Sado-Monetarism in New Zealand

In his Inflation Fighting Tunnel Vision RBNZ Governor Adrian Orr is Crushing the Livelihoods of New Zealanders

In deeply worrying news for the economic wellbeing of New Zealanders real gdp has now fallen by four percent in the last fifteen months on a per capita basis.

This is especially worrying as fiscal and monetary policy settings are both set to maximally restrictive. Under the leadership of governor Adrian Orr RBNZ has increased rates faster and harder than his international counterparts leaning on the theory that at least a mild recession was necessary to reduce demand, but this gamble has now backfired spectacularly.

Since monetary policy acts with a lag of two years before the full effects are felt and the New Zealand government is signaling further budget cuts the worst may be yet to come. Even if Reserve Bank New Zealand immediately cut rates by one percent or more policy would still have a contractionary effect. The worst-case scenario is that the faltering economy gets hit by monetary and fiscal austerity causing business confidence to collapse even further than it already has and mass layoffs to ensue. Once this negative spiral sets in generating growth can be extremely difficult even if policy makers enact strong stimulus measures. The result could be a lost decade of stagnation, something that has happened to the UK after it made the mistake of responding to a recession with austerity policies.

At this point an intelligent reader might want to know if the inflation problem is worse in New Zealand, then other countries? But in fact, although the shape and timing of inflation differs slightly between the United States, Australia and New Zealand the pattern is broadly very similar. There is no reason to believe that as the effects of disruptions caused by the covid pandemic and government responses subside inflation in New Zealand wont continue to reduce, as has been the case in these other countries. New Zealand’s ‘necessary’ recession was totally unnecessary. Now instead of admitting his mistake governor Adrian Orr is clinging on to his failed economic theory and making the recession even deeper than it needs to be.

A contentious debate

Since inflation spiked globally in 2020 central banks have faced a problem — how to rein in inflation without crushing growth, demand and investment. This has caused an at times heated public disagreement within the economics profession.

This debate has been labelled in the infinite wisdom of internet nomenclature ‘team persistent’ vs ‘team transitory’.

One side — the inflation hawks or ‘team persistent’ is lead by Laurance Summers while Claudia Sahm is an outspoken voice for ‘team transitory’ urging the US federal reserve to be patient in waiting for inflation to come down.

Team persistent stressed the role of demand in causing inflation while team transitory focuses on supply factors associated with the pandemic which should naturally abate over time — hence the moniker ‘transitory’.

Both sides view the stakes as very high. If inflation is allowed to continue it could become embedded in the economy and then be impossible to stamp out without worse pain the longer term. In other words back to the bad old days of the nineteen seventies and eighties. Alternately too high interest rates risk causing a recession that may not have been necessary.

What was the outcome of this clear difference of opinion?

A clear view of team persistent was that inflation would not come down without a rise in unemployment. But in this case the optimists were clearly right. US inflation did nosedive, while unemployment has remained very low. Higher interest rates helped cause the fall but so did workers coming back to work and supply chains reorganizing after the disruptions of the pandemic and Ukraine war. Chalk up one point for team transitory.

But back to New Zealand.

Most central banks including the US Federal Reserve and the Australian RBA split the difference between team persistent and team transitory not agreeing fully with either side, the one exception was New Zealand. Under Orrs leadership Reserve Bank New Zealand leaned heavily towards the view that inflation had to be aggressively stamped out whatever the cost. Orr flirted with a ‘beneficial’ recession and now New Zealand has a much deeper and more dangerous downturn then he bargained for.

Behind the Times

New Zealand has been conducting a unique economic experiment for some time.

Ever since the Rogernomics era of the late 1980's when the new labour government transformed the economy New Zealand has embraced the free market ideology of that era more wholeheartedly than other countries. But its not the nineteen nineties anymore, the world has changed and economic thinking has evolved.

Consider that New Zealand has a flatter tax system and more deregulated labour market then it’s neighbor Australia which is itself considered an open economy. This means that even as New Zealand’s living standards have fallen well behind Australia it has also become more socially unequal.

Economic reform was sold as a trade of — social protections were given up but the promise was that in return the economy would become more productive. But instead it has been all pain and no gain.

New Zealand’s leaders are stuck in the past. Listening to Nicola Willis outline her plans for the economy and you could be forgiven for thinking it was 1990 all over again. The government is seen as a purely parasitic organization merely leeching of private business.

Yet around the world it’s being acknowledged that governments provide critical inputs to growth such as education, infrastructure, plus support for investment and innovation. In the US ‘Bidenomics’ with its focus on governments role on the supply side is proving a huge success. The UK Labour government in waiting has espoused the idea of partnership between the public and private sectors and the importance of investment.

Nationals plan to implement a single mandate for Reserve Bank New Zealand is another example of this ideological zealousness. Other countries such as the US, UK and Australia all have a duel mandate giving their central banks a strong mandate to fight unemployment as well as inflation.

The context for Reserve Bank New Zealand decisions are important but in any case its clear Orr will focus single mindedly on inflation. In his many media appearances, he mentions inflation dozens of times, makes bizarre references to Zimbabwe and the 1970s whilst the risks of an economic downturn are ignored. Inflation is described as a straightforward result of ‘money printing’ a clearly erroneous view. There’s talk of a vision of fairness and social justice of a kind. Inflation is described as evil and its insisted that it hurts the poorest worst. But this is even more true of a recessionary labour market. The task is to balance between different kinds of evil.

Monetarism was an idea popular in the 1980s that if the money supply was controlled the economy would self-regulate. This later gave way to the idea that if inflation was stable the economy would self-regulate. These ideas failed, which is why central banks have dule mandates and financial firms are regulated. Orr is no economic theorist, but he’s imbibed the prejudices of a bygone era. Hence sado-monetarism.

Outside analysts of the economy such as Goldman Sachs generally predict big interest rate cuts will come soon if the economy continues to weaken. A cut now would provide insurance against a collapse in consumer confidence. But those outside analysts might be underestimating the stubbornness of Orr and the monetary policy committee.

I hope for the sake of New Zealanders that an old dog can learn new tricks — but I’m skeptical.