Keynes warned us that practical men and women are but slaves of defunct economists. The comment is particularly relevant as we try to understand the prospects for inflation.
During the 1951 election there was a ditty ‘Vote for Sid and save your quid/ vote for Nash and lose your cash.’ They voted for National’s Sid Holland over Labour’s Walter Nash. Subsequent events show not a skerrick of evidence that National did any better at changing the track of inflation than Labour would have. That’s election politics. They were ignoring the deep international processes unwinding from the Second World War which were driving the inflation. (See Chapter 28 of Not in Narrow Seas.)
But, you say, today we know more about inflation. Are you sure? How many times do you see Milton Friedman misquoted: ‘inflation is always and everywhere a monetary phenomenon’. What was actually written was ‘substantial inflation is always and everywhere a monetary phenomenon’. (Milton & Rose Friedman, Free to Choose, p.254.) Omitting the ‘substantial’ from the phrase is like omitting the ‘not’ from the seventh commandment, as the Adulterer’s Bible did. Were he alive, Friedman would probably doubt that today’s inflation was ‘substantial’; although he would rightly say that we should pay close attention to monetary conditions when thinking about it.
Discard those clinging to defunct economics, and there is considerable international discussion among economists about what is going on. I am not sure there is a consensus. Such a situation is not unusual among scientists. Some of my Christmas reading was about disputes over about the beginnings of the universe. The difference is that the cosmologists’ thinking does not have to be applied to a current practical problem.
There is an additional challenge of applying these disagreements to New Zealand. A key learning is to be careful about how inflation is defined. It is common to use the official Consumer Price Index as the standard measure of inflation. It was designed for a particular purpose. For other purposes it may not be as useful. When the Reserve Bank makes its inflation assessments, it looks at a whole raft of measures of price increases.
It will be paying particular attention to the household living-costs price indexes. They are also the measures which most closely correspond to the (new) Prime Minister’s statement that the government’s focus is going to be on the cost of living. Here is the percent increase between December quarter 2021 and December quarter 2022 (the latest available):
Household Type Percent Increase
All-households 8.2
Highest Income Quintile 5 9.0
Income Quintile 4 8.6
Income Quintile 3 8.4
Income Quintile 2 7.5
Lowest Income Quintile 1 7.5
Beneficiary 6.9
Māori 8.1
Superannuitant 7.4
Consumer Price Index 7.2)
Notice that the 8.2 percent increase for all households is higher than the reported Consumer Price Index increase of 7.2 percent over the same period. The main reason is that the CPI does not include interest payments. That reflects the concept being used to define the CPI – it is really a consumption of goods and services price index.
So when the Reserve Bank increases interest rates to reduce inflation, it adds to the living costs of households in higher interest rate payments.
Instructively, Joseph Stiglitz, an economist who is as respected by professional economists today as Friedman was in his day, has urged the American Federal Reserve (the equivalent of our Reserve Bank) not to further increase interest rates. I would be a little more cautious. The implication is that we should not rely on the RBNZ to fight inflation on its own but to make sure that other policy settings contribute to reducing inflation. That is a long way from the position that those who misquote Friedman take, or of the promise that underpinned the 1989 Reserve Bank Act. (I discuss some of the supporting policies here.)
The second thing the table shows is that there is variation by household type. This is because different households consume different things. For instance, high-income households will purchase more airfares than low-income households. Different households have different levels of mortgages and are exposed differently to an increase in interest rates. (Some households will have higher incomes from the interest they receive from their bank deposits and the like but the measure does not allow for this.)
There was some surprise that those on higher incomes are experiencing higher price rises. There is a tendency to assume that all economic measures impact more heavily on the poor. (Actually that is not true on the evidence, but any contradictions get ignored.)
Even so, we need to recognise that the poor have less income (if any) for discretionary spending than the rich, so it is harder for them to cut back their spending, even if in percentage terms they have to cut back less. Foregoing an overseas trip is not as painful as having to eat chips because one cannot afford proper food.
The pattern of the poorer not experiencing as much inflation is reflected in the lines of the table which show the price increases for beneficiaries, superannuitants and Māori. That the beneficiary price increase did not rise as much as the conventional CPI must reflect a purchase of goods and services which have not risen as much as average, as well as that most of the poor can only dream of a mortgage..
Lurking behind this data and its policy implications is a comment by Olivier Blanchard, a towering figure in the economics profession (and who is one of the economists who got recent American inflation more or less right). He said, ‘inflation is fundamentally the outcome of the distributional conflict, between firms, workers and taxpayers. It stops only when the various players are forced to accept the outcome’, a point, he said ‘often lost in discussions of inflation and central bank policy’. (He ought to know. As a former chief economist of the International Monetary Fund he was in charge of such discussions; he has also held very senior chairs in economics at MIT.)
I’ve mentioned two impressive economists who are offering different accounts of inflation from that of defunct economics. They are not alone. My conclusion might be that if you are certain about the inflationary system, you have not been listening.
Instead I update the mindless slogan from seventy years ago: Vote for Chris and you’ll get your bliss/vote for Chris and you’ll get a miss.