As the Reserve Bank raises interest rates, vodka could be the answer
Damien Grant is an Auckland business owner, member of the Taxpayers Union and regular opinion contributor for Stuff.
OPINION: Imagine that you are the vodka commissar of the People’s Republic of Donbass.
Your task is to ensure the distribution of vodka to the citizens of the nation. Your mandate is to reach an average level of vodka consumption between 1 and 3 liters per adult annually.
Over the past year, however, there has been a malaise in the national psyche. In response, you decided to increase the availability of vodka to boost national morale. Voluntary pun.
Subsidized vodka for everyone! Consumption has increased and is now at 6 liters per person. It certainly lifted the nation’s mood, but the resulting rational exuberance proves disruptive. It’s time to bring down the level of consumption.
* Adrian Orr suggests the Reserve Bank is ‘incredibly worried’ about inflation
* The Reserve Bank raises the official exchange rate by 25 basis points and now sees the rate climbing to around 3.4%
* Adrian Orr says Reserve Bank has ‘small role’ in unsustainable house prices
Alas, you discover a problem. In the past, vodka consumption was evenly distributed. Today, most consumption is concentrated among a small percentage of the population, as some citizens have reacted aggressively to the supply of cheap alcohol.
You accelerate a resolution by liquidating those who have consumed too much. It’s a bit drastic, and as a result, you can expect to be fired as the state seeks to restore faith in the vodka market.
Now you might be wondering, that was a great story, but what does that have to do with Adrian Orr?
When Don Brash – not to be confused with Donbass, but the literary allusion was too tempting – was tasked with reducing inflation, nearly 74% of the population owned their homes. Today, that figure is at least 10% lower.
Brash managed to defeat inflation by reducing the purchasing power of those with floating mortgages. This pain was spread over no less than half of all households. A drop in demand followed and reduced spending put downward pressure on prices.
Orr faces a different set of facts.
Someone who bought a house before 2016 enjoyed at least a doubling of the value of their property and, thanks to historically low interest rates, a large part of the repayments would have gone to reducing the principal.
Those who have bought in the past few years will have paid dearly and borrowed so much that many of them are now walking stooping. As Orr increases the cost of borrowing, it’s those unfortunate few who are going to be liquidated, while the rest of us are largely unaffected.
It is possible that the rise in interest rates will not have a short-term effect on businesses either. For most companies, servicing debt is only a small part of their total expenses and although a rise in rates will reduce new investment, this effect will take years to trickle down to demand.
Perhaps the Reserve Bank understands this and can explain why the OCR hike was only a nominal 0.25% instead of the 0.5% some were expecting. Or maybe it was another misstep in a long series of missteps.
More importantly, the bank announced that it would not renew the large-scale asset purchases it made at the start of the pandemic.
The assumption, at least mine, was that these debts would be rolled over, meaning they were never to be repaid until inflation reduced their face value to the price of a single Ukrainian hryvnia.
Orr put the Treasury under pressure. The maturities of these loans are staggered over the coming decades, with the tail ending in 2041. However, seven and a half billion are due in April next year and five billion in May 2024.
In order to meet these repayments, Grant Robertson, and perhaps Simon Bridges after him, will have to either raise taxes, cut spending, or borrow on the open market. This is a problem because large budget deficits are expected in the years to come.
This means that the Crown will have to borrow not only to cover its current deficit, but also for the $53 billion owed to the central bank.
As the Treasury seeks funding, it will pay market rates for its sovereign debt. As a result, New Zealand is going to experience higher interest rates for longer and the cost of this is going to be spread unevenly among those who responded to the incentives created by the bank.
Asked last Thursday by Epsom MP David Seymour, Orr blithely replied that “we don’t target house prices, we target consumer price inflation”.
“We lowered interest rates to achieve what we had done. Whether people want to use this to buy and sell assets is the choice between them and the financial institutions.
The problem, Governor, is that these individuals responded to the incentives created by your institution and now they are the ones who will pay the price for what is widely perceived as a massive mistake.
Opposition spokesman Andrew Bayly quizzed the governor on how we appear to be the second most aggressive country in the OECD on quantitative easing, but again Orr dodged responsibility , highlighting the dire economic situation he faced in March 2020.
It does not make sense. Orr began easing monetary conditions in May 2019, nearly a year before the pandemic hit, leaving him with little room to react in a crisis. There is near consensus that he overreacted when the crisis hit.
Economic consultancy Infometrics echoes the views of most commentators when advising its corporate clients: “Our view is that the Reserve Bank has lost control of inflation, with real costs climbing. soaring (and) rising inflation expectations…”
In his monetary policy statement, Orr did not even acknowledge that his quantitative easing policy is responsible for the price spike in the non-tradable sector; goods and services produced and sold in New Zealand.
An effective central bank is a credible bank that has the confidence of the market.
This governor appears unable or unwilling to admit past mistakes and hampers the bank’s ability to fulfill its regulatory function. He should resign.