Analysis by Keith Rankin.
Public policy in New Zealand is paralysed by an unwavering mis-framing of the current economic stagnation. A key part of the problem is the popular attachment to the phrase ‘cost of living crisis’ as a catch-all for contemporary economic malaise.
The first task towards clear thinking is to disentangle ‘cost of living’ from ‘inflation’. To do that it helps to separate the words ‘price’ and ‘cost’. We should get out of the habit of saying ‘cost’ when we mean ‘price’. A commonplace expression of the crisis is that ‘prices are too high’, though that is often translated in the minds of professionals – economists, journalists, politicians – as ‘inflation is too high’. Inflation is the rate of change of certain prices, not the prices themselves. We note that the CPI – the consumers’ price index – is a direct measure of average prices; and is thus the measure from which inflation is usually calculated.
Rising (rather than high) real costs of production are important contributors to price increases. Real contributions to high consumer prices may include ‘profiteering’ by retail or wholesale firms with the market power to set high margins; ie high price markups. Although this situation begs the question as to why firms with such power would wait for a crisis to exploit their power. Such firms – such as supermarkets or banks or power companies – may or may not contribute to high costs, but are unlikely to be contributing to high inflation. By and large, these industries are being used as scapegoats; distractions from the real problems.
We note that the word ‘real’ serves critically as a contrast to the word ‘nominal’. A real crisis (or real crises) can easily set off a monetary inflation that’s presented as the main crisis. Indeed, that’s what has happened in the world economy in the 2020s so far. The real cost-crises (the disruptions to the global supply chains in, especially, 2021 and 2022) were the primary events, and the subsequent inflation – by definition a nominal (ie non-real) event – has been a secondary event. By ‘nominal’, economists agree that inflation happens, but that it’s simply a fall in the price – that is, the purchasing power – of a dollar. Inflation is deemed to be a problem, because people with money in the bank – or under the bed – wish their dollars to be able to buy as much tomorrow as they will buy today.
The quite simple story of price increases has however been complicated and perpetuated by poor narration and poor policymaking, by both central banks (such as the Reserve Bank) and by governments (such as New Zealand’s from 2022) pursuing policies of ‘fiscal consolidation’. Thus, as occurred with the Great Depression of the 1930s, a potentially simple crisis of real shocks and monetary adjustment has morphed into a fullscale crisis of inept policymaking, weasel words, and technocratic butt-covering.
We start by noting that real costs must be borne, whereas nominal price adjustments only have a distributional impact. The costs of pandemics, wars, and global warming are real and must be borne; whatever their causes.
The Malaise: a Mix of Non-Inflation and Inflation
The present ‘high price’ crisis is not an ‘inflation’ crisis; although some inflation is symptomatic of the crisis. ‘CPI inflation’ is a measure of how fast prices are increasing. Prices don’t have to be increasing to be problematically ‘high’. Further, increases in the CPI – our favoured ‘metric’ for the general level of prices – represent a mix of real price increases (due to higher costs) and nominal price increases attributable to (monetary) inflation.
(Milton Friedman, the renowned Chicago School ‘monetarist’, was right. ‘Inflation’ is everywhere and always a monetary phenomenon, by definition. But not all increases in the general level of prices are inflation. Further, such academic monetarists have a naughty ‘remedy’ for non-inflationary price increases; that remedy, ‘monetary deflation’ – negative inflation – can be used to conceal real price increases. Monetary policy can, seemingly, counter any crisis of higher prices; not just an inflation process. ‘Inflation’ can be defeated, even if it isn’t inflation. But at a cost.)
So, we have two definitions of inflation. Many commentators – including economists – switch backwards and forwards between the two meanings. The statistical measure (definition one) is called ‘CPI- inflation’. The economic process (definition two) is ‘monetary inflation’. The two definitions overlap, but are not the same. The latter is the correct technical definition of ‘inflation’.
The difference is important. To give an example. Perhaps the annual rate of increase of ‘CPI inflation’ is three percent. Quite possibly two percent of that (strictly, ‘two percentage points’) is due to an increase in ‘real costs’. And the other one percent is technical inflation. If so, then we can say that the ‘price of money’ has fallen by one percent, not by three percent. Monetary inflation – the economists’ definition of inflation – is the rate of depreciation of money. (And we note, given that money is a social technology rather than a pottle of wealth, any depreciation of money may or may not be a bad thing; and if it is a bad thing, it’s probably – like physical pain – a symptom of a problem rather than a problem in itself.)
