We’re in unusual times. The economy is growing strongly yet deflation (falling prices) is on the cards. There are still serious problems in other developed economies which are creating great hardship for working people and could bite us through falling demand for New Zealand exports – but also contribute to falling prices. Employment in New Zealand is growing strongly but unemployment is still much too high.
We’ve been seeing static or falling prices for most imported goods and most recently in fuel prices. But even for domestic goods and services inflation has been subdued with the main exception of housing.
It is good that the Reserve Bank has stopped raising its Official Cash Rate may even lower it. That has helped bring down the exchange rate which is still far too high. Further interest rate reductions would help reduce the exchange rate further – but the Reserve Bank would need to take other action against speculation in housing and in financial markets.
Deflation is not necessarily a good thing. It is to be feared when an economy is contracting, people are losing their jobs and businesses are closing. That can end in a downward spiral that only government action can fix by spending financed by borrowing. While everything is not right we are certainly not in this situation. But neither can we just sit back and enjoy it.
First, falling prices aren’t of much benefit if wages and incomes fall too (or rise very slowly). Secondly debt (such as mortgages) and interest rates get harder to pay off. At present, people think they are have low interest rates. That is an illusion. Because we have such low inflation, real interest rates are as high and higher than they were during the mid 2000s. Historically, inflation has been an important way that people and governments have dug themselves out of indebtedness, and New Zealand as a whole has high debt levels that it needs to reduce.
Lower prices can help wage and salary earners. Even with unchanging incomes, the real value of them doesn’t get eaten away by rising prices as quickly. But that is not the whole story. First there is a lot of catching up due. Workers in the public sector are particularly due for a catchup. Secondly, the statistics generally show only average wage increases. People on lower incomes have tended to get lower increases. Thirdly, there is housing: unaffordable housing needs lower prices but also higher incomes. And finally, low income households have seen faster price increases years than higher income households.
Download the full bulletin: CTU Economic Bulletin 164