8 Mar 2018

Is keeping inflation low a bad thing?

8:17 am on 8 March 2018

Fears the world's central banks will not have enough fire power to combat future recessions have some economists favouring raising New Zealand's inflation target.

The Reserve Bank of New Zealand

The Reserve Bank of New Zealand Photo: RNZ / Alexander Robertson

A survey of American economists last year found nine out of 10 thought raising the US inflation rate to percent would make it possible for the Federal Reserve to lower rates by a greater amount in a future recession.

The American benchmark rate stands at 1.5 percent at the moment, while New Zealand's official cash rate (OCR) is at a historic low of 1.75 percent.

While uneasy about higher inflation, economic commentator and former Reserve Bank official Michael Reddell said increasing the Reserve Bank's inflation target band of one to three percent was worth discussing.

"It's really important to start planning, having the discussions about how we're going to cope with the next downturn."

"The next recession could be relatively minor," he said.

"We could just get away with needing to cut the OCR by 50 or 100 basis points [0.5 to one percent]."

"But the typical severe recession, whether it's in the US or New Zealand needs, typically, [400-600] basis points of interest rate cuts, and we're just not positioned for that," Mr Reddell said.

But Victoria University School of Government professor Arthur Grimes was adamant New Zealand's existing inflation target band was more than adequate.

Professor Grimes said raising inflation to four percent, for example, would do nothing but hit households in the wallet.

"Why would we want the cost of living to be rising any faster than that? Don't forget the cost of living makes it harder for people to live. It's wonderful that inflation expectations are low and that inflation is pretty low."

Business would also suffer, Business New Zealand chief executive Kirk Hope said.

"If the target is too high and there's too much inflation and interest rates are too high, then it reduces investment in the economy ... and that in the end costs jobs."

New Zealand's Reserve Bank is in better shape than most to cope with a downturn, as it has some scope to lower rates. It could also effectively print money by adopting quantitative easing.

The government's spending power is another tool to fight a severe recession.

Again, New Zealand is well-placed compared with most countries, with the government running budget surpluses and having relatively low debts levels.

But Council of Trade Unions economist Bill Rosenberg warned fiscal policy needed to be targeted to help those who need it most when the economy tanks - something Australia did in the wake of the financial crisis.

"They did some very sensible things. The government put money directly into the pockets of lower income people which meant that they [Australia] never went into recession, unlike New Zealand and most other countries in the OECD."

Dr Rosenberg said the incoming Reserve Bank governor, Adrian Orr, could allow a little more inflation to build up before stepping on the interest brake, and allow workers to enjoy fatter pay packets, something that had been missing from the current economic expansion.

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