Rodney's Ravings: History suggests a recession is inevitable, and it could be a double dipper

Even though signs are good that inflation is easing, it’s going to be a drawn-out battle.

That’s because (as discussed last month) the Reserve Bank allowed New Zealand’s unemployment rate to fall well below the level consistent with its inflation target.

This month, I wanted to take a look at whether a “soft landing” is possible for the NZ economy – as well as in the US, UK and Australia, where central banks similarly overstimulated in response to Covid, creating underlying inflation problems separate from higher energy costs.

What is a soft landing?

It’s when a central bank slows economic growth to a low level and keeps it there for long enough to boost the unemployment rate back up to the level consistent with balanced bargaining power between employees and employers.

In a perfect world, a soft landing avoids a painful recession – falling economic activity – which is possible if a central bank makes quality, proactive decisions. Unfortunately, history offers up no cause for optimism when it comes to central bank decision making.

In a recent client report, I reviewed the approaches taken in NZ, the US, UK, and Australia over the last 50 years in respect of managing inflation.

In particular, I was looking at whether these countries had succeeded in avoiding recessions after their central banks allowed inflation problems to develop – and unfortunately, history suggests the answer is no.

So, it seems none of these four countries have any chance of avoiding a recession, if not a double-dip one, because of poor decision-making by their central banks.

After massively overstimulating in response to Covid, New Zealand’s Reserve Bank (RBNZ) is charging ahead blindly with OCR hikes, ensuring a reasonably big recession is inevitable.

But inflation is a global issue – not just a NZ one – so I wanted to use the UK as a case study of past experience with inflation and recessions.

Prior to this current period, the UK has had two other episodes of inflation in the last 50 years, illustrated by the grey line in the chart below.  

The first – big – one took two major recessions to fix, in the 1970s and early 1980s, which you can track on the chart's blue line. As with the current inflation episode, oil price spikes played a part, and there was also an underlying inflation problem due to over-stimulatory monetary and fiscal policies.

And the UK’s most recent inflation episode before the current one was in the late 1980s. It was less severe and less entrenched, but still required a moderate recession to fix.

Recessions can be caused by other things, like the GFC and Covid. In NZ’s case we headed into recession even before the 1988 financial crisis because of a sustained period of high interest rates related to the Reserve Bank’s last battle against inflation.

There are no precedents to suggest that NZ, the UK, US, or Australia can escape the current inflation problems without recessions. This is because monetary policy is a blunt tool, and central banks show no finesse in operating it.

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