OCR HIKE A 'DANGEROUS' APPROACH THAT WILL CAUSE 'IMMENSE PAIN' - ECONOMIST

An economics professor has labelled the Reserve Bank's continued rate hikes, as inflation stabilises, as "evil" compared to the alternative.

But another expert says the increases are likely not over yet.

The central bank hiked the Official Cash Rate (OCR) 50 basis points on Wednesday to 5.25 percent, the highest it has been since 2008's global financial crisis.

"We are raising interest rates because inflation is too high," the bank said in a statement. "Raising interest rates is the main tool we use to get inflation down."

Increasing the cost of borrowing limits spending, which reduces demand and - according to standard economic theory - eases pressure on prices.

In the fourth quarter of 2022 - the latest for which we have data - inflation was running at 7.2 percent, unchanged from the quarter before and down 0.1 percent on the second quarter of 2022.

"It's flattened-out in this country, and in many countries it's beginning to drop," economist Dr Robert MacCulloch of the University of Auckland told Morning Report on Thursday.

"Most central banks - because inflation is dropping - are holding off. And most central banks are saying, 'We'd like to bring inflation down gradually and engineer a soft landing,' which means that you don't have a recession, but our central bank has said that it wants to engineer a hard landing and it does want a recession, so there is a more gradualist approach that could have easily been adopted in this country."

The US has curbed its inflation - falling from a peak of 9.1 percent in the second quarter of 2022 down to 6 percent in the first three months of 2023.

Australia's is still rising, hitting 7.8 percent at the end of last year, whilst in the UK it has been bubbling around 10 to 11 percent since mid-2022.

Our other major trading partner China has got its inflation down to 1 percent.

Robert MacCulloch. Photo: Supplied

The Reserve Bank has estimated the economic effects of Cyclone Gabrielle will keep inflation higher than it otherwise would have been.

"Over the medium-term, the committee anticipates economic activity to be supported by rebuilding efforts in the aftermath of the weather events," its statement on Wednesday said. "The demand on resources is expected to add to inflation pressure by more than assumed in the February Monetary Policy Statement."

The Reserve Bank also said wholesale interest rates "have fallen significantly", raising the risk lending rates will follow - so hiking the OCR 50 basis points would help "maintain the current lending rates faced by businesses and households, while also supporting an increase in retail deposit rates".

'Quite a dangerous policy'

Asked if going hard now, with the ability to reverse course was the lesser of two evils - the alternative being to leave the OCR where it is, a wait-and-see approach - MacCulloch said no.

"The evil here is that you're creating a recession and you're causing pain up and down the length of the country to mortgage holders to the unemployed," he replied.

"So maybe the Reserve Bank can just reverse itself after it feels it's made a mistake, but in the meantime, there's going to be immense pain. And then there's enormous uncertainty now as to where inflation is going to go, but it is coming off its highs.

"The policy of most central banks has been to wait and see, to hold off until they have more knowledge about where the world economy is going, so it's quite a dangerous policy to say, well, we're not going to wait and see - we're just going to hike rates 50 basis points and induce a recession, and there will be untold pain in the meantime."

Typically during recessions and times of high inflation, unemployment rises. That has not happened yet - though the Reserve Bank in its statement said "employment is beyond its maximum sustainable level".

"We are beginning to see a weakening of the labour market," said MacCulloch. "That is coming through and by the way, there's a law in economics called Okun's Law that when GDP drops, unemployment nearly always starts rising. And the fact is, GDP is weakening. In fact, GDP is shrinking and now it's predicted to shrink even further.

"So practically, in every economy in the world, when you get shrinking GDP it starts showing up and rising unemployment. So that's the expectation now."

Higher unemployment can weaken inflation, according to economists, as people needing work settle for lower wages, reducing their purchasing power.

How we're different to Australia

ANZ chief economist Sharon Zollner said our Reserve Bank perhaps felt it needed to go harder, earlier than other central banks because of the way our debt was structured and where in the economy our inflation was occurring. Australia earlier this week decided to keep its cash rate unchanged at 3.6 percent, despite similar inflation rates to New Zealand.

"It's probably the closest we macroeconomists get to a controlled experiment, given the CPI inflation numbers are looking so similar," Zollner told Morning Report.

"But I think there's a couple of things going on. One is the wage inflation is very different - in New Zealand, the private sector wages hit 8 [percent] and in Australia they're running about 3 [percent], so that makes the Reserve Bank of Australia feel less urgency, I would say.

"Secondly, a lot more mortgage debt is floating over there - about two-thirds versus just over 10 percent here, so they get a lot more than for their buck quickly when they raise their policy rate.

"And thirdly, household debt in Australia is actually quite a lot higher - like, about a quarter of GDP higher. So again, that means that when they do raise their rates, they have a bigger impact on disposable income than the Reserve Bank here.

"So essentially, they think they've got a bit more time on their side and have the luxury of waiting and seeing how what they've already done feeds through into the economy, whereas the Reserve Bank of New Zealand's saying, 'Well, it's gonna be a year or more before this even takes effect, so we'd better err on the side of caution'."