‘There is little doubt we face a fully-fledged economic crisis, beyond the current cost of living crisis.’ (Matthew Hooton, New Zealand Herald , 30 September 2022)

It is unwise to be certain about the state of the economy. Experience and research has long taught us that the only certainty about commentariat pronouncements is that the more certain they are, the more likely they are to be wrong. If you know what is happening in the New Zealand economy, you are not following closely enough.

Hooton’s analysis is really Econ101. He jumps to the conclusion that because there is much liquidity in the New Zealand economy there will be inflation (unrelated to a cost of living crisis).

His argument includes misquoting Milton Friedman, who did not write that 'inflation is always and everywhere a monetary phenomenon'. In fact he wrote that  'substantial inflation is always and everywhere a monetary phenomenon'. (Milton & Rose Friedman, Free to Choose, p.254.) Omitting the ‘substantial’ is a common mistake, and reduces Friedman to as crude a thinker as most members of the commentariat. In fact Friedman the economist, as distinct from the ideologist, is a subtle thinker; otherwise his contribution to economics would have been long forgotten.

For economics is a lot more subtle than it is often portrayed. For instance, one of the recipients of this year’s Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel was Ben Bernanke. It was not for his sterling work guiding the US Federal Reserve (and hence the world monetary system) through the Global Financial Crisis, but for his scholarly work on the Great Depression which, among other things, showed that Friedman’s account was misleading. That does not mean that there is a move to revoke Friedman’s 1976 award. Good scientists make mistakes which are corrected by their successors.

To be clear, the liquidity in the New Zealand economy is a concern but it is difficult to deal with quickly without causing great economic stress. No doubt even Hooton was relieved to learn, less than a week after his confident prediction, that the fiscal deficit for last year was only half that which had been anticipated, because the deficit is a major source of the liquidity. (The forecasting error may lead one to doubts; the deficit is the difference between two very large numbers so small forecasting errors in them can lead to large swings in the difference between.) The just-announced consumer inflation figure is, however, in line with Hooton’s expectation.

Thus far, the excess liquidity in our money markets has not fuelled the inflationary forces in the economy. Certainly there are pressures arising from the ongoing struggle with supply chains, with the impact of the Ukrainian invasion, and with some unusual weather effects. I am puzzled why, given the state of the labour market, with low unemployment and employers screaming for workers, there is not more upward wage pressure. I suppose it may break out, especially if the government and the Reserve Bank cannot reduce the excess liquidity (higher interest rates are a means of doing this).

Note that we tend to equate inflation with consumer price inflation. In fact much of the liquidity enabled the house price bubble, a different form of inflation. Now that the housing bubble is deflating, there is one in the art and collectable markets. There is less booming in the New Zealand share market than one might expect, but that may reflect that their overseas equivalents are currently soggy.

Which reminds us to always begin an analysis of the state of the New Zealand economy with a review of the world economy. It is not looking too happy.

The Chinese property market appears to be a crash waiting to happen. Were China a capitalist economy, such a crash would cause havoc in financial markets but there is so much public ownership and intervention in China’s there may be a different outcome. The government managers of China’s financial system have never really been tested. Let’s hope they are up to it, although I doubt they have anyone of Bernanke’s historic knowledge, skills and judgement.

The story of the US economy is that it appears to be going into a downturn, precipitated in part by the US Fed raising interest rates. Those hikes are going to put pressure on interest rates throughout the world economy.

Britain is not so important in the world economy today. Its economy is struggling to adjust to withdrawal from the European Union, but those difficulties have been compounded by mismanagement by the short-lived Truss Government which seems to be economically naive. Its failure is well illustrated by Bill Clinton’s political adviser, James Carville, who said that ‘I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody.’ Hopefully, Truss’s misjudgements will not lead to ongoing difficulties in London’s financial markets which will impact on the rest of the world. She has almost certainly weakened London’s role as a financial centre (reinforcing Brexit’s effect).

The European economy is also struggling from the cutoff of gas and oil supplies from Russia. Fingers crossed that they have a warm winter.

The Russian invasion of Ukraine is causing difficulties to the world economy. One cannot have a war of that size without some impact. Wars do not come for free (even if the human costs of death and mobilisation are being avoided by most countries), most notably in rising prices which flow into the New Zealand economy, and supply shortages which restrict goods inflows. That is the origin of our ‘cost of living crisis’; we are helping to fund the defence of Ukraine.

Minister of Finance, Grant Robertson, says the New Zealand economy is well placed to deal with such shocks. I am more cautious, unless he means that we may not be damaged as much as some other economies. It is extremely difficult to avoid international impacts.

Domestically, we face the usual trying uncertainties. The probability of great difficulties is not high but it is not zero. You will observe that economists tend not to project ‘crises’, although they will talk about past economic and financial ones and look for parallels.

Unfortunately, the term ‘crisis’ is usually used pejoratively, typically without any clear analysis of what is going on, by those with political agendas wanting to justify a major change in direction which is really underpinned by ideology rather than analysis. The cliché, ‘never waste a good crisis’, is not an excuse for trying to manufacture one.