Inflation today – what is the best response?

The Inflation globally has been on the increase and above the target band in most developed economies. This applies to both Headline and Core inflation.

Headline Inflation – all goods and services
Core Inflation – all goods and services excluding food and energy.

Economic theory suggests that inflation could accelerate and return to levels seen in the 1970’s. A lot will depend how policymakers react to the challenge of bringing inflation down to their specific target level – RBNZ 1-3% but CPI in NZ is 5.9%. See chart for inflation breakdown in OECD countries.

Source: IMF

Key reasons for inflationary pressure.

Supply chain bottlenecks: Lockdowns and shipping problems (container shortages) but latterly the demand side has accelerated – economic recovery and demand for durable goods as well as panic buying.

Demand for more goods than services: Much of the inflation has been in durable goods whilst service inflation has only seen a small increase. This is dependent on which country – for instance demand for used cars in the US has soared.

Fiscal and Monetary stimulus: Approximately US$16.9trn of government spending has been injected into the global economy. This is accompanied by expansionary monetary policy (low interest rates) is conducive to more spending and higher inflation. Savings that accumulated during the lockdowns were now being spent. There was a debate between leading economists whether the inflation would be transitory or persistent. It seems that the data now supports those of the persistent camp. Whether it persists depends on central banks.

Labour supply: Labour participation rates have dropped – for instance for every job opening in the US there is only 0.77 unemployed people per job. See previous post – US Economy – potential for wage-price spiral. This is due to continue meaning that there is a job seekers market where there is likely to be pressure on wages.

Russian invasion of Ukraine: Russia and Ukraine are big exporters of food and major commodities so higher prices have been inevitable with major disruptions to the supply either through sanctions or conflict areas. They supply 30% of global wheat exports so prices have been increasing.

Source: IMF

What should central banks do?

Mainstream policy by central bankers should ignore supply-side shocks like higher commodity prices as this is only temporary. When central banks have intervened and raised interest rates they have ended up worsening economic conditions – ECB raising rates post GFC in 2008 and 2011. Already inflation globally is increasing but there is little central banks can do with higher global energy prices. A focus on home grown inflation (core) might be a better indicator to watch as well as the labour market – fast wage growth might mean higher interest rates. Economist John Cochrane argues that bringing down inflation through higher interest rate is a blunt tool, especially when prices have risen predominately through a loose fiscal policy. He states that inflation might get worse if people doubt the government’s ability to repay its debt without a discount from inflation.

Ultimately the outlook for inflation depends on how determined central banks are to rein in inflation and the confidence of the bond market to governments willingness to pay their debts. Below is a good video from the IMF on the inflationary problem.

Sources: IMF – Will Inflation Remain High? The Economist – ‘War and Price’ – March 5th 2022

A2 Economics – Macroeconomic policies essay

With the A2 essay paper next week here are a couple of mindmaps I produced using OmniGraffle (Apple software). I found it a useful starting point for students to discuss the effectiveness of each policy and the conflicts within macro objectives. This is a very common essay question in CIE Paper 4. My question would be:

What policies has the government in your country implemented since Covid-19 and how successful have they been in meeting macro economic objectives? (25)

Macroeconomic Policies – Mind map

Just covering macro policies / conflicts with my A2 Economics class and produced this mind map in OmniGraffle (Apple software). I found it a useful starting point for students to discuss the effectiveness of each policy and the conflicts within macro objectives. This is a very common essay question in CIE Paper 4.

My question would be what policies has the government in your country implemented since Covid-19 and how successful have they been in meeting macro economic objectives?

Adapted from Susan Grant – CIE AS and A Level Revision

Types of Macroeconomic Policies

Just been doing some revision with my CIE AS class and discovered this diagram on macro policies. Mind maps like this are very useful ways of revising topics.

Fiscal policy can be distinguished from monetary policy, in that fiscal policy deals with taxation and government spending and is often administered by an executive under laws of a legislature, whereas monetary policy deals with the money supply, lending rates and interest rates and is often administered by a central bank.

Supply-side policies are mainly micro-economic policies aimed at making markets and industries operate more efficiently and contribute to a faster underlying-rate of growth of real national output

Macro Policies.png

Monetary policy – not too tight in New Zealand?

Brian Fallow of the New Zealand Herald wrote a very informative article on the inflationary target that the Reserve Bank of New Zealand keeps missing – the CPI has been below the bottom of the bank’s 1 to 3% target band. Some will say that the RBNZ has been too tight with its monetary policy stance – maintaining high interest rates for too long. Assistant Governor John McDermott has defended the bank’s position for the following reasons:

  1. Nearly half the CPI consists of tradables where the price of goods is impacted by competition from outside New Zealand. For the last four years the global economy has been in a disinflationary environment caused by excess supply and in particular low commodity prices especially oil. Year ending September 2016 Tradables = -2.1%. This offset almost all of the +2.1% rise in non-tradables prices. See graph below.
  2. The recovery form the GFC has been quite weak and with the NZ$ strengthening (imports cheaper) accompanied by lower world prices has meant that import prices have been very low.
  3. The growth of the supply-side of the economy has been particularly prevalent which again has led to less scarcity and lower prices.
  4. Recent years has seen immigration boost the demand side of the economy but because the age composition is between 15-29 rather than 30-40 in previous years, the former has a much less impact on demand as they don’t tend to have the accumulated cash for spending.
  5. The RBNZ reckon that the output gap is now in positive territory (actual growth being higher than potential growth) which will start to put pressure on prices as capacity constraints become more prominent.
  6. Statistically with a weak inflation rate in the December 2015 quarter the December 2016 quarter is most likely to be higher as the percentage change is taken on the CPI of the previous year.

nz-cpi-2004-2016

The spectre of deflation hitting the New Zealand economy does not seem to be a concern at this stage especially with the longer-term inflationary expectations being in the mid range of the target bank i.e. 2%.

Supply Side policies Chinese style

The names of Reagan and Thatcher are identified with supply-side policies of the 1980’s in the US and the UK. Now the Chinese authorities are suggesting the need to implement supply side policies as the country looks poised to post its slowest annual economic growth rate in a quarter century.

During the 1980’s the concern in the US was production bottlenecks fuelling inflation and stifling growth. However, in contrast the Chinese have the opposite issues – excess production, the threat of deflation and unsustainably rapid growth. In classic supply-side economics, the government should reduce its role in economic activities, but in the Chinese context, the government will continue to play a big role in making supply-side changes.”

The differences between US and Chinese Supply Side Policies

US v China supply side

‘Sputnikonomics’

Sputnik was the first Earth-orbiting artificial satellite. It was launched into a low Earth orbit by the Soviet Union on 4 October 1957. Although it only transmitted a beeping noise it changed the world forever. The chain of events sparked by Sputnik set man walking on the moon and led to a total overhaul of the American education system. Sputnikonomics is the term given after Obama’s State of the Union address last month. He said that in order for America to compete better against China, India and other emerging economies, our society had to invest in more long term infrastructure.

Although the Republicans confronted Obama for suggesting more spending after QE2, Sputnikonomics encompasses something disparate. The stimulus was a Keynesian measure which focused on stimulating demand but Obama’s plan is to improve long-term growth rates by boosting supply. This means greater productivity and increasing the pace of innovation – a supply-side policy – and one which was similar to that of Thatcher and Reagan in the 1980’s. But with major budgetary problems why spend more? The return on investment from the building of the Interstate Highway System in the 1950’s and 1960’s has been estimated at 35% annually. And investments in military technology during the original Sputnik moment gave us, among other things, satellites, the microchip, G.P.S., and the Internet, the cumulative benefits of which are incalculable.