By Matt Fletcher
The complex realities of Covid-19 have had profound effects on economies across the globe – impacting consumers directly in their pockets. Disruptions to supply chains, shifts in consumer spending, and heightened government expenditure have culminated in decades-high inflation. These figures scarcely remain absent from headlines, from the United States witnessing annual inflation of 7% for 2021, to the United Kingdom’s rate at 5.4%. Aotearoa’s inflation rate for 2021 was 5.9% – the highest in over three decades. Increasing household costs have disproportionate adverse impacts on low-income households and young people. Understanding the root causes of inflation – and what legislatures and central banks can do to ameliorate it – are essential steps.
Inflation at a Glance
Owing to its direct, everyday impact, inflation rarely finds itself absent from public consciousness. The “rate of inflation’’ is measured by the Consumers Price Index (CPI). This metric assesses the changing costs of common household items across economic quarters. It is based on a fixed “basket” of common goods, such as food, clothing and transport, that are all weighed up relative to typical spending patterns. An increase in the aggregate price of this basket accords with an increase in inflation – it informs us that the household costs incurred by average consumers are on the rise. The figure most frequently cited is the annual inflation rate – the extent to which the CPI rose compared to one year prior. By the end of the third quarter of 2021, annual inflation was 4.9%. This increased to the aforementioned 5.9% figure by the end of the fourth quarter; experts warn that we are almost certain to surpass 6% and see further increases lasting until late 2023.
Inflation levels seen throughout 2021 are undesirable and harmful for all. The Reserve Bank of New Zealand (RBNZ) has long been intent on moderating inflation, warning that a failure on this front will serve only to dampen long-term economic growth. As money becomes less valuable, investors are less likely to secure deals that boost local, domestic, and global economies. Inflation also devalues the real wages of most consumers, who will struggle to cover essential living costs.
How Did We Get to This Point?
Inflation derives from a mismatch between the amount of money in circulation relative to the supply of goods and services available in an economy. The oil shocks of the 1970s drove a decade of unwavering global inflation, as the global embargo imposed by OPEC nations drove aggregate supply down significantly and increased prices. New Zealand saw inflation continue well into the late 1980s as a result of the Good and Services Tax (GST) being introduced. The issue of hyperinflation is also pertinent here. This refers to when the effects of inflation reach high levels – typically at a rate of 50% or more every month. This has historically been driven by extreme cases of a disconnect between money supply and the supply of goods and services. If an economy’s money supply is driven to extreme highs – via, for instance, governments printing vast amounts of money – this will lower its value. Likewise, huge spikes in demand that exceed the available supply of goods will also lead to inflation. Two of the most infamous examples from the past century include Germany in 1923 and Zimbabwe between 2004 and 2009.
This basic outline is vital for contextualising the current inflationary period. At the core of our current crisis lies what ASB Bank described in its Q4 2021 Report as a “relentless stream of price and cost rises from a multitude of domestic and external sources”. At the heart of this issue is the bottleneck of global supply chains; disruptions to global trade and labour shortages brought on by Covid-19 have severely reduced the ability for exporters to effectively ship goods overseas. Imports to New Zealand, including food, fuel, and building materials, have been halted. This has resulted in supply shortages and an accompanying spike in prices. This is coupled by rising domestic demand for imported goods – aided by the expansion of online shopping since 2020. Inflation is also marred by a self-fulfilling quality. When costs incurred by businesses increase, such as construction and energy costs, they will increase the prices of their goods or services to compensate for foregone profits. Meanwhile, other businesses – even those not directly impacted by these losses – will observe the rising cost around them and will accordingly increase prices to protect their profit margins. Furthermore, it is known that when a shortage of goods and services finds itself coupled with an excess supply of money, inflation is bound to worsen. Accordingly, many economists have attributed increased fiscal spending by governments – in the form of programs aimed to soften the economic blow caused by Lockdowns – as additional contributors to this current period of inflation.
Policy Solutions, and How Policymakers Can Assist Those Worst Impacted
In the long term, the effects of inflation can be tempered by a country’s central bank – in Aotearoa’s case the RBNZ. They achieve this by undertaking contractionary monetary policies aimed at reducing the amount of money in an economy – thus eliminating the economic conditions of excess money supply. The central tool used is an increase in interest rates. This increase discourages consumption and borrowing and incentivises saving, as the cost of taking out loans – and therefore the cost of investment – increases. As observed by New Zealand economist Ben Phillips, however, there is a trade-off between high inflation and high unemployment. When central banks engage in monetary policies of this sort, they necessarily discourage investment and economic growth, exacerbating unemployment. Indeed, when the RBNZ undertook these policies during the early 1990s – in the wake of a period of severe inflation – Aotearoa’s unemployment rate skyrocketed to some of the highest levels ever recorded.
In the more immediate term, governments can alleviate, rather than eliminate, the impacts of inflation through targeted assistance schemes. As real wages decline due to inflation, minimum wage increases are a vital step that offset the reduced purchasing power of consumers. In line with regular increases to New Zealand’s minimum wage under the current government, the new rate will increase from $20 to $21.30 an hour from April 1st. Relief funds led by central and local governments are also essential policies to consider.
The effects of this current period of inflation are likely far from over, and Aoateroa is likely to see supply disruptions and rising costs remain facets of daily life throughout the next two years. Policymakers from Cabinet to the Reserve Bank have the means and policy tools at their disposal to ensure that working New Zealanders – who have already faced the brunt of the Covid-19 crisis – are not sanctioned by further economic peril.
https://www.ons.gov.uk/economy/inflationandpriceindices/bulletins/consumerpriceinflation/december2021#:~:text=The%20Consumer%20 ; Prices%20Index%20(CPI,of%200.3%25%20in%20December%202020.