Inflation in New Zealand has been on the rise (7.3 percent last quarter) as have the attempts to explain it. The RBNZ points to strong global economic activity, supply disruptions, and the Ukraine war. Others highlight fiscal policy, while some eccentrics blame supermarkets.
Supply chain issues do add to inflationary pressures. But these have been easing: the Freightos Global Container Index (FBX) has decreased since its peak in September 2021 by about 42 percent.
The Ukraine war plays some role. But the HWWI commodity price index has decreased by 19 percent since February. Notice that inflation started to increase well before the Ukraine War.
The combination of monetary and fiscal policy is the more obvious cause.
The average annual growth rate of government consumption expenditures between 2020 and 2021 was 11.5 percent (average 2010 to 2019: 4.6 percent).
How was this financed? The RBNZ’s balance sheet roughly tripled since 2019, with broad money increasing by 21 percent since January 2020. This was mainly done by using the Large-Scale Asset Purchase (LSAP) programme, which bought New Zealand Government bonds. It started in March 2020 and currently stands at about $53 billion.
What does research tell us about the effects of fiscal policy? Lessons are that fiscal policy has larger effects in a recession, that it has larger effects when interest rates are close to zero, and it creates inflation with a delay of about one year.
The government started spending during the June 2020 quarter, when the OCR was 0.25 percent, and GDP fell temporarily by about ten percent. Inflation started to increase substantially during the June 2021 quarter. Coincidence? I don’t think so.
Some of this spending was an appropriate response to the pandemic, but much should have been pared back later.
Central bankers say that the next two quarters will tell us whether the inflation increase is temporary or persistent.
Macroeconomists know that the Producer Price Index (PPI) leads the Consumer Price Index (CPI). PPI inflation has been even larger than CPI inflation and shows no signs of slowing (currently roughly 9 percent). This implies that inflation will be high in the next quarter and might increase further.
What worries me are that inflation expectations among consumers and firms are increasing and appear to be becoming unanchored.
Managing expectations is critical for effective monetary policy, and that requires credibility, which the bank is starting to loose (see Arthur Grimes’ comments from Tuesday here).