Economic Serial Killer returns after many years absence
The world economy is again set to do battle with the old enemy – Inflation according to a leading article in the Economist recently. For example the Reserve Bank in New Zealand is forecasting a rise to 4.7% per annum, a more pessimistic outlook than that taken in the recent budget forecasts. Yet as this article discusses the old enemy is stalking the world again.
The headline below sums it up.
Double-digit price rises are about to afflict two-thirds of the world’s population
RONALD REAGAN once described inflation as being “as violent as a mugger, as frightening as an armed robber and as deadly as a hit-man”. Until recently, central bankers thought that this thug had been locked up for life. Thanks to sound monetary policies, inflation worldwide had stayed low in recent years. But the mugger is back on the prowl.
Even though America is close to recession and growth in other developed economies has slowed, inflation is rising. Jean-Claude Trichet, president of the European Central Bank, this week gave warning about the mistakes of the 1970s, when inflation was let loose at huge cost to growth.
Adam is sure that Alan Bollard is well aware of the problem. Though it is unfortunate that in NZ the Reserve Bank has only the blunt weapon of interest rates.
The Economist article noted:-
Taken as a whole (and using official figures), the average world inflation rate has risen to 5.5%, its highest since 1999. The main cause has been the surge in the prices of food and oil, which briefly soared above $135 a barrel this week. But Mr Trichet’s concern is that higher headline rates could push up inflation expectations, leading to bigger pay demands, and so trigger a wage-price spiral, as in the 1970s. Central bankers’ mistake then was to hold monetary policy too loose, so that higher oil prices quickly fed into other prices. So it is worrying that global monetary policy is now at its loosest since the 1970s: the average world real interest rate is negative.
There has been a call from the CTU in NZ this week for employers to raise wages. The CTU apparently said as companies were profitable they should pay workers more. Well that is not a reason. Productivity would be a reason.
The Economist went on :-
There are alarming similarities between emerging economies today and the rich world in the 1970s when the Great Inflation lifted off. Many policymakers in emerging markets view the rise in inflation as a short-term supply shock and so see little need to raise interest rates. Instead they are using price controls and subsidies to cap prices. Money supplies are growing almost three times as fast as in the developed world. Many central banks are still not fully independent. And inflationary expectations are not properly anchored, increasing the risk of a wage-price spiral. Emerging markets may as well be inviting the muggers into their own homes.
After discussing various other factors, the article concludes with this statement:-
But with an economic serial killer on the loose, one way or another monetary policy will have to tighten and exchange rates rise.
This caused the following questions to gain Adam’s attention
- Now one interesting question is what will this all mean for NZ?
- Will we see the NZ dollar lose ground against other currencies as interest rates around the world rise?
- A fall in the NZ dollar would make life easier for exporters, it may slow consumer demand, but the cost of oil and key critical imports would rise?
- Would that choke demand to the benefit of the economy?
- Would businesses face increased wage demands from workers and is there the scope to obtain productivity gains, or would it lead to job losses and disinvestment?
- Would the Reserve Bank see a need to further increase interest rates to attract foreign capital to fund the payments deficit?
- Would a rise in global inflation cause an increase in our inflation rate, or is the Reserve Bank allowing for that in it’s forecasts?
Adam will take some time to try and figure some of this out, but if anyone has the answers, he would appreciate knowing.
