Flaws in focus on inflation

Legislation privileges inflation as the ill of all ills to be contained at all costs. But, Dr Ganesh Nana wonders, is the cure more harmful than the disease?

Our calculations put the cost of the current fight against inflation about 95,000 jobs lost over the next three years.

In GDP terms this equates to about $7.4 billion, or about the size of the entire agriculture sector's annual contribution.

Yes, inflation is bad. Unemployment is also bad, as are low wages, a trade deficit, a skill shortage and a migration exodus.

If so, why is the fight against inflation given exalted status as the only economic target specified in legislation? New Zealand has a law that says policy-makers must fight inflation.

Why are there no laws directing policy-makers to fight these other ills with equal tenacity and venom?

Because the weight of law means the fight against inflation takes precedence over other economic targets.

For example, say we are faced with the choice between: scenario A involving higher inflation with higher employment; and scenario B comprising lower inflation and lower employment.

The Reserve Bank is currently obliged to choose scenario B simply because it has lower inflation.

And the damage to employment prospects is lost in the fine print.

That is effectively how policy choices are being made at present.

When faced with a choice, most of us weigh the benefits against the costs before reaching a decision.

The benefits of taking the car to work may be convenience, not getting wet while waiting at the bus stop and not having to carry the shopping all the way home.

The costs probably include petrol and parking, among other items.

OK, we probably don't do spreadsheet calculations, but we might just think about options during a coffee break.

Of course, you and I can get away with giving options just a passing thought.

The consequences of our decisions are unlikely to impact on the whole New Zealand economy (and its people) for years to come.

However, as the costs of our choice to fight inflation are potentially large they should be properly calculated.

Indeed, one would have thought this would be a prime role for economic policy officials and advisers.

Then, these costs should be explicitly published so that an appropriate choice can be seen to be made.

The problem is that the present legislation implicitly assumes that the benefits of fighting inflation are so overwhelming that official calculations on costs are not needed.

Our calculations put the cost of the current fight against inflation about 95,000 jobs lost over the next three years.

In GDP terms this equates to about $7.4 billion, or about the size of the entire agriculture sector's annual contribution, but this almost certainly underestimates the cost.

While losing jobs is bad enough, this cost has further consequences in later years.

In particular, skills are lost and the replacement of machinery is deferred as we make do with out-of-date technology.

It is this vicious circle that leaves me unsurprised when New Zealand's productivity growth continues to be outpaced by our competitors.

To extract ourselves from this downward spiral, policy-makers need to stop paying lip service to the need to improve productivity.

Exhortations to increase competitiveness need to be replaced with legislation that puts other economic targets on the same level of importance as inflation fighting.

And policy choices (in particular, interest and exchange rates) need to properly balance the benefits and costs on the export sector and the potential to create high-skill, well-paying, productive jobs.

Otherwise, I fear we'll continue to export these jobs and not much else.

Ganesh Nana is a senior economist with Business and Economic Research Ltd (Berl).