The inflation thief is here, syphoning off cash from our pockets as the cost of living increases at a rate not seen since 1990. Businesses are going to have to rise to the challenge of taming it and not just rely on the Reserve Bank.
Many in the workforce and business owners have not yet seen the destructive impact of inflation. And it is hitting at a time when businesses are already being buffeted by many challenges. Some managers can step up, others cannot. Inflation creates uncertainty, the antithesis of investment, erodes competitiveness and savings, reduces purchasing power, and can cause social unrest. The annual rate of inflation is currently 5.9 percent and expectations are it will close in on 7 percent. Wages are rising at half that pace, but pressure is building to rise, a lot. Inflation/the cost of living is now the number one concern for households according to the IPSOS Issues Monitor, knocking housing off the top perch.
There are two sides of the coin
While most focus on the destructive aspect of inflation, it also unlocks opportunities. Inflation erodes debt. Housing debt is around $330 billion. The government has a lot of debt too. Inflation increases tax revenue, which allows more government spending. But the inflationary drug is not one you’d want any government to become too addicted to. Inflation can encourage spending. Cash loses its value by doing nothing. Price rises can buoy company profits and investment if margins can be expanded under the guise of inflation. Many are taking the opportunity. Having inflation is a lot better than deflation, which raises the real debt burden and discourages spending and investment. Despite these positives, the consensus is that moderate inflation is good, and high inflation or deflation is bad.
The culprits
Ukraine, Covid-19 and an overheating economy are the key offenders. Wars and conflicts are inflationary. Energy prices are up, but there are wider impacts on food and industrial commodity prices. Covid-19 has thrown global logistics and supply chains into disarray. The economy is too hot, and the likes of the construction sector cannot keep up with demand. The unemployment rate is 3.2 percent. The unemployment rate for full-time employees is 2 percent. The labour pool is empty. Too much of a good thing (low unemployment, growth and demand) has a nemesis – inflation. The hope is that temporary offenders such as Covid will dissipate. Central banks will raise interest rates which will mean less growth, or even a recession. Taming strong and persistent inflation is not growth-friendly.
The other culprits
A rising concern is that inflation could be persistent. The Great Resignation could be the start of economic rebalancing in favour of workers and unions. Climate change and ESG responsibilities add to costs. The world is becoming more fragmented and less “globalised”. Baby Boomers are starting to spend rather than save. An era of bigger and more costly government appears to have arrived. Covid-19 has well-known but previously hidden frailties. Border closure has exposed an under-investment in people. Supply chains being disrupted and altered has reinforced how poor a lot of New Zealand’s infrastructure is.
What’s the bottom line?
Bond markets are saying inflation will not be overly problematic. This is not to be confused with an expectation inflation will continue to average around 2 percent. Odds are it might be higher on average but still “moderate”. Many businesses are going to get caught in a tight spot. Passing rising costs on to consumers means more inflation, forcing central banks to hit demand by raising interest rates. Conversely, a hit on margins could help alleviate the extent to which central banks hit demand. This is not at all palatable to businesses, especially in the consumer space. Maybe, just maybe, the current bout of inflation drives more intensity and drive on lifting productivity growth which would help mitigate rising costs. At the epicentre of this needs to be microeconomics; all those small levers that businesses can pull to be more efficient and effective. Do not just point the finger at the Reserve Bank and the government when it comes to taming inflation. It is going to need contributions across the board.
Some of the facts
- Inflation has averaged 2.1 percent per year for the past 20 years, almost the exact middle of the 1-3 percent policy band. Job well done.
- Tradable (imported) inflation has averaged 0.8 percent over that period, while non-tradable (domestic inflation) has averaged 3.2 percent. A big contributor to non-tradable inflation has been housing and household utilities, which have averaged 3.8 percent per year.
- Housing and household utilities have a weight of 28.3 percent in the consumer price index. When those costs increased, they add a lot to inflation. The flipside also applies. Getting inflation down means moderating housing cost growth or prices falling. The really big ones are rents and construction costs.
- A positive aspect of national lockdowns has been increases in household saving. The household savings ratio was 7.5 percent in the September 2021 quarter as households saved $3.85 billion in the quarter. That money can be deployed. Pent-up demand can be unleashed. But New Zealanders are not great savers overall. The household savings rate has been negative as many times as it has been positive since 1987.
- Demographic shifts will bring major spending pattern changes across the economy, as the population aged 65 plus is projected to rise from 800,000 to 1.4 million. An example is e-bike demand. Around 200,000 of the population aged 65 plus still work and this could potentially rise to more than 350,000 in 20 years. The population aged 65 plus is also estimated to hold around $542 billion in net household wealth.
Article written by Cameron Bagrie – Bagrie Economics is a boutique research firm that specialises in independent, authoritative analysis of the New Zealand economy and economic issues generally.
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