Inflation: Creeping Toward Fiscal Management

Note written for circulation in March 2024

There’s almost no issue on which outgoing Labour MP and former Finance Minister Grant Robertson would find agreement with former National and Act leader Don Brash. But when Robertson was asked during his exit interview with the Herald whether he thought it was worth considering Brash’s idea of moving away from the blunt Official Cash Rate as the Reserve Bank’s primary tool for controlling interest rate[1], he said it was worth looking at, at least. (‘Weekend Herald’(March 23, 2024)[2]

My purpose here is not to explore the constitutional implications of taxation being implemented without representation (although the First British Empire fell because they pursued this course). Nor do I want to explore the fact that Brash took a different position when he was Governor of the Reserve Bank – one is allowed to change one’s mind. Rather, I want to consider the evolving issue of fiscal management being used to regulate demand in the economy for macroeconomic purposes, albeit for anti-inflationary purposes rather than the traditional ones of managing the business cycle or the external current account.

Even traditionally – when I was a lad – it was recognised that interest rates could have a role in this demand management. However, there were a number of reasons not to rely solely on interest rate management. Perhaps the most compelling at the time was that the burden of adjustment was carried by only part of the economy – investment, inventories and consumer debt purchases. Since it was only part of the economy, the burden on those components was far larger than if the burden had been shared across the economy. One could go on to describe the side effects of the imposition, especially on capital formation, but that is not necessary here.

(Demand restraint often means a rise in unemployment with incomes – especially wages – not rising in line with prices and productivity. So part of the burden of adjustment is borne by low-skilled, low-income workers, especially. That is always true.)

In those days the exchange rate was fixed. Once the exchange rate was floated, the export sector was to those activities which would take the brunt of the demand management since interest rates would impact on the exchange rate.  (It is unnecessary for the purposes of this note to pursue the issue further; it is mentioned for completeness.)

However, there was another channel of adjustment which was once not paid a lot of attention. Today a powerful reduction in aggregate demand comes from higher mortgage interest rates. Essentially, a rise in the OCR raises interest rates across the economy, so that mortgage holders have to cut back their other spending thereby reducing aggregate demand.

The models we use to discuss these macroeconomic stories typically excluded any distributional effects. It is a part of the common assumption of the dominant economic paradigm that distribution does not much matter. (Which, not incidentally, is a major reason why economists have less impact on the political economy than they think they deserve.)

Moreover, traditionally – when I was a lad, to be confirmed when when we got the data – interest paid by households was about equal to interest received by households. That meant that a rise in interest rates simply redistributed income among households. That is no longer true. Today households borrow offshore (via banking and other financial intermediaries) so that household interest payments exceed household interest receipts. A rise in interest rates transfers income offshore. I leave others to discuss whether those matters.

What certainly matters is that the impact of the measures to reduce inflationary pressures affects one group in the community far more than others and, as in the previous examples I have given, the burden is greater on a narrow, and often more innocent,  group in the economy than if it were shared more evenly.

That is a point Brash made: recent home purchasers with large mortgages were hit more heavily than long-time home purchasers, while those who were about to purchase their first home had their ambitions further thwarted. As I noted elsewhere, children are particularly affected.[3]

The view that Brash and Roberston seem to be favouring includes that when aggregate demand needs to be restrained, GST should be increased, so that aggregate consumer demand is reduced across all households; that would share the burden of adjustment more widely. I leave others to judge whether such a policy would be equitable, although it would probably be more equitable than loading all the adjustment onto home owners with mortgages.

(I mention that it is very hard to explain to the public how increasing prices via a GST hike is anti-inflationary; it would be a repeat of the difficulties we used to have when a hike in excise taxes on tobacco and alcohol was justified by saying it was fighting against inflation.)

The previous paragraph neither supports nor rejects changing GST rates as an anti-inflationary measure. There are some obvious administrative problems as well as constitutional issues (see the appendix on the ‘regulator’). But it would also be helpful if advocates would quantify the tradeoff between an interest rate hike and a GST hike; what is a percentage-point hike of GST equivalent to a change in the OCR in terms of the impact on aggregate demand?

Rather, the point of this brief and simplified ramble though New Zealand’s macroeconomic policy history is that there seems to be some (growing) return to the recognition that there is a role in aggregate price management from fiscal policy as well as from monetary policy. Even the current governor of the Reserve Bank has said that fiscal policy could help the RBNZ. The purpose of this note is to encourage some careful discussion on what that role might, or could, be rather than locking us into the commentariat obsession with monetary policy alone.

Appendix: The Regulator

The ‘regulator’ was a measure used in Britain in the 1950s and 1960s. An Act of Parliament gave to the Chancellor of the Exchequer the power to change overnight the excise duties on alcohol and tobacco (possibly also petrol – I don’t remember) without consulting Parliament. However, the Chancellor then had to report to Parliament shortly after and was, in principle, open to the House of Representatives rejecting the change. That was unlikely given the Chancellor’s party was in the majority but it meant that the elected representatives of the people were still formally in charge of taxation. Were the tax changes to be made by a governor of the central bank, there would be no certainty that the governor had the confidence of parliament.


[1] The newspaper text says ‘interest rates’. Possibly Brash said that, but from the rest of the article ‘inflation’ seems more likely. Perhaps the journalist misread his short hand.


[3] .