‘Inflation main problem

Press, 4 May 1981, Page 26

‘Inflation main problem

The fourth report of the Economic Monitoring Group to the New Zealand Planning Council will be released today. The Group is an independent body charged with reporting on the implications of current and prospective short-term economic developments for medium-term strategy. It finds that there are some encouraging aspects to the immediate out-

look, but policy must be well managed if the medium-term prospects are not to be prejudiced. In particular the Monitoring Group considers that New Zealand’s high inflation is the most important problem to be solved. The report is over the names of Sir Alan Low, acting chairman, Prof. G. R. Hawke, Mr P. F. Polson, and Prof. G. J. Schmitt.

New Zealand’s high inflation is the most important problem to be solved, according to the Economic Monitoring Group’s report to the Planning Council, published today. The main recommendations of the report are:— ... Adoption of a target of reducing our rate of inflation to the average of our trading partners (about 10 per cent) within two years. ... There should be a taxwage bargain, combining income tax reductions with reduced wage-rate increases, with a commitment by all parties to minimise the impact of inflation. ... The budget deficit for 1981-82 should be no more than 5 per cent of gross domestic product. ... The budget deficit should be financed to a greater extent than last year from non-bank internal borrowing, if necessary by raising interest rates on Government securities to a competitive but non-dominating level.

... There should be a commitment to taxation reform with a prime objective of widening the tax base. ... Improvements to the tax system should continue especially in indexing the tax scales and basing company tax on current cost accounting.

“In the light of its analysis, the Monitoring Group recommends that the county should aim to bring its inflation rate down to the world level within two years, i.e. to an average of about 12 to 13 per cent for the March quarter, 1982, and that after 1982-83 the aim should be to reduce inflation still further. “Since the mid-1970s there has been very little growth in output. Slow economic growth, combined with a rising proportion of the population in the working-age group and a rising participation rate, has meant rising unemployment,” the report says.

“During the 1970 s private consumption rose — strongly in the first half and being more than sustained in the second half. At the same time, since the peak in 197374, private investment has fallen considerably, contributing to the weak employment situation. The need for reversing the fall in investment is again emphasised by the Monitoring Group, and the prospect of this happening in 1982-83 is welcomed.

“New Zealand’s balance of payments position has considerably improved since the 1974 to 1976 period, when the deficit on current account was over 10 per cent of GDP. In the last two years it has been under four per cent. The improvement has been helped by a valuable increase in the volume of exports, especially of manufactured goods and forestry products, but we are now entering a period of higher imports including those associated with the construction phase of major development projects.

“inflation continues to cause the greatest concern. In virtually the whole of the post-war period New Zealand’s inflation rate has moved Very broadly in line with, those of our major trading partners, except for the latest five years when the rates have markedly diverged. New Zealand’s 16 per cent is currently well above the overseas average, which is about 10 per cent, and falling. “The prospects for the coming year, 1981-82, are mixed. It should be the first since the early 1970 s in which private capital formation grows faster than consumption. The benefit of big new projects in energy-re-lated and other industrial fields, in stimulating demand and providing jobs, will be useful but not dramatic in these early stages. In any case, the spin-off for local industries will be limited by the import content which is as high as 60 per cent in

some cases. A greater stimulus can be expected in later years.

“The scope for deliberate stimulation of the economy, on top of the renewed growth that is already expected to occur, is regarded by the Monitoring Group to be still limited by the need to bring inflation down and to avoid a further rise in the external deficit. Equally, a policy relying heavily on reducing demand is not acceptable. A combination of policies is needed to tackle inflation and unemployment while being consistent with a manageable balance of payments position and improved growth. “The Monitoring Group believes this to be the crucial policy problem underlying all others, and therefore has given special attention to this subject in its report. First, it emphasises that inflation is not only directly harmful to the economy but, because of its pervasive effects, hinders the achievement of many economic and social objectives. This is cause:1. It causes unintended changes, in the distribution of income. 2. It leaves certain sections of the population (e.g. farmers and other exporters) vulnerable to - erratic changes in prices. 3. It accentuates industrial strife. 4. It hinders long-term capital investment by creating uncertainty and discouraging adaptation to change. 5. It encourages a diversion of funds to shortterm uses and into sources of non-taxable income.. 6. It forces up interest rates. 7. It makes budget management more difficult. 8. It tends to increase , unemployment. 9. In conjunction With less-than-adequate adjustment to the scale of

personal income tax, inflation causes effective rates of taxation to rise without any specific decision to do so being taken by Government. 10. It dangerously distorts the calculation of business profit so long as historic-cost accounting is used. “It is true that some of the harmful redistribution of income has been reduced by

the adoption, in practice, of various forms of indexation, enabling people to increase their incomes to compensate for the loss of purchasing power resulting from inflation. This process, however, tends to make inflation selfperpetuating because it sustains the interaction of prices and incomes. “In the light of these facts, the Monitoring Group sees no basis for relaxing the fight against inflation. On the contrary it expressed concern at the tendency for people to become complacent about inflation and to aim to live with it rather than tackle it. There can be a lengthy and complex chain of events between the initial cause of inflation and the eventual rise in the consumers price index.

“The urgency of reducing inflation combined with the continuing problem of unemployment, leads the Monitoring Group to give strong support to the idea — already under discussion — of a tax-wage bargain between Government, employers and unions. This would involve, first a reduction in the rates at which personal income tax is levied, either by raising the income levels at which increased marginal rates take effect, or by lowering those rates of taxation themselves. Second, there would be a moderation in the size of increases in wage rates so as to have a more or less compensating effect on real after-tax incomes. This leaves open the possibility that real wage rates can increase as a result of normal bargaining if real effective GDP per head is increasing.

The group remains concerned about the size of the budget deficit. It seems likely that, without a change in policy, this year will see another increase in the deficit, relative to GDP, at a time when there is likely to be an increase in economic growth. Particularly large deficits feed the whole interactive process of inflation, it says.