Explainer - Reserve Bank governor Adrian Orr says climbing mortgage interest rates and a recession are the price New Zealanders will have to pay to get inflation under control.
His comments came as the Reserve Bank hiked the Official Cash Rate (OCR) a whopping 75 basis points yesterday, to 4.25 percent - its highest level since December 2008.
But what is a recession? How long could the one New Zealand is headed for last, and how might it affect you?
RNZ is here to clear it all up.
What is a recession?
A recession is a significant contraction in a country's economic activity, usually over a period of several months.
It differs from a depression, which tends to last longer - often years - and have a much more significant economic impact.
Back in 1974, economist Julius Shiskin, the commissioner of the USA's Bureau of Labour Statistics, looked at data from past recessions and came up with a number of criteria to determine whether or not a recession was in progress.
The one which subsequently gained the most traction, though Shiskin himself noted it was not foolproof, was that a recession required an economy's GDP to decline by at least 1.5 percent for at least two consecutive quarters.
Speaking to The Detail in June, economist Shamubeel Eaqub offered two explanations of what a recession was.
The technical definition, he said, was "the economy going backwards for six months".
"Or there's a more practical definition, which is when people get so scared of doing things, they don't hire, they don't invest, and they don't spend.
"And that collective sitting on hands is really what recession is about."
So, in addition to a sustained fall in GDP, recessions can be marked by job losses, slower wage growth and a decline in retail sales.
Many recessions - different causes
While the prospect may seem daunting, the New Zealand economy has already weathered several recessions this century.
The longest was sparked by the global financial crisis (GFC) and lasted from March 2008 until June 2009, RNZ's business editor Gyles Beckford told that June episode of The Detail.
"That was largely a reflection of the global financial crisis - the way that the housing market started to fall, inflation pressures started to rise, finance companies were failing, overseas influences and the shocks that came with that, that's the one we noticed the most."
However there was also a recession at the end of 2010 - largely caused by drought - and another after the pandemic first hit in 2020, he said.
"You can have recessions of varying types, for varying reasons, and they will hit certain parts of the economy, or the whole economy, to varying degrees."
Infometrics principal economist Brad Olsen told Nine to Noon the Reserve Bank was now forecasting a four-quarter long recession and there was no avoiding the fact it would be challenging for some.
"Spending activity is still remaining high even though those interest rates have been going up and inflation's been hitting," he said.
The Reserve Bank's Monetary Policy Committee said yesterday that its members had "agreed that the OCR needs to reach a higher level, and sooner than previously indicated, to ensure inflation returns to within its target range over the medium-term".
In other words, the economy is currently running so hot that the Reserve Bank has little choice but to try and cool it by continuing to increase the OCR.
The flow-on effects of doing that - namely, mortgage rates rising - will impact consumers' ability to spend on other discretionary items.
And if people started spending less, businesses would no longer feel able to keep increasing their prices, Olsen said, "because otherwise they'll lose market share, they'll lose business".
That pattern should eventually see those much talked about cost-of-living prices begin to drop, but there would be "some pretty bitter pills to swallow" in the meantime, Olsen added.
"New Zealand now has to sacrifice economic growth to ensure that we can get inflation under control because it is too persistent, it's too pervasive, it's causing some huge problems for families and the quicker we nip it in the bud, the better."
Who will be most-affected by the anticipated recession?
Olsen said two groups were already struggling more than most with the impacts of inflation: Those on low incomes and those who had bought houses in the past two years.
Increased food, rent, energy and fuel bills were "an absolute disaster for households that are trying to make ends meet", he said, and those who had borrowed for short-terms at mortgage rates of around 2.2 percent would also be feeling the pinch as their mortgages came up for renewal at higher rates.
"Anyone who bought, probably in the last two years - man, they're in a tough spot."
Banks had stress-tested mortgage holders to around 6 percent, but any rise above that could see some people unable to make their repayments and forced to sell, Olsen said.
"There's been a huge number of people who locked in for one year, because 2.2 [percent] was just about too good to miss, but now ... they're fixing onto something higher."
Orr told Morning Report households would have to "adjust other spending as best they can" in light of the the rising rates.
"All households have been stress-tested at interest rates at these levels so, you know, it shouldn't come as a surprise."
People who had bought houses 5 - 10 years ago would be less severely affected by the rising interest rates, Olsen said, with many having faced higher interest rates in the past.
However, the predicted recession could still have some impact on this group, with the Reserve Bank now anticipating the unemployment rate could rise to 5.7 percent.
"The difficulty is that the more you have to hit the economy to bring inflation under control, the greater the risk that unemployment rises higher," Olsen said.
"You're all right if you've got a job - you can make a lot of things work when you're employed - [but] if you're not employed, if you've got unemployment rising, that makes the whole equation a lot more difficult."
If consumers generally responded to the Reserve Bank's OCR moves by starting to rein in their discretionary spending, businesses would see a related drop in their sales and that could cause some businesses to reassess how many staff they needed, he said.
"So there will be some pain to come."
Is there any good news?
Well yes, some.
While those facing rising mortgage bills in the coming months are in for a tough ride, every dollar they spend servicing mortgage debt is a dollar not being spent on other goods in our over-heated economy.
As demand for those other products decreases, prices should gradually begin to fall, though it's important to note that some expenses will continue to be driven by global supply chain issues, which New Zealand has little control over.
Olsen said those with funds available to invest should also see some benefits from the OCR hikes as increased term deposit rates made keeping their money in the bank a more attractive prospect than investing in the stock market or buying a house.
The fact the country had the highest levels of employment on record should also cushion some of the pain of the coming economic contraction, he said.
"A bit like Icarus, we've flown a bit too close to the sun; now we need to come back a bit, but importantly, we start from some strong foundations."