The global economic outlook is darkening, and economists are increasingly worried about a potential return to the unsettling economic conditions of the 1970s: stagflation. This unwelcome combination of high inflation, sluggish economic growth, and persistent unemployment is no longer considered a remote possibility, particularly in New Zealand, as geopolitical tensions and supply chain disruptions continue to ripple through the world economy. The current situation, fueled in part by the conflict in the Middle East and its impact on energy prices, presents a complex challenge for policymakers and households alike.
While a full-blown recession isn’t necessarily the most likely outcome, the risk of significantly weaker growth alongside stubbornly high inflation is growing. This isn’t simply a matter of rising prices; it’s about a fundamental squeeze on economic activity. Businesses are facing higher costs, consumers are seeing their purchasing power eroded, and confidence is waning. The delicate balance that central banks have been trying to achieve – cooling inflation without triggering a recession – is becoming increasingly difficult to maintain. Understanding the dynamics of this potential stagflationary environment is crucial for businesses and individuals preparing for a period of economic uncertainty.
The immediate trigger for renewed concern is the escalating conflict in the Middle East. Higher fuel prices, a direct consequence of the instability, are expected to exacerbate inflationary pressures. According to the U.S. Energy Information Administration, global oil prices have seen significant volatility in recent weeks, directly impacting transportation costs and broader consumer prices. The EIA’s data shows a clear correlation between geopolitical events and fluctuations in oil markets.
A “Stagflationary Shock” to the System
Mike Jones, chief economist at BNZ, describes the current situation as a “stagflationary-type shock.” He explains that the conflict is simultaneously hurting growth prospects and putting pressure on disposable incomes and business margins while also pushing up inflation. “We’re also vulnerable given the economy going into this was only starting to uncover its feet,” Jones said. While New Zealand benefits from elevated commodity export prices and a falling New Zealand dollar – which boosts returns for exporters – these buffers are unlikely to fully offset the negative impacts. He anticipates a disruption or pause in the economic recovery, rather than a full-scale curtailment, suggesting weaker growth but still some positive momentum.
The vulnerability stems from the fact that New Zealand’s economy was still recovering from previous shocks when this new challenge emerged. The country has been grappling with the lingering effects of the COVID-19 pandemic and the subsequent supply chain disruptions. This pre-existing fragility makes it more susceptible to external shocks like the current geopolitical instability.
Supply Shocks and Limited Pricing Power
Gareth Kiernan, chief forecaster at Infometrics, notes that stagflation was previously discussed as a possibility a few years ago, but didn’t materialize in the same way. “It was inflation followed by ‘we need a recession to rein that back in’,” he said. However, he believes the current situation is different because it’s a supply shock that is simultaneously pushing up prices and negatively impacting growth. Kiernan emphasizes that businesses are already being forced to pass on cost increases to consumers, even in an environment of limited demand. “I’m not talking about transport businesses putting up their prices. I’m talking about everybody who is using the transport services then being forced to put up their prices, because we’ve had an economy where for the last three years, it’s gone sideways. And people have been trimming and trimming, and there’s nothing left to trim.”
This lack of pricing power for businesses is a key concern. Unlike previous inflationary periods where demand was strong, the current environment is characterized by stagnant growth and cautious consumer spending. This means that businesses have limited ability to absorb higher costs and are forced to pass them on to consumers, further fueling inflation. The Reserve Bank of New Zealand (RBNZ) has previously suggested that fewer price increases would be passed on due to weak demand, but Kiernan argues this is an overly optimistic assessment.
The Role of the New Zealand Dollar and Export Opportunities
Westpac’s chief economist, Kelly Eckhold, remains cautiously optimistic, still expecting some economic growth this year, even though he acknowledges the potential for that outlook to change. Eckhold noted that a recent forecast update assumed improvements within a month, but warned that “things obtain darker quite quickly” if that doesn’t happen. He highlighted the low confidence levels surrounding current forecasts due to the numerous unknowns. He expressed significant worry, stating, “I think this is a very, very serious situation.”
A key factor mitigating some of the negative impacts is the lower New Zealand dollar, which makes imported goods more expensive but boosts the competitiveness of exports. Eckhold explains that a weaker currency can aid the external sector offset some of the economic damage. However, he stresses that “nobody in New Zealand can protect us from the loss of standard of living that has come from this shock.” He believes the government can only smooth the edges for the most vulnerable, and the burden of these costs will fall on New Zealanders.
The path forward, according to Eckhold, lies in strengthening the external sector and increasing exports. A lower exchange rate is seen as a crucial component of this adjustment. However, this requires a sustained effort to improve export competitiveness and diversify export markets.
Looking Ahead: Monitoring the Conflict and Inflation
The duration of the conflict in the Middle East remains the biggest uncertainty. As Eckhold points out, “significant damage has already been done and it won’t be fixed quickly.” The potential for further escalation and the resulting impact on oil prices and global supply chains are major concerns. Economists will be closely monitoring inflation data, employment figures, and consumer confidence indicators in the coming months to assess the extent of the stagflationary risks.
The next key data release will be the Consumer Price Index (CPI) figures for the September quarter, scheduled to be published by Statistics New Zealand on October 24, 2024. The CPI data will provide a crucial update on the state of inflation and will likely influence the RBNZ’s monetary policy decisions.
This is a challenging time for the global economy, and New Zealand is not immune to the risks. While the situation remains fluid, the growing concerns about stagflation underscore the need for careful monitoring and proactive policy responses. We encourage readers to share their thoughts and experiences in the comments below.
