Why the politics of inflation could ultimately depend on supplies

Tuesday, 1 February 2022

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

Dileepa Fonseka is a Stuff writer on business and politics.

OPINION: Right before the local body elections in 2019, Kiwibank put out a regional scorecard assessing economic performance, and dealing with the tricky question of how things were going in Wellington.

Tricky because, according to the economic numbers, Wellington as a region was not performing too badly, and merited a score of 7.

But numbers said one thing, and the vibe on the street was something else; Kiwibank made a note that it was a 7 that “feels like a 5”.

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The rising cost of living is contributing to the strain on places like foodbanks.

The feeling was from a general sense that things were going backwards, that the city was a little stuck: startling cost blowouts were starting to pile up, there were murmurings of infrastructure concerns, and project completion dates were being pushed forever outwards.

A similar thing is going on around the world right now when it comes to inflation.

There is always the hope you can “inflate” away debt with inflation.

Inflation – the rate at which prices rise – has been running below target for many years across the developed world. Often, the problem has been too little of it, rather than too much.

In this context, two or three years of inflation exceeding targets, after years of undershooting, might not seem something to panic about.

However, inflation is flaring up at places where many feel it most. At the petrol pump, with prices jumping significantly between refills; and at the grocery store, with bills ticking up and shelves periodically empty.

In the United States, it is being capitalised on by opponents of President Joe Biden, with a lot of people noting much the same thing as Kiwibank said about Wellington back in 2019: that the economy is roaring ahead, but it still “feels” bad.

Grant Robertson is likely to face a lot of demands for more money for Government departments to keep up with rising costs.

There is likely to be no shortage of inflation-related headaches that await the New Zealand Government this year. For starters, where inflation goes, so too will public sector salaries.

Any unionised public sector workforce whose multi-year contract comes up for renewal this year will inevitably demand a much larger pay rise to keep up with the rising cost of living.

Then there might be a minor embarrassment coming from the linking of benefit increases to wages, rather than inflation.

The change was meant to help provide larger benefit increases, since wages have traditionally grown faster than inflation, but now that wage growth is lagging, that rationale might end up providing a lower benefit top-up.

And the finance minister might have less money to play with at the next Budget if demands from departments try to keep up with rises in inflation.

Expect demands for larger wage increases to keep up with the cost of living.

Still, it is not all bad. Inflation can make your GDP numbers look better on paper, especially when it comes to GDP-to-debt ratios, and governments have often tried to inflate away their debt over time.

Plus, there is always the hope that, over time, higher rates of inflation can act as a kind of painless wealth redistributor, eroding the real value of assets and debts, and reducing wealth inequality. However, this assumes that wage increases keep up with inflation, and interest rates don’t rocket up as inflation rates go up (both big “ifs”).

Wages will inevitably lag behind inflation, though, especially in a world where most of the workforce is not unionised. Individual employees are unlikely to try and renegotiate their contracts every time the consumer price index goes up a little higher than expected.

The unionised workforce is often locked in to multi-year agreements too, so they will not all lobby for a pay increase at once.

Then there is the source of all this inflation. Inflation is often divided into tradeables and non-tradeables, which is a handy division for categorising inflation that comes from offshore in the form of imported goods versus others produced onshore.

Yet the dividing line between the two is not so simple, with things like fuel costs sometimes forming an important part of input costs for non-tradeables.

So even if the Reserve Bank of New Zealand raises interest rates to curb inflation, the average consumer will still be at the mercy of supply chain issues and price movements overseas.

In the end, people may be forced to grin and bear it, alongside rising interest rates: swapping out goods they want for cheaper goods they can afford, or simply going without.

This will be far from painless if some of the user-generated money-saving tips in economist Tony Alexander’s recent report are anything to go by, especially for generations used to being able to take the affordability of consumer goods like toilet paper more or less for granted.

“Some shops will let you collect newspapers that haven't sold,” one reader suggested. “Cut into squares, put a hole through one corner, tie with string and hang on the toilet roll holder.”

Note to readers: you probably should not leave it at that if you want to use it as a toilet paper substitute, because “it needs a good crushing and rubbing before use and ideally not flushed”.

If more people are forced to turn to money-saving tips like these to handle the rising cost of living, things could get very ugly, in more ways than one.