Category Archives: Inflation

Major contributions to inflation in New Zealand – NCEA Level 2 External

Finishing off the Inflation external standard with my NCEA Level 2 class and came across an ASB Bank publication which outlines what the main drivers of inflationary pressure are in New Zealand. They list 5 categories which are shown below and note that housing and commodity prices are quite prevalent. This would suggest that the government are trying to get the RBNZ to target house prices.

Source: ASB Bank Economic Note

Outlook
It is forecast (ASB) that the CPI will rise to around 2.5% – cost-push and demand-pull factors with strong NZ$ being superseded by higher external costs and prices. The inflation target for the RBNZ is 1-3% with a target of 2% but the inflation figure above the midpoint should be treated the same as when inflation is below the midpoint. Therefore this does not mean that the RBNZ will necessarily raise interest rates.

Source: ASB Bank. Economic Note – 5th March 2021

UK growers see high wage inflation.

Since 2016 UK growers of fruit and vegetables have seen their labour costs rise by at least 34% since 2016. This is when farmgate prices have stayed virtually the same.
This increase threatens domestic production in the UK growers and they need a higher price to halt them locating overseas or finding another revenue stream with the land that they have.

Between 2015 and 2020 there has been an increase in the hourly rate for workers of 34% rising from £6.50/hour (NZ$12.40) to £8.72/hour (NZ$16.63). However many growers have seen a 40-50% rise in employment costs since 2015 as:

  1. Lower output and reduction in productivity with newly recruited UK labour because of Brexit. Fruit and vegetables are normally picked by some 70,000 to 80,000 migrant workers, mainly from eastern Europe who tend to be much more productive than local labour. From this year any foreign worker wanting to come to the UK will have to meet a minimum salary threshold of 25,600 – well above what farm pickers would normally be paid.
  2. A weaker £ also makes it less attractive for foreign workers as when they convert their income in £ it buys them less of their own currency.
UK Farmers Weekly

Labour costs account for 40-70% of a growers revenue which mean some are seriously looking at the financial viability of their business. This is concerning as the domestic growing industry contributes more than £3.8bn to the UK economy. What is true is that although some agricultural sectors are highly mechanised there is still a need for manual jobs carried out by labour. A report, by farm consultant Andersons suggested that a farmgate price increase of between 9% and 19% is needed simply to offset the increase in the National Living Wage (NLW) hourly rate – it will rise to £8.91/hour (NZ$17.12) from 1 April 2021. The problem with the NLW is that it doesn’t take into consideration the differences in the cost of living in a country e.g. London as compared to Manchester. However evidence suggests that workers are more motivated when the living wage is being paid and staff retention is higher.

Source: UK Farmers Weekly 15th February 2021

US velocity of money lowest since 1946

Velocity of circulation of money is part of the the Monetarist explanation of inflation operates through the Fisher equation:

M x V = P x T

M = Stock of money
V = Income Velocity of Circulation
P = Average Price level
T = Volume of Transactions or Output

For example if M=100 V=5 P=2 T=250.   Therefore MV=PT – 100×5 = 2×250. Both M x V and P x T are equivalent to TOTAL EXPENDITURE or NOMINAL INCOME in a given time period. To turn the equation into a theory, monetarists assume that V and T are constant, not being affected by changes in the money supply, so that a change in the money supply causes an equal percentage change in the price level.


Hoisington Investment Management -Q4 2020

However when the velocity of money in the US is falling, monetary policy which would otherwise cause inflation doesn’t seem to do so. The velocity of money fell 17.7% in 2020 with velocity for the year averaging an estimated 1.2, the lowest level since 1946 (see chart above). With less money going around the circular flow this frees up what available funds people have for financial investment which put up prices in asset markets especially in the housing market. However this money is with the higher income groups.

We have no idea of how the future is going to unfold because we have never seen anything like this before – to quote Rogoff and Reinhart – This time it is definitely different.

Source: Hoisington Investment Management – Q4 2020

How interest rates affect inflation – flow chart

Below is a useful flow chart for anyone studying monetary policy. Both the NCEA Level 3 and CIE A2 courses cover this topic.

Negative – lower interest rates might depress spending by some retirees who rely on interest income. But these counterproductive channels are small compared to the
Positive – lower interest rates = a lower propensity to save and a higher propensity to spend.

The side effects of monetary policy.
Falling interest rates = accelerating house prices = social problems and political anxiety.
If RBNZ kept interest rates at around 8% as in the 2000s to prevent the house price = New Zealand in deflationary spiral.

The economic and social consequences of deflation would be far worse than the (undeniable) problems with rising house prices. The low inflation / falling interest rate dynamic of the past two decades has been a global phenomenon, ultimately caused by a global change in the balance between savings and investment. The Reserve Bank of New Zealand could not have prevented this global trend from affecting New Zealand interest rates without causing severe damage to the economy. In New Zealand, the most important transmission channels are asset prices and the exchange rate. Falling interest rates tend to push asset prices up, which stimulates consumer spending. Falling interest rates also tend to reduce the exchange rate, which generates inflation via the prices of internationally-traded goods and services.

Source: Westpac Bank

A lack of containers adds to shipping costs and inflation.

