Yes, inflation is an evil. And, yes, monetary policy is an appropriate tool to combat inflation. But there are also costs incurred in securing a tight leash on inflation. The psychotic fear of inflation is clouding the need to pursue more important economic goals. Indeed, New Zealand’s attitudes to inflation control are actively hindering progress towards other goals.

In our submission to the Inquiry into the Future Monetary Policy Framework BERL encouraged the Finance and Expenditure Select Committee to account for the costs of inflation control. Excerpts from this submission follow.

“As there is no stated requirement to account for the cost of an over-zealous pursuit of an inflation target, there is no transparent balancing of the benefits of monetary policy actions against the costs of such actions.

“Ideally, we need to be slightly more relaxed in our attitude to inflation control. This would enable the country to make more progress against the other economic objectives, like real incomes, productivity, and the balance of payments.

“Indeed, the pursuit of stringent monetary conditions has led to perverse effects on house prices. Higher New Zealand interest rates have seen funds being increasingly attracted to New Zealand. This has bolstered the home loan market and so acted to further increase house price inflation. The costs of this perverse cycle have been borne by activities in the external sector, as the NZ$ exchange rate rose. That the external sector is being sacrificed in the pursuit of perceived imbalances in the New Zealand housing market just adds to the perversity of the situation.

“In summary, we submit that in announcing monetary policy actions to control inflation, officials clearly report:

• the assessed benefits - in terms of the degree to which inflation will be lower and the benefits therefrom - as a result of the announced action;
• the assessed costs - in terms of the impact(s) on the capacity of productive resources to deliver on the primary goal of economic policy - as a result of the announced action; and
• the assessed degree to which the above benefits exceed, or fall short of, the above costs and how such an assessment was determined.”

In presenting our submission to the Committee we were asked if New Zealand was still fighting the ghosts of inflations past. We would add that New Zealand is also fighting phantom inflations of the future.

The country has enjoyed a prolonged period of economic growth with measured CPI inflation “on average over the medium term” well within the specified target range. But, increasingly, new partial measures of inflation are being used to continue a state of heightened inflation alert. First it was housing prices, then it was non-tradable prices and, most latterly, food prices are being singled out as evidence that inflation continues to lurk and will strike us down if we lower our vigilance.

And it is this living in a perpetual state of heightened inflation alert that obstructs other key goals necessary to expand our economic productive potential.

One of those goals would be investment in productive capital. Remembering that New Zealand consistently has amongst the highest nominal and real interest rates in the OECD, it is unsurprising that New Zealand’s investment record over the past two or three decades has been nothing short of anaemic.

Excluding housing investment, the nation has struggled to devote one-sixth of its annual income to investing in productive assets for future. In 2005 the nation re-invested 17% of its income (or GDP), and this was the highest this re-investment ratio has been for nearly twenty years. The twenty-year average for this ratio is just under 16%.

By way of comparison, take Spain. In 2005 they re-invested nearly 21% of their income. Their twenty-year average is close to 19%. Why use Spain as a comparator? Well, twenty years ago Spain was more than 25% below New Zealand on the income per head ladder. Now, Spain is all but on the same rung. That’s a pretty impressive return on investment.

Another example is South Korea. Their 2005 re-investment ratio was nearly 23.5%, while their twenty-year average is over 26%. No, they haven’t caught up with us on the ladder, but they are catching us fast. From over 60% below New Zealand twenty years ago, South Korea is now only 15% below us. That’s a pretty envious rate of return on investment as well. Meanwhile Australia has also maintained a higher re-investment ratio than us. And New Zealanders all know how far ahead they have leaped.

And so New Zealand continues to deliver minimal improvements to the wealth and well-being of its people, while celebrating our sole success of achieving low inflation. At what cost, we ask?

Clearly, the time has come for the inflation goal to removed from its legislative pedestal and made sub-ordinate to the primary economic goal of improving the capacity and enable and encourage the efficient expansion of the capacity of New Zealand’s productive resources. Then, and only then, will there be any sustainable improvement in the well-being of the New Zealand nation and its people.