(We do not have a way to accurately measure how much of a CPI increase is due to rising costs vis-à-vis inflation. While economists can estimate the proportions of each contribution to a ‘headline’ CPI number, many – especially those who wish to interpret a rising ‘cost-of-living’ as an inflation crisis – prefer not to make the distinction. What we can always say, however, is that a ‘headline’ CPI-inflation measure – like many measures – is an overall estimate for an underlying but unknown composite reality. While standard textbook remedies for inflation are quite different from remedies for cost overruns, some economists have an ideological predilection for anti-inflation remedies. For those economists, such remedies can represent a solution looking for a problem.)
So, what do we mean by an increase in ‘real costs’? (Price increases arising from such costs represent the non-inflationary component of CPI-inflation.) A good example is the cost of picking fruit from trees. If we only pick low-hanging fruit, then the cost of fruit picking (and hence the price of fruit) is ‘low’. If there is only high-hanging fruit on the trees, then the cost of fruit-picking is much higher; the price of fruit will be higher, because more labour was required to pick the fruit. A switch from low-hanging to high-hanging fruit can be expected to cause a price increase of fruit; this is not inflation.
We can apply this insight to other products, such as crude oil. If the oil is seeping out of the ground, then it’s the equivalent of low-hanging fruit. If the oil is deep under the North Sea or Alaskan ice, then it’s the equivalent of high-hanging fruit. Another possible source of rising real costs is increased bureaucratic compliance. Any situation where the economy is supporting more bureaucrats than is really necessary is an example of excess cost. A further source of real cost is a ‘primary increase’ in ‘factor costs’ such as interest rates (capital cost) or wages (labour cost); primary cost increases set off an adjustment process; secondary increases are the adjustment process itself. A primary increase in interest rates or wages may be due to a policy; for example, a ‘tightening of monetary policy’ or a ‘general wage order’. (On the matter of general wage orders and the like, see my Equal Pay, Pay Equity, and Cost-of-Living Narratives, 22 August 2025, here or here.)
A ‘secondary increase’ is an increase which represents a market response to a ‘non-clearing market’. Primary events are destabilising ‘shocks’ or ‘stresses’; secondary events represent stabilising adjustment processes, corrective ‘ripples’. Inflation is, for the most part, a secondary event. There is an important exception – called primary inflation – which is the impact of a demand-shock or a demand-stress; in my account so far, I have confined the discussion to supply shocks and supply stresses.
Generally, a ‘supply shock’ is a name for a sudden and unexpected increase in real costs (ie an acuteadverse event). And a ‘supply stress’ is a slow and ongoing increase in real costs, or an anticipated cost increase, such as we get from carbonisation of the atmosphere. A supply stress is a chronic malaise. Both kinds of increase in real cost have to be borne, to be paid for; in themselves they have no impact on the price of money.
A ‘cost-of-living crisis’ is a supply shock or a supply stress; or, very likely, both.
The capitalist marketplace has a mechanism for distributing the cost burden efficiently; it is an aspect of what is sometimes called the invisible hand. It is inflation, secondary inflation. It involves price increases; in effect the shocks and stresses ‘rippling’ through the whole economy. This shock-absorbing process of decelerating inflation works best when there is an accommodating monetary policy, meaning that – through banks’ double-entry bookkeeping – the money supply is allowed to rise to smooth this adjustment. This is inflation, but not problematic inflation; this inflation is the cure, not the disease. Problems occur when this process is suppressed by monetary authorities.
If the inflation process was initiated by a supply shock, the process settles down so long as it’s not disrupted or aggravated by further shocks or stresses; just as ripples in a pond eventually settle. (If the supply shock is a war, and the war comes to an end, there may then be a ‘benign supply shock’; ie falling real costs. The appropriate resolution is to facilitate CPI inflation to remain at the target level – eg two percent – despite a fall in real costs potentially decreasing average prices. This is an example of beneficial monetary policy, in this case seeking to prevent an adjustment which could be interpreted as deflationary.)
In the case of supply stresses, optimal market adjustment likewise requires a degree of ongoing secondary inflation. Again, such monetary inflation is a solution, not a problem. In this case the ripple-effect may not decelerate; it’s as if a continuous supply of stones is being thrown into the pond. (Another obvious part of the solution, of course, is to address the supply stress – by removing or mitigating that stress – the stress being a ‘root cause’ of a rising ‘cost of living’ burden. Stop throwing stones.)
Contractionary monetary policy can be a supply shock or a supply stress.
