OPINION: The cost of living is rising fast. It is hurting everyone. But homeowners have done well on massive wealth gains and mortgage relief, unlike half of Kiwi adults who are renters.
As the Reserve Bank raises interest rates, it is trying to scare people off from asking for big pay rises, the very thing that would be a salve against a global cost shock.
Implications for real people
Cost of living rose by nearly 5 per cent over the last year. Incomes rose by just over 2 per cent, excluding promotions. The impact of inflation over the last year has been very different depending on if you are a renter or homeowner.
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For the average renting family, the cost of living has gone up by around $50 a week over the last year, while their income has gone up by $25 a week. They could save $25 a week last year, but now they can’t save anything unless they cut spending.
For the average home-owning family, the cost of living has gone up by around $60 a week, while their income has gone up by $40. They are saving about $5 a week, down from $40 a year ago. But they also got a lot richer because of rocketing house prices, by just over $200,000 in the last year according to QVNZ. They essentially saved around $3900 a week, every week, for 52 weeks, in their house.
This is of course not an even experience, depending on your family, where you live, and all sorts of other factors. But it is clear that while the last year has been very tough for some families, it has been financially great for others. The winners and losers are very different.
When the RBNZ tries to dampen inflation, it is very likely that those who lost last year will lose again.
Global price shock
The sharp increase in prices over the past year can be put into three broad buckets.
First, sharply higher global prices because of surging commodity prices and supply chain disruptions. They make up around half of all the price increases. The silver lining is our exporters are also benefiting from these increases.
Some commodity prices, like crude oil and food, have surged. Demand is strong after falling last year, but production is still disrupted by the pandemic. Shipping costs are through the roof and shipping capacity is uncertain. Just-in-time supply chains have become not-in-time, pushing prices higher.
These disruptions have wide ripples. Shortages of computer chips are slowing new car manufacturing, for instance, and lifting the price of second hand cars. This could go on, as many of the world’s factories are still dealing with repeated Covid waves and restrictions.
We have no control over this. Changing interest rates in New Zealand will have no impact on global factors.
Second, rents and construction costs are rising rapidly. These make up a quarter of the inflation surge. Because the population is growing, and the rental supply isn’t, rents are rising sharply in many regions.
In Gisborne for example, the population has grown by 1 per cent a year for three years, while the number of rentals has fallen by 1 per cent. Rents have predictably surged by 10 per cent a year.
The policy solution isn’t to raise interest rates, it is to direct more credit towards house building, particularly rentals.
Construction costs are similarly rising as we gear up to build at the fastest pace ever – 46,500 new homes were consented last year, compared to an average of 25,000 before the pandemic hit. Ramping up construction during global supply shortages, and with a closed border to cheap labour, has predictably compounded costs.
For example, the maker of Dulux paint said prices are rising because of shortages and cost increases of additives, petrochemicals and packaging.
But higher prices in construction are also necessary to draw in investments in new technology like prefabrication and better trained, treated and paid new workers – as we saw in Canterbury after the earthquakes.
Arguably, the RBNZ should not be trying to dampen down construction cost inflation, as we want to build lots of new homes to deal with our crippling housing shortages. Rather it should be trying to direct more capital into the construction sector to adopt the best available technology and improve its performance. Our construction sector is embarrassingly unproductive – each construction worker in New Zealand produces a third less than Australia.
Finally, domestic prices are rising. They made up around a third of the inflation surge. This is mainly because of increasing costs like wages, or to make up for additional costs in the health sector over Covid for example, and catchup from postponed price hikes last year (like local government rates). Just a tenth of the recent inflation is from wage increases.
Fearing the inflation bogeyman
Right now the RBNZ is worried that because prices are rising, we will expect them to rise like this in the future. To make up for it, we will demand higher wages. This risks a vicious cycle, like in the 1970s and 80s, when prices went up, so wages were bid up, and so prices went up some more.
This assumes that New Zealand will revert back to something like the new green light alert level quickly and that the economy will be strong and in-demand workers will get their pay increases.
There are a few reasons to be leery of this.
First, there is no smoking gun of runaway wages when 90 per cent of the inflation is due to global events beyond our control and the need to build homes at scale.
Second, we haven’t yet seen wage increases in every nook and cranny of New Zealand. If anything, we have seen very little wage increases for overworked essential workers who carried the country through the lockdowns. This is the smoking gun the central bank in Australia is looking for.
It’s a myth that wage increases always lead to higher prices, rather than coming from increasing productivity or reducing profits. So far we have seen explosive improvement in productivity, meaning wage increases are “deserved”.
In the wholesale sector for example, the share of sales going to wages is the same, but profit margins are at record highs. Who is to say that some future cost increases will not see profit margins shrink to more normal levels?
Finally, New Zealand isn’t going back to normal anytime soon. As the country transitions from an elimination to suppression strategy, fear from rising cases and deaths will numb economic activity.
If Singapore’s reopening at something akin to level 2.5 is anything to go by, we will get a small taste of the economic havoc of Covid seen in other countries last year. A highly vaccinated population should moderate the fallout. But the RBNZ could have waited to better understand the economic fallout before lifting interest rates this month.
It is entirely plausible that the big price increases globally will go on. They may become a bigger problem domestically. The RBNZ could have been right, but we don’t know yet.
There are reasons not to be too bothered by interest rate increases so far. Very little of the current inflation shock is due to low interest rates in New Zealand.
As they rise from near zero to still very low levels, it will have little impact on the real economy, outside of those trading second hand houses and new mortgage borrowers. But it is also true that there is so much debt now (mainly in mortgages) that if interest rates rose to say 10 per cent like in 2008, it would crush the economy and inflation exceedingly quickly, if messily.
The RBNZ is moving swiftly on the fear of potentially rising wages, but has been slow, plodding and ineffective against skyrocketing house prices. They could take back the initiative and act where they are powerful. The real game is not in changing ultra-low interest rates anymore, but in how much money is lent and for what purpose.
The RBNZ can make it hard for banks to lend to second hand houses and direct them to building new homes and help businesses invest in growing their capacity and efficiency.
This wouldn’t help people affected by a rising cost of living, but it would make the RBNZ useful in spurring the pandemic recovery.
What can be done?
Rising costs are hurting people. Especially those on lower incomes and renters, who don’t gain from soaring house prices.
There is a policy role for the government to moderate the impacts. They should improve benefits, make family allowances fairer and more generous, urgently review wages and working conditions of essential workers, and keep increasing the minimum wage.
Finally, we should just copy Australia’s more progressive income tax thresholds (people earning less than $60,000 a year pay far less tax in Australia). This would give immediate relief to those who need and who would spend it.
Shamubeel Eaqub and Rosie Collins are economists at Sense Partners.