New Zealanders are poorer since the pandemic and trying to keep up with higher costs could lead to a deeper recession, RBNZ says

Thursday, 23 March 2023

Reserve Bank of New Zealand chief economist Paul Conway says Kiwis are worse off because of the pandemic, the war and the floods.

Reserve Bank chief economist Paul Conway says Kiwis are poorer since the pandemic and the country risks a deeper recession if businesses and workers try to keep up with increasing costs.

The bank has been raising interest rates aggressively in an attempt to curb inflation near a three-decade high of 7.2%, ahead of its 1% to 3% target band.

Last month, it hiked the benchmark interest rate by 50 basis points to 4.75%. It has increased the rate by 450 basis points in 18 months, the most rapid rise in its history.

Conway told the NZ Capital Markets Forum in Wellington on Thursday that inflation was high and widespread and the Reserve Bank was “incredibly determined” to get inflation and inflation expectations back.

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He said businesses had passed on higher costs and workers had sought higher pay to compensate for higher prices.

“If businesses are trying to keep up with cost increases and workers are trying to keep up with price increases, where does that sort of dance stop,” he said.

“We've had a tough time, we've had supply side shocks over the last few years that means we are worse off than we otherwise would be.

“If we all just try to sort of pretend that didn't happen, increase prices, increase wages to maintain real profit margins and real wages as they were had those events not happened then inflation expectations are just going to keep up there and inflation is going to keep persisting throughout the economy and into the future.”

Getting inflation back to the Reserve Bank’s target could be more difficult if businesses and workers push up profit margins and wages to make up for the inflationary impact of the pandemic, the war, and the storms, he said.

“In this case, monetary policy would need to be more contractionary for longer, resulting in a deeper recession,” he said.

The Reserve Bank expects its monetary policy tightening to cause a shallow recession later this year as demand slows. A report last week showed the economy shrank 0.6% in the final three months of last year.

Conway said the effectiveness of higher interest rates in bringing balance to the economy and lowering inflation depends on how realistic and pragmatic New Zealanders are in accepting that we are worse off than we otherwise would be given global events of the past few years and recent storms.

People were poorer because of the pandemic and war, and the recent floods in Auckland and the cyclone along the East Coast had also reduced wealth and prosperity in New Zealand, he said.

“In practice, this means accepting the fact of higher prices for some producer inputs and consumption goods, meaning lower real wages and profits than otherwise,” he said.

Resisting the “squeeze” on incomes and spending power would mean the Reserve Bank had to increase interest rates further or hold them up for longer, requiring a deeper recession to get inflation back within the target band, he said.

However, if people expected inflation to be within the 1% to 3% target in the future and acted accordingly, the less work the Reserve Bank would have to do with higher interest rates that weaken demand, he said.

Conway said weak competition in some New Zealand markets contributed to the country’s poor productivity, making it easier for businesses to pass on cost increases to their customers.

“There are also things people can do to enhance the power of competition and keep price pressures in check,” he said.

“Shop around for that good deal. Wait for the sales. Use price comparison websites. And go to the effort of changing banks or utility providers if it means getting a better deal.”

Conway said improving competition was about regulatory changes that lowered barriers to entry and discouraged anticompetitive behaviours.

He said it was “excellent” to see the Commerce Commission undertake market studies and have better regulatory tools at its disposal to pursue abuse of dominance cases.

Improving productivity was the best way to lift incomes sustainably, he said.

“We're all for higher wages, and higher profits, but it needs to be driven by improvements in productivity,” he said.

More productive businesses could hold or even cut prices while paying workers more and remaining competitive, he said.