Small on Inflation

Vernon Small critically looks at Labour’s claims on inflation:

Labour’s Phil Goff and his inner circle had settled on attacking over the forecast spike in inflation, figuring there was a ready market for suggestions the tax cuts would be swallowed by rising prices.

But the case Labour has tried to make risks backfiring, because frankly, the evidence looks a bit fishy.

I had planned to write along these lines, but glad Vernon has done it for me.

The Treasury forecasts that inflation will surge to 5.9 per cent next year before falling back and staying at 2.4 per cent for three years; well within the Reserve Bank’s 1 per cent to 3 per cent band. It also notes that “underlying” inflation would remain relatively subdued and have a limited impact on interest rates

Next year’s spike includes 2 per cent from the rise in GST, which is compensated for by tax cuts and increases in superannuation, benefits and support for others on state-supported incomes.

More than compensated for.

It also includes a contribution of 0.5 per cent from the rise in tobacco excise (that Labour enthusiastically supported in Parliament)

Which will only affect smokers, and for those whom quit smoking will save them money.

and another 0.4 per cent from the fuel and power prices associated with the Emissions Trading Scheme, which Labour would implement with bells on, pushing inflation much higher. (In any case, the inflationary impact of the ETS was already included in the December half-yearly update.)

Now this is crucial. Quite a few people are unhappy at the impact of the modified ETS scheme, which adds 0.4% on 1 July to overall costs through higher petrol and power charges, but what Labour have not mentioned is their unmodified ETS would add 0.8% to inflation. They had passed a law which would have doubled the price increase due to the ETS.

Take those and the impact of GST away, and underlying inflation next year would be about 3 per cent, close to the top of the Reserve Bank’s 1 to 3 per cent band, but not so unusual.

The other thing Labour has not mentioned is they have constantly called for more government spending. This would mean a higher deficit and more borrowing, which would be inflationary. So their crocodile tears over inflation are less than convincing – their stated policy is to spend more, and to have an ETS which doubles the impact on power and fuel prices at 1 July.

On the other side of the ledger, as the economy improves, the Treasury expects wages to increase by 2.6 per cent next year (the year Labour chooses, because of the unflattering comparison with the 5.9 per cent inflation spike) and then rise by 3.5 per cent, 3.7 per cent and 3.9 per cent in subsequent years, while inflation is tipped to stay at 2.4 per cent.

These are just forecasts, and should be taken with the usual shaker of salt. But if you take one year into account you should be prepared to take them all.

On that basis, wages could well outstrip inflation in the next four years, and beat underlying inflation by even more.

As is generally the case.

Does Labour really want to argue that, as well as compensating for any GST rise, the Government should offset all the effects of inflation? That was above 3 per cent in 2001, 2006 and 2008 – when Labour was in power – and there was no similar call then.

Personally I would be delighted if Labour adopted a policy of giving people tax cuts every year to compensate for inflation. But somehow I don’t think they intend to.