Josie Pagani: Reserve Bank had to choose - inflation or economic collapse

Thursday, 11 August 2022

Josie Pagani is a commentator on current affairs and a regular contributor to Stuff. She works in geopolitics, aid and development, and governance, and is a former Labour parliamentary candidate.

OPINION: In the middle of the Covid crisis, the Reserve Bank had a decision to make.

It had to choose whether the biggest headache in the years ahead would likely be inflation or jobs and economic activity.

Cast your mind back to the dark days of lockdowns and the Podium of Truth. Businesses had to suspend trading. Industries like tourism and hospo were laying off staff.

Around the world, supply chains jammed because white collar workers were at home online shopping. Most bank economists expected house prices to drop.

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Actually house prices went on a bender, unemployment dropped to record lows, and employers struggled to recruit staff.

The economy didn’t crash because the Reserve Bank and the Government pumped in cash. The Bank cranked up an electronic printing press and the Government borrowed to fund a stimulus package for programmes like wage support.

MSD says that over half of all jobs (excluding sole traders) received support from the original wage subsidy.

This kept the economy going. It saved jobs and businesses.

Monetarist economists warned at the time this would be inflationary. If you keep spending more than you have, and print money, all at a time of unprecedented supply constraints, then prices will rise, they cautioned.

Old school monetarists, including a past Governor of the Reserve Bank, argue that the Bank should have been more cautious about inflation. They want the Bank to return to a sole focus on inflation.

The Government argues that inflation today is not the result of New Zealand policies. Prices are rising around the world.

Some inflation is imported. Oil is more expensive and, since everything we buy is transported by ships and trucks, the higher price of oil is in just about everything we buy. The cost of imports is up by more than 7% compared to last year.

Our dollar is down compared to major trading partners, so our imports increase in price. It’s down because we are not raising interest rates as fast as them. Hot money isn’t flowing in to get a higher yield.

But imports are only about a third of our spending, so some of our inflation must also be caused by domestic prices. Therefore, the prediction made by monetarists came true at least partially.

Prediction, however, is not analysis. We need to know whether the risks were justified at the time the Bank and the Government made their decisions, and we need to weigh the costs of alternative policies.

It was valid for the Reserve Bank to ask which was the greater risk in 2020: a bit more inflation or an economic collapse. Get it wrong on inflation, and we pay a price in cost of living. Get it wrong in the other direction and the damage would be catastrophic.

Any conceivable government would surely have provided the wage subsidy.

The alternative would have been an economic crisis. Jobs gone - if more than half were subsidised, that gives us a glimpse of the disaster we avoided.

Economists calling for the Reserve Bank to go back to focusing on a single target, price stability, are really arguing that, in the middle of Covid, the law should have prevented the Reserve Bank from trying to minimise job losses and business collapses.

If the Bank’s critics had their way, the Bank would have looked at the Government’s borrowing for the wage subsidy then increased interest rates in response. Stimulus would be fought with punitive interest rates. We used to run the country that way, and it was a fiasco that dropped our economy lower in the world rankings than the All Blacks.

The deliberate policy of price stability through increased unemployment is background to National’s big policy announcement last weekend. National would introduce incentives and sanctions to force more young people to work.

I am all in favour of young people in work, but National’s policy makes no sense. It conflicts with their support for giving the Reserve Bank the sole target of ‘price stability’ (ie targeting inflation).

No amount of upskilling unemployed young people will make a difference if the Bank targets a minimum level of unemployment to restrain inflation. Economists call this the ‘natural rate of unemployment’.

‘Natural’ sounds wholesome and chemical-free, but economists mean something closer to the Hobbesian state of nature: If unemployment drops below the ‘natural rate’ they believe inflation will result, so interest rates must be raised, and the employment prospects of young people will be brutish and short.

In hindsight, the Reserve Bank probably should have tightened faster than it did, but that doesn’t mean its decision was wrong at the time.

Those critics who argue for the Bank to focus on inflation alone must be frank about the price of their choice: potentially deep recession, massive job losses and widespread business failures.

Instead, they tell us the unemployed just need more sticks to make them work. They blame them for being the victim of deliberate policy.

Bashing vulnerable young people turned out not to be a smart idea in the National Party this week. It won’t be smart in future either.