Orr agrees government spending feeding inflation, raising OCR risks recession

Thursday, 26 May 2022

Reserve Bank governor Adrian Orr discusses the risk of a recession in May.

Reserve Bank governor Adrian Orr has conceded that government spending is feeding short-term inflation and that “one of the risks” of raising interest rates is that it could force a recession.

But he qualified those comments at a select committee hearing on Thursday by saying that the Reserve Bank did not expect a recession and that the Government’s longer-term spending plans should reduce demand in the economy.

The Reserve Bank surprised economists on Wednesday by forecasting in a “hawkish” monetary policy statement that the official cash rate (OCR) could rise to about 4% by the middle of next year.

As was much more expected, it also raised the OCR by 50 basis points to 2% in a bid to drive down inflation, which is running at a 31-year high of 6.9%.

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Reserve Bank governor Adrian Orr says recession is “a risk” but not its core prediction.

National Party finance spokesperson Nicola Willis has laid some of the blame for high inflation and rising interest rates at the Government’s door, accusing it of putting “more fuel on the fire” through its spending plans.

Those include a $350 “cost of living payment” for low and middle-income wage earners which was announced in the Budget.

On Wednesday, Orr said that in the context of the broader inflationary pressures in the economy, the Government’s spending plans amounted to “small beer”.

Responding to National’s concerns at Parliament’s Finance and Expenditure select committee on Thursday, Orr did not attempt to hide a link, saying government spending was “putting upward pressure on aggregate demand and hence inflation now”.

But he maintained the impact was “at the smaller end” and said that pressure should reverse down the track if the Government met its fiscal forecasts, which include returning to an operating surplus in years from July 2024.

Orr voiced “discomfort” at being questioned on government spending.

“We don't get involved in fiscal policy. That is the Government,” he said.

One risk in the Reserve Bank threatening to raise interest rates much higher than it had previously proposed is that it could have a bigger hit on economic growth than the Reserve Bank is expecting.

The bank acknowledged in its monetary policy statement on Wednesday that “heightened global economic uncertainty and higher inflation were dampening global and domestic consumer confidence”.

Orr agreed at the select committee that the risk of a recession “internationally” had increased, saying that “could sheet home to New Zealand in different ways”.

“One of the risks” of the bank’s response to inflation was that it could force a recession, he said.

But he reiterated that was not its “core central prediction”.

A large movement in the construction or housing sector was one of the biggest recession risks, he agreed.

“The building sector has always been ‘New Zealand’s canary’; it’s either boom or its struggling,” he said.