Inflation up, growth down

For many years economists said that inflation and unemployment were effectively opposites, and that low inflation causes high unemployment. This myth has been truly put to bed thanks to the 1990s and early 2000s where we had the best of both worlds – dropping unemployment and low inflation

However we are now poised to have the worse of both worlds – zero growth in the last six to nine months and inflation heading upwards.

A prosperous economy should be non inflationary. This was traditionally defined as having about 1% inflation per year. A margin of +/- 1% was given to allow for peaks and troughs so we had the 0% to 2% range.

Successive governments have (sadly) weakened the target from 0% – 2%, to 0% – 3 % and then 1% – 3%. And instead of targeting the mid-point, it is now just to be within the bracket “over time”.

So we had already gone soft on inflation by saying 3% inflation is acceptable. But now for the third quarter in a row inflation has remained above even 3%.

The Reserve Bank used to be fearless when it came to fighting inflation. It got a lot of political heat for its actions, but did a world class job (literally) of getting rid of inflation.

Sadly the Bank seems to lack the political will to take the hard decisions. It toys around with reviews of other mechanisms, when what was really needed was firm action over a year ago. Now it has got to a state where just raising interest rates will be less effective, as the markets don’t think (in my opinion) the bank is serious about low inflation. They see a Reserve Bank which complacently is allowing inflation to drift towards 4%.

Because inflation’s effect is quite diverse, many people don’t worry about it. But they should – is basically steals from our standard of living, and reduces the incentives for NZers to stay in NZ, as our earnings decrease relative to the rest of the world.

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