Rising demand, withering supply, lifts inflation risk: BNZ

By NZPA

Thursday 22nd March 2007

A clash between rising demand and a withering ability to supply is a recipe for higher inflation, the Bank of New Zealand is warning.

Productivity was sagging under the weight of an over-extended and imbalanced growth phase, jamming New Zealand's economic speed limit into low gear, senior markets economist Craig Ebert said today.

Official data out last week put the rise in labour productivity in the year to March 2006 at a record low 0.4%.

Amid such a poor productivity performance, economic growth had relied even more heavily on extra inputs to give the impression of advance, Ebert said.

The labour input, basically total hours worked, was up 0.9% in the year to March 2006.

"We're working harder, in other words, not smarter," Ebert said.
Productivity typically struggled when the economic phase became over-extended and imbalanced, as New Zealand's surely had during the past couple of years.

Factors included "marginal" workers, high labour turnover typical of a tight labour market, a cruise mode in the belief that everything was "sweet" and sustainable, and supply bottlenecks.

There was also a switch to relatively unproductive sectors catering to basic consumer spending, away from the more productive and higher wage industries, including exporting.

The issue raised serious questions about perceptions, including those of the Reserve Bank, of how fast the economy could expand without fuelling higher inflation, Ebert said.

"It (the Reserve Bank) continues to have far too rosy an estimation on New Zealand's potential growth, meaning it's failing to appreciate the degree of excess demand pressure in the economy -- now, and for the coming year or two."

The latest productivity report implied a clear slump in potential growth.

The unemployment rate of 3.7% was already incredibly low and seemed more likely to press further downward this year, than ease up to any material degree, he said.

At the same time capacity utilisation remained near the highest levels of the past 30 years or more.

Serious wage acceleration was under way, particularly when looking at total unit labour costs.

Nominal wage inflation was running around the 5% to 5.5% mark.
The proxies for unit wage costs, the labour cost indexes, had picked up to just above 3% a year, and to above 3.5% when the second half of 2006 was annualised.

Adding in faster increases in non-wage costs gave the impression that total unit labour costs were testing 4% a year, Ebert said.

But something around 2% was needed to be consistent with the midpoint of the Reserve Bank's 1 to 3% inflation target.

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