'60% of the way to wage-price spiral and hyperinflation Armageddon,' economist says
Tuesday, 8 November 2022
On a scale of zero to 10 – with zero being normal and 10 being wage-price spiral induced hyperinflation and economic Armageddon – we are at six, says Infometrics chief forecaster Gareth Kiernan.
It is the closest New Zealand had been to this type of economic threat during his career, Kiernan said.
“I think inflation peaked at 5.1% prior to the global financial crisis, but even that inflation was much less widespread and pervasive than what we’ve got at the moment,” he said.
“I feel like we are a little beyond that tipping point where inflation will naturally get back under control, and that’s evidenced by the evolution of interest rate forecasts over the last couple of months, and how quickly they’ve had to be revised up.”
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He said the key thing to watch was how effective the Reserve Bank’s official cash rate hikes were in keeping behaviour under control, and changing expectations about how long high inflation would continue.
The longer people expected inflation to remain high, the more likely they were to demand higher wages, he said.
“I think that’s the biggest risk that you run now – people are going: ‘Right, OK, inflation is running at 7.2%, the labour market is tight, so you can turn up to work and tell your boss you need a 7% pay rise’.”
He said he did not predict a 1980s-style runaway situation, because the Reserve Bank had made inflation fighting its number one priority.
“But I think they’ve been too relaxed in late-2021 and early-2022, and I think you’re sort of bearing fruit from that.”
Kiernan said in the past during periods of inflation, companies did all they could to avoid passing on costs because they feared losing market share, but today businesses were granting the pay rises, and simply passing the cost on.
He used an example of why this was being allowed to happen. “Say you turn up to the supermarket and something gone up in price again – well it only went up last month by 50 cents or a dollar, and you say, ‘well I’m kind of used to that now’, and I think that’s kind of what businesses are relying on.”
“I’m not saying they’re gouging, don’t get me wrong, but it’s a function of being in an environment where you are able to pass cost increases on, which is very different to seven or eight years ago when no one wanted to put up their prices because they were worried about losing market share.”
If that mentality were allowed to continue, Kiernan said the end point was an accelerating spiral.
“Then we get into the situation where you come back in a year’s time, and you still have inflation running at 7%, and you want another 7% pay rise, and that’s what the wage-price spiral ends up being.”
Kiernan said until the Reserve Bank had convinced workers that inflation was heading in the right direction, the risk of such a spiral remained “very real”.
He said most economists expected inflation to ease, but the rate may not get below 3% again until 2024, or later.
Kieran expected annual inflation to reduce slightly to 6.7% when the December quarter figures were released in January.
He said easing the pressure on the labour market would be key to getting inflation under control faster.
Unemployment is currently running at 3.3%, near a historic low, and below what is considered a sustainable level.
ANZ economist Finn Robinson said this was teamed with historically high labour force participation, which meant there was little ability domestically to increase the available workforce.
“As much as a really strong labour market is great news for workers, it is just adding more to that inflation pressure,” he said.
“It does reinforce the Reserve Bank has to be pretty quick to resolve the supply demand mismatch in the labour market,” he said.
“Low unemployment is great, but we still have so many job vacancies compared to unemployment.”
Robinson said the country was on the road to a wage-price spiral.
“It’s certainly fairly well-developed, and I think in the absence of the Reserve Bank trying to suppress demand in the economy you would just see wages and prices feed off each other in that loop,” he said.
The spiral so far was manageable, and containable by the Reserve Bank, but to keep it in check would require an official cash rate of about 5%, Robinson said.
He said the bank economists’ forecasts had inflation easing off while wage gains stayed strong, which would mean workers’ wages stayed ahead of price rises.