Nearly 50 years ago, in October 1973, the Organisation of Petroleum Exporting Countries suddenly raised the price of a barrel of crude oil from US$3 ($4.60) to US$12. We continued to buy OPEC’s oil, so they put up the price again, reaching US$40 by the end of the decade.
This was an event unprecedented in modern history, which even needed a new name – a massive “supply-side shock”. For the first time, a single commodity had become so important to Western economies that major changes in the price it was supplied at had repercussions right through the economic system.
And, short of invading Saudi Arabia – which was considered – there was nothing the West could do. We were suddenly worse off than we had been before, we just had to tighten our belts and make the best of it.
Except that nobody wanted to tighten their own belts. Instead, they instigated an ultimately futile attempt to compensate for the increased cost of living by increasing wages and prices, in what became known as a “cost/price spiral”, pushing annual Consumer Price Index inflation above 13 per cent in 1980.
At this point, the chairman of the Federal Reserve – America’s central banker – Paul Volcker, announced he’d had enough.
Volcker – a big bear of a man smoking huge cigars (not Cuban, of course) – firmly told American households and businesses that, if they kept on with their inflationary ways, he was going to make them pay for it.
And he did. Using the only tool available to central bankers – monetary policy – he squeezed spending out of the economy. Interest rates reached double figures, and as a result, so did unemployment.
It took two awful years of what is now called the “Volcker Recession”, but eventually the message got through, and inflation subsided as fast as it had risen.
New Zealand and other countries followed suit, and we have all since enjoyed decades of low-single-digit consumer price index increases, until 2021 when our inflation rate leapt to almost 7 per cent.
So, what has suddenly happened? Covid, of course: supply-chain disruptions and workplace absenteeism adding up to a new supply-side shock at least as serious – if shorter-lived – as anything OPEC did to us.
And what are we doing about it? Same old same-old: over to the NZ Reserve Bank to “apply the brakes” to our supposedly rampant spending. Will it work? Only if it puts, say, 100,000 New Zealanders out of work, with tens of thousands losing their new houses, and a similar number of businesses going broke. Collateral damage, sorry.
It’s like you have a nice lawn, but this is marred somewhat by pesky weeds. So you bring in the bulldozer. Result? Your weeds are gone, but so is your lawn. Wouldn’t a targeted weed spray have been a better idea?
Our Reserve Bank only owns a bulldozer, and it is firing it up right now. But isn’t there a targeted anti-inflation policy that government could deploy, without laying waste to the economy at large? There actually wasn’t, the last time this happened. But there is now: at least, there is in New Zealand.
My suggestion is that we directly match the bad supply-side shocks of supply-chain disruptions and workplace absenteeism with a “good” shock: cut GST, overnight, by at least five percentage points, perhaps more – thereby instantly reducing retail prices by a near-similar amount.
Let me be clear. I am not suggesting a GST cut will solve any fundamental problems. It would actually create some problems on the fiscal side, which would need to be adroitly dealt with. But it could cut through the wage-price spiral, pulling back self-fulfilling inflationary expectations and give us breathing room until the Covid shocks reverse – as they will – and do so without inflicting all that horrible collateral damage of unemployment etc that the Reserve Bank bulldozer is lining up for us.
Anyway, that’s my suggestion. If you’ve got an idea for a better-targeted inflation weed spray, then please, let us have it.
• Tim Hazledine is Emeritus Professor of Economics at the University of Auckland.
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