28 July 2007
In a week when lies in Parliament led to the unceremonious departure of Labour’s 10th Government Minister, another statement made during Question Time deserves closer scrutiny.
In particular, in answer to a question on the Reserve Bank, Finance Minister Michael Cullen stated, “a large tax cut, feeding further demand into the economy, would clearly place further inflationary pressure into the economy, thereby leading to even tighter monetary policy.”
The question of whether that statement is correct is an important one for New Zealand since it epitomises the ideology that drives the Labour Party’s management – or mismanagement – of our economy.
Since being elected to government, Labour has used a variety of excuses to claim that the country cannot afford tax cuts. Usually those excuses hinge around the fallacy that tax cuts would mean that people like nurses, teachers, and the police could not be paid.
That, of course, is utter rubbish. The programmes targeted through tax cut policies are not those that provide core services. Rather, they are those that are ill advised or would be better carried out by the private sector.
Such ill-advised expenditure would surely include the $652 million purchase of 105 LAV3s, the armoured personnel carriers that can’t be used by our troops in action, because they are too big to be transported out of the country! Another would be the $20 million on-going cost of storing and maintaining the Skyhawks and Aermacchi planes that Labour are left with after foolishly deciding to disband our Airforce.
What about the wisdom of funding a second Maori language TV channel or holding educational training courses in prostitution? And why does the government run ACC, when the private sector did it more efficiently and better?
Another burning question is why a small country like ours needs another 15,000 public servants? Are they the reason that so many questionable new laws and regulations – such as the proposed new air quality standards – are being introduced? These new air quality standards will not only force a wider ban on the use of fires for home heating, but it has been estimated that the proposed restrictions on emission controls on cars will cut the importation of used cars into New Zealand by up to two-thirds!
Or what about the new regulations on “biosprospecting” that are being proposed by the Ministry of Economic Development (MED)? This new regulatory regime is being set up in anticipation of Maori being given the rights to all of New Zealand’s indigenous flora and fauna by the Waitangi Tribunal. While many thought the flora and fauna claim would be laughed out of court, the government clearly believes that it will succeed and are busy setting up new systems to deal with it. If you would like to have your say on Bioprospecting, visit the Government Consultation page of the NZCPR.com website and click on MED with a view to sending in a submission before October 12th.
Returning to the question of whether or not tax cuts are inflationary, we need to examine the fundamental causes of inflation. Inflation occurs when the supply of money grows faster than the supply of goods and services. This results in too much money chasing too few goods and services, causing prices to rise across the board.
The prices of goods and services sampled from fifteen different locations around the country are collected on a three-monthly basis and used to calculate the Consumer Price Index (CPI), which is the official measure of inflation. These goods and services are sourced from the tradable sector where there is plenty of competition, and the non-tradable sector where there is none.
It is the role of the Reserve Bank to maintain price stability in the economy by keeping the CPI under 3%. To do this it uses the Official Cash rate (OCR) to tighten money supply through higher interest rates, or to loosen it through lower.
When Labour became the government in 1999, they inherited a CPI of 0.5% and an OCR of 4.5%. As at June 2007, the CPI was 20% higher than it was in June 2000. The Reserve Bank has now pushed the OCR to 8.25% – giving New Zealand the dubious honour of having one of the highest interest rates in the western world – and the currency markets responded with the kiwi peaking at over US81 cents, the highest level in 25 years, before falling back.
In order to better understand the complex forces behind the rise and fall of the kiwi, I asked the NZCPR Guest Commentator, Dr Roger Bowden, Professor of Economics and Finance at Victoria University to explain the dynamics. In his article “The NZ dollar: End game or a new game altogether”, he describes how Japanese housewives fund the mortgages of NZ homeowners: “Most of our housing mortgages are funded by Japanese housewives who invest in uridashis, which are NZD denominated bonds. Foreign banks and corporations like to issue such bonds into the Japanese market because the housewives do like the high coupons that they carry. After all if you can get 7% on a NZD uridashi and 1% on an equivalent yen bond, it looks like a bit of a no-brainer”… to read the article click
The Reserve Bank has copped a fair bit of flak for its recent performance including its futile visit to Japan to try to discourage investment in the kiwi, its costly intervention in the foreign exchange markets, and – most importantly – its failure to lay the lion’s share of the blame for driving up inflation on the Labour Government’s big-spending habits.
Since 1999, government spending has increased by a massive $21 billion. As a result, the non-tradable part of the economy, which is made up of the activities of central government and local government, has consistently produced annual inflation of around 4%. In comparison, inflation in the competitive parts of the economy, which includes retail, has been tracking closer to 1%.
In their submission to the Parliamentary Inquiry into the Future Monetary Policy Framework, the New Zealand Business Roundtable identifies those factors which contribute to inflation. In particular they mention the flow-on effect of high taxes in reducing productivity, which has now slumped by two-thirds since 2000. They estimate that if annual productivity growth had been just 0.2% higher, the increased level of goods and services in the economy would have kept inflation down, interest rates would be at least 50 basis points lower and the exchange rate “well south” of US70 cents.
Other inflationary factors they identify include the increases in labour market regulation; cost-raising regulations in areas such as ACC, telecommunications, electricity and banking; cost increases caused by the Resource Management Act, the Building Act, and council restrictions on land supply for housing; and the failure to press on with essential reforms in areas of infrastructure such as roading and water.
In addition, they mention the growth in local council spending and the increases in rates, fees and charges as a result of the Local Government Act 2002, which encouraged to local authorities to dramatically expand their roles and functions.
[However, concerns about the cost increases and poor services provided by local government are not specific to New Zealand. These same concerns were responsible in 2005 for driving the residents of Sandy Springs in the US State of Georgia to overwhelmingly support a referendum – 96% to 4% – in favour of privatising their city. Now run by just four employees, this city of 90,000 contracts out all of its services, except fire and police, with residents being delighted with the fall in costs and the rise in efficiency with which their services are provided. (More )]
Finally, having identified the factors that cause inflation as being largely the responsibility of the Labour Government, the submission describes the factors that do not cause inflation. These include the saving or spending habits of New Zealanders, house prices, the lending policies of banks, and tax cuts. (To read the submission, click here ).
The reason that tax cuts are not inflationary is that tax in the hands of government is spent – and maybe even wasted – but that same money given back as tax cuts will be saved, used to reduce debt, invested to improve productivity, and generally used to improve the lives of those who earned it.
Clearly Labour has driven up inflation with its profligate spending and is itself largely responsible for most of the pain that our high dollar has caused. Isn’t it time that this government accepted accountability?
The poll this week asks: Would you like to see the Reserve Bank take the government to task for excessive government spending? Go to Poll
Reader’s comments will be posted on the NZCPR Forum page click to view .
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