Steven Joyce opines on the gathering economic clouds:
. . . The sad fact is that the world economy is facing darker days ahead. Despite appearing to have skated smoothly through the pandemic, the pressures have been building up. Ironically, the very medicine that has made the pandemic seem so economically benign has created the pressures we now have to deal with. Like much in life, in economics it seems you can take your lumps now or later — but you will have to take them.
The most obvious problem remains inflation. Pretty much everyone now accepts that central banks and governments overshot the stimulus response. Inflation is not transitory as was the collective hope of policymakers last year. In the US it has now hit 7 per cent, the highest level in 40 years. Federal Reserve chair Jerome Powell has finally admitted inflation represents a “real threat” to the US economy. Not before time.
Back here things are not yet as bad, but we are doing our best to emulate our American friends. Inflation for the September year was just a tick under 5 per cent, with much of that occurring in the most recent six months. There is every chance we will be much closer to 7 than 5 by the middle of this year.
Inflation is bad enough, because it erodes the purchasing power of ordinary people and hits the poorest hardest. But the medicine needed to treat inflation presents its own significant problems.
What the left like to call the failed policies of the 80s and 90s were the tough medicine required to treat inflation which raged in the years before the medicine was prescribed.
Inflation fools people into thinking they are wealthier when the reverse is true. Any increase in value is an illusion when inflation is eroding the real value of money.
In order to bring inflation under control, interest rates have to go up, and all the signs suggest a more aggressive set of rate hikes than many were envisaging even six months ago. In the US they are now expecting four interest rate increases this year, while here in New Zealand our largest consumer bank has just upped its expected interest rate increases by a further percentage point, and now expects the OCR to hit 3 per cent. . .
A lot of people have borrowed a lot of money to buy houses.
Even small increases in interest rates on a lot of money is a big number that will be unaffordable from some, possibly many.
At the same time, asset prices are going to come under downward pressure. Indeed, that is already happening. In America the sharemarket has had a tough start to the year, with all three major indices significantly down and the Nasdaq entering correction territory. Here at home, the NZX is off around 5 per cent since the start of the year. . .
Low interest rates fuel higher share prices. As interest rates climb shares will be less expensive and will fall in value.
Given all these risks, prudent governments would be starting 2022 with a plan to constrain government spending where they can to take pressure off interest rate increases, take steps to increase competitiveness and encourage competition in consumer markets to lower prices, and make it easier for firms to do business.
Unfortunately that isn’t the mood around much of the world currently. Governments seem to believe their policy decisions in all areas need not be concerned about economic consequences and our own is no exception.
Indeed, our Government makes matters worse through its highly reactive approach to issues (think the Covid response), and its huge mistrust of the private sector (think Covid again and issues like MIQ, rapid antigen testing, and vaccination). It’s a fair guess the economy is hardly on the Cabinet’s radar currently.
The Government’s economic team should stop the self-congratulatory economic back-slapping of the last six months, roll up their sleeves and think about how we are going to encourage more business investment and grow our way out of this pandemic. Otherwise the coming storm could mean a long, unhappy period of economic underperformance and all the negative effects on wellbeing that come with that.
The uncertainty we’re facing owing to Covid-19 and the response to it, will add pressure to the economic clouds and there’s little hope that the government that is fueling inflation will be any help in sheltering us from the coming storm.