or negative, inflation was high and interest rates rose to compensate for inflation.

We, and other countries, had stagflation and had had it for some time.

Government deficits ran high, unemployment was increasing and there was considerable emigration among younger age groups.

The last point shows, in relation to arguments in the past couple of weeks, there is nothing new in the ebbs and flows of human and economic activity.

Dr Brash's comment about stagflation seemed to be more a warning of a possibility than a prediction it would happen. There are more resemblances to the 1970s in the current situation than young people going overseas, which they have done since the days of Ernest Rutherford and Katherine Mansfield.

Oil prices rose substantially over the past year and the dollar fell in relation to other currencies. Read "dollar was devalued" for the latter point.

Higher oil prices led to increases in oil-based imports such as plastics and other products with an oil connection.

The dollar's recent market decline (devaluations in 1973 and 1975) further increased the price of oil and any other goods price-denominated in US dollars. There will be more of that as importers buy at new prices.

Rising prices for imports affect internal consumer activity which in turn can affect general economic growth.

Improved export receipts offset that point, particularly as exporters are enjoying the double benefits of higher commodity prices, as such, and the lower (devalued) New Zealand dollar.

The new generation since the 1970s could have thought Dr Brash was talking about some dreadful condition afflicting deer when he referred to stagflation but they should take note.

Dr Brash and many others lived through stagflation and did not enjoy the experience.

There are tools available now to minimise the effects of high inflation and low growth but they come down eventually to questions of balancing positives and negatives.

That is another difference from the 1970s when governments floundered from one intervention policy to another, culminating in the 1980s when the late Sir Robert employed price freezes, wage freezes, interest rate controls and subsidies among other techniques.

People who criticised Dr Brash for his reference to stagflation or praised him in the hope of embarrassing the government are in the position of those in the saying about the message and the messenger, with the twist that those who praised overdid the message.

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