Sorry governor: Inflation is not ‘evil’

Sunday, 7 April 2024

OPINION: Reserve Bank governor Adrian Orr has described inflation as “evil” at least three times in recent months.

It is a curious development given that earlier in his tenure he appeared to have a refreshingly healthy perspective on the limited overall significance of monetary policy and its impact on the “real” economy.

Don’t get me wrong.

Anyone born without a silver spoon in their mouth is likely, at some stage in their life, to have experienced the stress of wandering around a supermarket and wondering what they could afford.

I’m not trying to make light of the financial stresses that many people are under and inflation does have “distributional effects”, meaning it creates winners and losers.

Stable prices are a nice-to-have in an economy.

But it would be misleading to suggest that inflation has any kind of “agency”.

It is not the ghost in the machine, the snake in the Garden of Eden or the equivalent of freewill in a philosophical debate about determinism.

In and of itself, anything other than run-away inflation has few consequences when the flow of money around the merry-go-round of the economy is viewed in its totality.

Rather, inflation is simply an adjustment mechanism; the way of ensuring that the amount of stuff we can afford to buy and the amount of stuff we can make matches up.

It’s the more convenient alternative to rationing.

Yes, if inflation is rising quickly, it is likely to be the symptom of an underlying problem unfolding in an economy and associated with a decline in people’s standard of living.

But describing it as the actual illness, as Orr has appeared tempted to do, can only divert attention away from the underlying condition.

And over the past few years, there are a couple of underlying conditions we can point to as having given rise to the symptom of inflation.

One is that labour productivity in New Zealand and other developed countries has fallen.

As we can’t make as much stuff as we used to per person, what we can make costs more.

Economists have suggested many possible causes; post-Covid fatigue, an ageing workforce, growing protectionism eroding some benefits of free trade, dwindling natural resources, supply chain disruptions caused by wars and climate change.

And let’s face it, there haven’t been a truck load of innovations over the past couple of decades to boost our productivity.

For many of us, computers are getting slower rather than faster to switch on in the morning.

All a nuisance, but not exactly “evil” either.

The other underlying condition is the Reserve Bank along with many other central banks around the world dramatically increased the supply of money during the Covid pandemic to drive down longer-term interest rates.

That had the effect of pushing up the price of assets such as shares and housing.

The wealthy got wealthier on paper, but that is not additional wealth that can ever really be “spent” unless we do actually become collectively more productive.

In that regard, inflation is the adjustment mechanism we’ve needed to erode accumulated paper wealth and ensure the people actually doing the work in future — mostly younger people — will have the share of goods and services that will be justified by their economic contribution.

Without it, we’d just have needed something else such as further nominal house price declines or sharemarket corrections to bring old, accumulated spending power and future, new spending power back into equilibrium.

As it’s an adjustment mechanism, it will go away when its job is done and come back when it’s next needed — deaf to the name-calling.