Simplistic views of the causes of inflation don’t do the left any favours

Chris Trotter pillories Act’s Brooke Van Velden for her response to Jack Tame in  Q+A last Sunday.  While Act deserves all the scorn we can muster, this attack makes me very uncomfortable.

Jack had disingenuously asked her a patsy question: “Are income tax cuts right now in the best interests of lowering inflation?” Trotter had a gleeful ‘gotcha’ moment from her affirmative reply:

“ the word “WRONG!” should have flashed across the screen – in much the same way as incorrect answers are blasted on the British television show “QI”. Because, as Van Velden, herself, Hoggard, economics graduates everywhere, and even the reasonably well-educated person in the street, knows: cutting income taxes right now is most assuredly NOT in the best interests of lowering inflation.”

For Chris, it is a simple matter: inflation is what you get when “too much money is chasing too few goods”. He says:

As an economist, Van Velden would not hesitate to condemn the idea of putting additional dollars in the hands of people already under severe cost-of-living pressures. She would know that the increased spending power being injected into the economy would inevitably lead to further price rises, as the extra money chased the same quantum of goods and services.

I am an economist and I have a different interpretation. Yes, she may have given the answer that Jack Tame was trying to elicit with a trick question, but I also heard in the interview her frustration at the lack of understanding of the multiple and subtle causes of inflation. 

While for Chris, it is black and white: income tax cuts give people more money, ipso facto, they must be inflationary, Van Velden’s hesitation was because she was seeing the whole picture more clearly than either Jack or Chris. 

The old ‘money chasing too few goods’ explanation of inflation is far from satisfactory and leads to punitive recessionary policies and tight monetary policy. It is better to think of inflation in terms of demand and supply in the context of the state of the economy.  

First, there are numerous reasons to sheet home a lot of the problem to supply side issues, for example, overseas bottlenecks, profit seeking distortions in the banking and supermarket sector, and cost pressures from deliberate policy changes such as in transport. These cost side pressures affect supply and won’t be cured by fiscal cut-backs. 

On the demand side, those at the bottom of the heap supported by benefits and part time work are unable to meet their basic living costs fall further behind. Giving this group less in order to curb inflation is stupid and only further reduces their productivity and the supply side of the economy.   If they can’t eat, what do they do?  They spend even more energy and time trying to squeeze extra assistance from hardship grants or charities, or institutionalised foodbanks, loans and support from friends and relatives, or by taking on more debt. They get what they need in a highly inefficient way.

The next group are those struggling to live on low paid work. They are carrying an extraordinary tax burden. When a parent earns more than $48,000, surely a very low income, every dollar extra over this threshold is taxed at 30% but they may also lose 27% for Working for Families, 12% for their student loan, 25% in housing assistance. If for example they earn an extra $20,000 they might retain only 6 % or $1200 (or even less after ACC and KiwiSaver).  And then, when they spend their extra disposable income 15% is taken for GST. Why would they bother to work harder to help the supply side of the economy?  

Now think of a self-employed sole parent who offers much needed nursing services to the private healthcare sector.  Working hard and conscientiously, she suffers the claw backs detailed above, but furthermore, as soon as her gross client fees exceed $60,000, she has to register for GST.   This threshold has been unchanged since 2009.  GST is an effective charge on her labour unless she can increase her fees adequately to compensate. When she puts up her fees, it directly adds to inflation while reducing demand for her vital services.

I don’t necessarily endorse the tax package that the coalition has in mind, but giving low income people some relief from terrible poverty traps that come from fixed thresholds is unlikely to cause more inflation and may usefully enhance the supply side of a desperately inefficient economy.  

The other group paying the price of inflation reduction are those who have large mortgages because of the highly distorted housing market that was not of their making. With crippling interest payments, many of these vital productive members of society are simply leaving NZ. 

The group that has not been asked to sacrifice are the top one third who hold most of the wealth and for whom cost of living pressures are irrelevant as they can buy whatever they want.  They don’t need to know the price of a litre of milk or a block of cheese. They are the super wealthy who have benefited from untaxed gains and who as landlords think nothing of increasing rents regardless of justification and social impact. It is their spending that is the most damaging.   Chris notes, 

It is also possible, of course, that throwing the New Zealand economy into a deep recession, and increasing social misery, will bring the inflation rate down dramatically. 

But the figures show we are already in a recession and its effects are evidenced daily by   welfare agencies dealing with increasingly high needs.  This means there is slack in the economy and suggests that a tax stimulus of the right kind, along with other regulatory controls, could help slow a further downward spiral without reigniting inflation.