Orr: How much unemployment is needed to tame inflation 'a global problem'

Thursday, 27 October 2022

Prime Minister Jacinda Ardern says New Zealand's inflation rate is starting to peak.

There are urgent challenges in the global economy, but New Zealand is in a strong position to navigate the path out of the pandemic disruption, Reserve Bank governor Adrian Orr says.

He spoke at the Infinz conference in Auckland on Thursday.

Orr told attendees that he had been re-engaging with global economic policymakers face-to-face in recent months and while people were pleased to meet in person again 'that's where the fun stopped. The content of the meetings was far from positive.'

Orr said the world's economy was facing high inflation. Central banks globally were working to slow spending by increasing interest rates.

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'This means employment prospects will be increasingly compromised, as people delay their spending and investment decisions.'

An increase in unemployment was the price to pay for a return to low inflation.

Adrian Orr says the same problems are being faced around the world.

'The trade-off of the long-run benefits of low and stable inflation versus near-term spending and employment is being confronted in virtually every country simultaneously. New Zealand is relatively well positioned but inflation is still too high in an absolute sense.'

The extent of the tradeoff was unclear, he said, given the significant labour shortages globally and the very different means of employment being adopted post-Covid.

'Importantly, it is highly unlikely that we are at maximum sustainable employment if inflation is still high and variable.'

Covid had been a shock to the productive capacity of the entire planet, he said.

People were worse off and spending plans had been 'radically disrupted'.

'We are still working through the lingering economic impacts of the lingering virus.'

He said rising interest rates globally would test the resilience of the financial system and economic participants.

Adrian Orr pointed to problems in the UK’s economy, where fiscal policy had an unintended consequence.

'The financial system is complex, making it hard to pinpoint what, if any, particular Achilles heel exists in real time,” Orr said.

“All we know is that the financial system has experienced many legal, operational, financial and/or reputational problems in the past – few of which were predictable in timing or scale. Most recently, for example, in the UK we saw liquidity issues rapidly escalate in their pension-investment industry as an unintended consequence of fiscal policy announcements. Meanwhile, in other countries, IMF and World Bank financial assistance is being drawn on heavily to manage through both short-term food and energy crises, and longer-term climate change risk mitigation and adaptation.

'Notable also is the growing home bias and flight to quality being expressed by global investors as they shift their capital. Supporting these trends is the heightened geopolitical risks that exist, leading to increased fragmentation in global trading blocs and economic reliance.'

He said a strong US dollar was a challenge to smaller, open economies.

'Those nations with floating exchange rates – such as New Zealand – are experiencing higher imported cost pressures, which can lead to longer-term embedded inflation if expectations become unanchored.

'There is also rising tension globally between monetary policy aimed at low and stable inflation, and governments’ longer-term fiscal priorities. Governments are looking to provide the necessary support to those people most impacted by geopolitical tensions and health and wellbeing-related expenses accentuated by the Covid pandemic – amongst many other priorities.

'This fiscal tension is further accentuated by the need to progress climate change adaptation. Investment is needed at scale to manage a transition to more environmentally-sustainable forms of economic production. Investment will put demand pressure on resources and hence inflation in the near-term. Likewise, there are potential one-off relative energy price changes as nations move away from fossil fuels to more sustainable alternatives.

'The rising geopolitical tensions are also significantly constraining global trade. This is concerning when you consider how important the decline in the relative price of technology-related goods has been in maintaining low inflation over recent decades. Less access to shared resources and technology globally will slow potential output growth – all other things equal.”

He said there were urgent challenges facing the global economy, and the tensions being felt were already testing political consensus within and between countries.