Prices are stable; some people say that’s bad

The NZ Herald has a business editor who would like you to know why low inflation is terrible.

– Low inflation remains one the biggest risks facing the global economy although it seems like a subtle problem relative to the political turmoil that has dominated the past few months.

– New Zealand’s remained stuck at 0.4 per cent, in the year to the June 2016 quarter. That’s below Reserve Bank expectations of 0.6 per cent. And well below its target band of one to three per cent and ideal average mid-point of to per cent.

– When prices are stagnant so are wages. Business margins are squeezed by price pressure and the focus goes on costs rather than expansion.

– Low inflation can also prompt consumers to delay spending on big ticket items on the expectation that prices will fall further. This further squeezes businesses.

– Lower than expected inflation puts more pressure on the Reserve Bank to cut interest rates to stimulate the economy and bring the value of the kiwi dollar down.

That might be good news for mortgage holders but really interest rate cuts aren’t a sign of a strong economy. For many older savers this is bad news.

– Lower interest rates may also pour fuel on the already overheated housing market. The Reserve Bank knows this but it has little choice as its responsibility is to keep inflation in the target band.

– Soaring asset prices at a time when prices and wages are stagnant exacerbates economic inequalities. Globally we are seeing rising inequality generate volatile political conditions which put further pressure on an already fragile economic outlook.

– New Zealand remains highly vulnerable to these global shocks which further slow the world’s economy. Everyone – especially dairy farmers – are hoping that global demand for commodities will start to rise again soon. If global growth slows then commodities including dairy may stay lower longer.

– Apart from petrol, which rose about 5 per cent, the only big gain for the quarter was construction costs – the one area where this country doesn’t want inflation. Construction costs were up 2.1 per cent in the quarter as the Auckland boom starts to put the squeeze on capacity.

– New Zealand isn’t alone in facing low inflation problems. Japan and Europe have seen deflation – where prices keep falling – and have been forced to cut interest rates into negative territory. Our Reserve Bank has an advantage because our rates are still relatively high at 2.25 per cent. There is at least some room to move.

– But how long this cycle lasts is anyone’s guess. Some argue that it represents a structural shift in economics as technology puts constant downward pressure on pricing. If that’s the case this problem is going to require some lateral thinking by economists and politicians to overcome.

Cut interest rates into negative territory?

How does that work?  You pay the bank 3% to keep your money in an account?

At times I think people forget inflation exists.  After all, when you have 3% inflation and you get a 2% increase in wages, you’re still going backwards.  Similarly, if you’re earning 7% on your investments and inflation runs at 4.5%, you may see bigger dividends in real terms, but they aren’t worth as much as you think.

Ultimately, wages should go up only to adjust for inflation, a scarcity of  skills or to reflect an increase in productivity.  Doing it for any other reason is generally a bad thing for business over time.

What would you pick, and why?

a) 0% inflation, 0% wage increase, 2% savings/investment return or

b) 2% inflation, 1% wage increase, 3% savings/investment return

 

– Liam Dann, NZ Herald


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