Inflationistas get their day in the sun, but what should the Reserve Bank do about it?

Tuesday, 16 November 2021

Econ Talks - inflation spikes to 4.9 per cent in September quarter.

OPINION: Just as economists have predicted nine out of the last five recessions, “inflationistas” have surely predicted just as many inflation spikes that never materialised.

Yet every oracle has its day, and there are signs the broken clocks that chime “inflation” every time an unexpected bout of government spending occurs might be about to have theirs.

In advanced economies, inflation debates often come with a lot of political baggage, where big-spending left-wing governments are seen as more inflationary than their right-wing counterparts.

People on the right of politics prefer to use inflation arguments to nix government spending plans, rather than getting into a debate about whether those spending plans are any good.

* How rising inflation could disrupt the world’s economic policies

The inflation spikes prophesied by “inflationistas” just might have arrived.

* Homeowners underestimating scale of home loan rate rises to come

* What's next for interest rates?

But inflation isn’t just about how much money you print; it’s about how quickly it is spent, and a couple of big trends have really slowed down spending until recently. These include demographics (older people spend less), globalisation (disruption has driven down prices), and debt (paying it off takes cash out of circulation).

All of these factors are why, for a long time, those stoking inflation fears have been wrong.

Fisher Funds head of fixed interest David McLeish remembers when the inflationistas last got it wrong in a big way: 2014, when Reserve Bank governor Graeme Wheeler hiked interest rates four times in a bid to tame inflation, then reversed those hikes the same year.

David McLeish says the call on inflation comes down to how you see Covid-19 playing out.

“There have been a lot of false starts when it comes to inflation … those false starts have persisted since the 1980s.”

This is why some have not been too worried about inflation for much of the Covid-19 pandemic, but the current false start is looking more real with every headline.

Last week, the United States posted a 6.2 per cent consumer price index increase, an inflation ascent so rapid nothing like it has been seen in 30 years. Bank of England governor Andrew Bailey says he is “very uneasy about the inflation situation” and came close to voting for a rates hike.

Over here, where the Reserve Bank is supposed to be trying to keep inflation between 1 and 3 per cent, inflation jumped 4.9 per cent in September.

McLeish admits inflation could be more permanent than he first thought, and says in the end it comes down to a judgment call about Covid-19, and how likely many of the pandemic’s effects, like supply chain disruptions, are to persist.

Zero covid has become a point of pride in China.

The “zero covid” policies in Asia have amplified some of these disruptions, and are a big part of this calculation.

Zero covid means strict containment measures and a conservative approach to testing, using painful Covid-19 testing methods.

These invasive tests are harder to run, and the population at large is unlikely to get tested.

A series of interest rate rises have been foreshadowed by Reserve Bank governor Adrian Orr, but will the painful hikes tame inflation?

This limits surveillance testing and means, when a case is picked up, the virus might have been circulating for quite some time, so a strict lockdown may be the only way to stop the spread.

Which is why China has had to shut down two major ports this year to contain outbreaks. On another occasion, hundreds of flights were cancelled after workers tested positive at the country’s largest cargo airport.

All of this disruption is flowing through to China’s manufacturing sector, with producer price inflation – the cost of goods sold by manufacturers and producers – running at highs not seen since 1995.

Now that “zero Covid” appears to be a source of national pride for China, there are worries such disruptions could become a permanent feature of the global landscape.

Facing these longer-term problems, central banks seem to be backing away from trying to see the “whites of the eyes” of inflation, with New Zealand’s Reserve Bank seemingly the most hawkish.

It clearly feels its credibility as an inflation-tamer is at stake. Not an unreasonable fear, given credibility is worth a lot when it comes to inflation.

A recent International Monetary Fund report showed how inflation could have reached much higher levels during this pandemic if central banks in advanced economies weren’t taken so seriously.

By and large, producers and firms believe central banks in advanced economies will keep inflation under control.

The point McLeish makes is what, if anything, will the Reserve Bank achieve by increasing interest rates?

Home ownership rates are at their lowest in almost 70 years, meaning fewer households hold the mortgages that are directly impacted by these rate hikes.

And if the increases go ahead, McLeish says the most indebted households, or households with the lowest savings rates, could face a double whammy of higher prices coupled with restricted credit.

To make things worse, the price increases, which largely stem from factors outside the Reserve Bank’s control, will probably happen regardless.

“[Indebted households] can’t draw on their savings to maintain their purchasing activities. They immediately have to tighten their belts because they’re essentially spending all that they’re earning,” McLeish says.

He is right to ask these questions. Just because the inflation bell has finally tolled doesn’t mean the same old tools will be useful in the fight against it.