July 08, 2021

Who remembers inflation?

Most under 50 year olds won't.

Since the early 1990’s, inflation has remained relatively low in New Zealand, but this could soon change.

Older New Zealanders will remember inflation and the difficulties it caused. But, for over half our population, there won’t be much, or any memory of it at all. For the past thirty years, inflation has been relatively low and steady, fluctuating around the Reserve Bank’s target rate of two percent. This steady level of inflation is all a generation of New Zealanders know, the impact high inflation has on the economy, hasn’t been experienced first-hand by many.

New Zealand’s inflation rate over the past fifty years paints two very different pictures.

Average inflation between 1970 and 1990 was 11.6 percent, compared to only two percent between 1991 and 2021. With an inflation rate of only two percent, it would take 36 years for prices to double. Whereas, with an inflation rate of 11.6, it would take only six years for prices to double.

The 1970’s and the early 1980’s saw significant inflation.

Inflation in the 1970’s came after an OPEC oil embargo was announced that led to prices increasing greatly. This is most famously known as the 1970s oil crisis. In 1984, inflation sharply declined as a wage and price freeze was introduced in New Zealand by Robert Muldoon, Minister of Finance and Prime Minister at the time. This temporarily combatted inflation, but it was swiftly removed twelve months later by the newly voted-in Labour government.

Inflation then returned to levels experienced in the late 1970’s due to the introduction of the Goods and Services Tax (GST). In the late 1980’s, New Zealand announced an inflation targeting system. Initially, the target rate was between zero and two percent, further developing to target between zero and three percent in the late 1990’s and early 2000’s. The introduction of this system, along with increases in GST in the late 1980’s, caused inflation to decrease to levels not seen in over thirty years.

Since the early 1990’s, inflation has remained relatively low.

In 2008, the world was shocked by the global financial crisis. Significant pressure was placed on economies, causing inflation to increase in New Zealand and around the world. In June 2011, inflation was the highest it had been since 1990, reaching a high of 5.3 percent. This spike was the result of significant increases to the price of petrol, food and cigarettes, plus an increase in GST in New Zealand.

Outside of these two spikes, New Zealand’s inflation target rate of two percent has been relatively well managed since the 1990’s, fluctuating only slightly either side of it. Particularly across the previous ten years, with the inflation rate the most stable it has been in over fifty years. However, as the economy continues to open up more and more, it is believed inflation will spike again in the near future.

What is to come?

With the New Zealand economy recovering from the shock of COVID-19, aided by the large fiscal stimulus package and the health of New Zealanders put first, we are expecting the inflation rate to rise in the near future. This rise might only be temporary, but the possibility of long-term higher inflation cannot be ruled out.

The United Kingdom is in a similar situation as New Zealand.

As the United Kingdom economy slowly opens up, and COVID-19 restrictions are eased, it is expected that the inflation rate will rise to three percent later this year. However, departing Bank of England’s Chief Economist, Andy Haldane, has warned that inflation may rise higher than initially expected . As of May, the United Kingdom inflation rate sits at 2.1 percent, with strong belief the three percent forecast will be reached sooner than anticipated.

Increases to inflation is being felt around the world. The average inflation rate for members of the Organisation for Economic Cooperation and Development (OECD) has increased from 3.3 percent in April to 3.8 percent in May. This is reflecting an increase in inflation for all 38 members, with New Zealand and the United Kingdom included.

This puts New Zealand and the United Kingdom in relatively the same situation. Both economies still face the potential threat of COVID-19, but as that threat diminishes, and consumer confidence grows, the likelihood of higher inflation is almost guaranteed.

Fortunately, the International Monetary Fund (IMF) has stated that increases to inflation for most advanced economies, including New Zealand, will most likely be transitory due to output and employment being below potential. The IMF believes that inflation will return to around the two percent target rate in the long-run. Transitory inflation is most certainly more positive than sustained long-term inflation, but the impact of short-term high inflation can still be disproportionately more hard felt by particular groups of people.

Who are disproportionately impacted by inflation?

Inflation tends to hurt those who are most vulnerable and least able to tolerate increased prices in the economy. This includes people who are on low or fixed incomes who do weekly food shopping, and have weekly rent payments. For them, the near future will present some new daunting challenges regardless of inflation being short-term or long-term.

In the coming weeks, three follow up articles will be released by BERL. These three articles will cover the results from the latest released Food Price Index, Rental Price Index and the Consumer Price Index.