Covid-19 has severely impacted the global trade for a number of reasons:

  • Container shortages as early as February 2020
  • Port congestion caused by increased checks at ports
  • Ship carriers cannot add more capacity as the entire global fleet is mobile.
  • Slow down in container emptying has led to a backlog of containers at many ports

Major Chinese ports like Qingdao, Lianyungang, Ningbo, and Shanghai are experiencing severe container shortages. This means that ships are leaving Chinese ports without a full load. Containers filled with consumer goods from Asia are usually unloaded, then filled with exports of other commodities. Products like meat, pulp and coffee, crops and lumber are then shipped in containers back to China. But, without the containers landing in these ports, there is nothing to fill for the home journey. As you’d expect, this is leaving exporters frustrated and very stressed, especially with seasonal crops needing to be shipped. See chart below for the increase in shipping costs from three major shipping companies – Maersk, Cosco and Triton.

SOURCE: Bloomberg

Baltic Dry Exchange – what is it?
The Baltic Dry Index (BDI), is issued daily by the London-based Baltic Exchange. It is reported around the world as a proxy for dry bulk shipping stocks as well as a general shipping market number cruncher. Every working day, a panel of international shipbrokers submits their assessment of the current freight cost on various routes to the Baltic Exchange. The routes are meant to be representative, i.e. large enough in volume to matter for the overall market. See chart below.

Inflation – an historical overview and how will covid-19 impact prices?

This is a very good video on inflation from The Economist – it discusses why over the past two decades inflation has remained low in good times and bad. There is a brief look at historical rates of inflation and policy with reference to Bill Phillips (Phillips Curve) and Paul Volker (US Fed Chairman) who increased the prime interest rate to 21.5% in 1981 to tackle inflation. Also low interest rates and government fiscal stimulus could start to see an upward movement in the inflation figure. Very useful for Unit 4 of the CIE AS and A2 Economics course.

Money velocity – you can’t have your cake and eat it

This post refers to Unit 4 of the CIE A2 Economics course. Velocity of circulation of money is part of the the Monetarist explanation of inflation operates through the Fisher equation:

M x V = P x T

M = Stock of money
V = Income Velocity of Circulation
P = Average Price level
T = Volume of Transactions or Output

For example if M=100 V=5 P=2 T=250.   Therefore MV=PT – 100×5 = 2×250
Both M x V and P x T are equivalent to TOTAL EXPENDITURE or NOMINAL INCOME in a given time period. To turn the equation into a theory, monetarists assume that V and T are constant, not being affected by changes in the money supply, so that a change
in the money supply causes an equal percentage change in the price level.

The speed at with which money goes around the circular flow is a significant indicator as to the economic activity of an economy. Money’s “velocity” is calculated by dividing a country’s quarterly GDP by its money stock that quarter – the bigger GDP is relative to the money supply, the higher the velocity.

Recessions – dampen the velocity by increasing the attractive of a store of value. People tend to save rather than spend. E.G. The Great Depression and the GFC. See graph for US velocity of money.

Covid-19 – with the closure of a lot of businesses and people worried about job security personal savings increased to 33.6% of disposable income. Also consumers didn’t have the money to spend.

The stimulus measures and the glut of dollars could cause problems once the consumer confidence starts to become prevalent. Inflation will inevitably rise again – which is not a bad thing considering the threat of deflation that we are currently experiencing. But the major concern is if the increase in spending spirals out of control with high inflation. It seems that central banks want the velocity of money to increase to kick-start the economy but they will need to consider how to control it if it gets above the ‘speed limit’. “You can’t have your cake and eat it”.

Source: Why money is changing hands much less frequently – The Economist 21-11-20

OCR – LSAP – FLP = New Zealand’s Monetary Policy Toolkit

Below is a useful flow diagram from the ANZ bank which adds Large Scale Asset Purchases (LSAP) and Funding for Lending Programme (FLP) to the Official Cash Rate (OCR – Base Rate)

LSAP – this is the buying of up $100 billion of government bonds – quantitative easing
FLP – this gives banks cheap lending based on the Official Cash Rate – could be about $28 billion based on take up
OCR – wholesale interest rate currently at 0.25%. Commercial banks borrow at 0.5% above OCR and can save at the Reserve Bank of New Zealand (RBNZ) at 1% below OCR.

With FLP and more LSAP this will mean lower lending rates and deposit rates. This should provide more stimulus in the economy and allay fears of future funding constraints making banks more confident about lending. Add to this a third stimulus – an OCR of 0.25%. The flow chart shows the impact that these three stimulus policies have on a variety of variables including – exchange rates – inflation -unemployment – consumer spending – investment – GDP. Very useful for a class discussion on the monetary policy mechanism.

Changes to the CPI in New Zealand – 2020

The consumers price index (CPI), New Zealand’s best known measure of inflation, measures the rate of price change of goods and services purchased by households. The CPI consists of a basket of goods and services that represent purchases made by households. The goods and services in the basket, and their relative importance, are reviewed every three years to ensure the basket remains up to date.

There are about 649 goods and services included in the basket. They are classified into 11 groups:

  • food
  • alcoholic beverages and tobacco
  • clothing and footwear
  • housing and household utilities
  • household contents and services
  • health
  • transport
  • communication
  • recreation and culture
  • education
  • miscellaneous goods and services.

These groups are then broken down further into 45 subgroups and then into 107 classes. The CPI is reported each quarter down to the class level.

After a review in 2020 the following goods or services have been added and removed from the CPI

Items that have been included in the basket of goods

Items that have been removed in the basket of goods