The contractionary (ie ‘tight’, or austere) monetary policy of jacking-up interest rates (mainly performed by Reserve Banks) in itself creates or perpetuates ‘cost-of-living crises’. These are direct policy interventions to increase the cost-of-living. The initial supply shock of high interest costs becomes a supply stress if persevered with for more than a year. As a shock or stress, tight money is a problematic policy response either by exacerbating some other supply shock (such as the major 2021 [pandemic] and 2022 [war] disruptions to the global supply chain) or by adding an adverse supply shock to an adverse ‘demand shock’. (Both kinds of ‘adverse shock’ cause prices to rise.)
A ‘demand shock’ or a ‘demand stress’ constitutes a primary inflation; an increase in spending that is too great or too sudden to be accommodated by the economy’s surge capacity. (The technical term for ‘surge capacity’ is ‘supply elasticity’.) Tight policy – monetary or fiscal – was initially devised as a countershock to a demand shock. With a demand shock, the risk of problematic inflation is greatest when the economy has zero or very little surge capacity. The next and biggest coming inflation of this ‘demand shock’ type will arise from the world’s pension funds being liquidated as baby-boom generations either retire or are retired.
If this projected demand-side inflation gathers pace before the present supply-side CPI-inflation subsides, the two events stand to be conflated by future historians into a single inflation event. In the coming case, if future historians look back closely, they will come to see a demand-stress inflation as the ‘second-half’ of a conjoined 2020s’ and 2030s’ inflation event.
In the 1970s the reverse happened; a global demand stress inflation got underway from 1968 – the main source of the stress was the financing of the Vietnam War – followed by oil-supply shocks emanating from the 1973 Arab-Israel War and the 1978/79 Iranian Revolution. This ‘great inflation’ of the 1970s was perpetuated well into the 1980s by the problematic monetary-policy-induced supply shocks of the early 1980s; in particular those associated with Margaret Thatcher in 1980, with ‘Reaganomics’ in 1981, and in New Zealand with ‘Rogernomics’ in 1985. (I use the word ‘problematic’ rather than ‘counterproductive’ or ‘mistaken’ because, while the policy aggravated rather than ameliorated inflation, the policy did effectively serve other somewhat opaque purposes. While this is not the place to discuss the power-realigning unstated or understated reasons behind this type of policy, we may note that many – maybe most – policies have multiple objectives including unpublicised objectives. See The New Zealand Economy 1900-2000, by Geoff Bertram, New Oxford History of New Zealand, 2009; one of Bertram’s main themes is “the rise of a business and political elite based in the service sectors, particularly finance”, using the analogy of a political “coup”.)
Change in Real Costs plus Monetary Inflation equals CPI Inflation
This has been the main technical point of this article. When we hear in the media of ‘the inflation rate’, it means ‘CPI inflation’. Since 2021, both the ‘change in prices due to real costs’ and the rate of ‘inflation’ have been positive numbers. I have argued that the ‘monetary inflation’ has been the smaller of these two, and that the ‘real cost’ problem has been due to global supply-chain disruption and to the contractionary monetary policy of jacking-up interest rates. This policy response was done earlier and harder in New Zealand than in most other countries; though has now eased, in comparison with Australia, the United States, and the United Kingdom. (CPI inflation remains stubbornly high in those countries which continue with their supposedly ‘anti-inflation’ settings. Canada, with lower interest rates than New Zealand, also has lower CPI inflation.)
In past times of low CPI inflation, typically either the ‘change in real costs’ or the rate of ‘monetary inflation’ have been negative numbers. In better times such as 2013 to 2019, productivity (crudely measured as real gross domestic product per person) was increasing, meaning that real costs were decreasing. (We may note that, according to classical and neoclassical economics, in growing economies the CPI should for the most part be falling rather than rising; as indeed occurred in the nineteenth century.) So, in March 2018 for example, the annual change in real costs was around minustwo percent, and the rate of inflation was about plus three percent (together adding up to one percent). This is another example where inflation – a fall in the ‘price’ of money – was beneficial, because it averted CPI deflation and encouraged the circulation of money.
A further reason why inflation can be beneficial is that inflation tends to improve the distribution of monetary wealth (making wealth slightly less unequal), whereas deflation – negative inflation – tends to aggravate such wealth inequality. So, the combination of negative real cost growth and positive inflation is one of macroeconomic success; wages rise faster than prices.
An Engineered Deflation
What policymakers have been trying to do since 2021 is the opposite; they have been trying to engineer a deflation (a rise in the price of money) as a way of hiding non-inflationary increases in the ‘cost-of-living’; a real ‘cost-of-living crisis’ means a sustained period in which disposable incomes – meaning annual after-tax incomes – increase more slowly than prices. (This is how real costs are borne; typically, the burden unfairly falls on those least responsible for the problem.)
The way to achieve such a monetary deflation is to engineer a recession through, among other methods, maintaining a supply-stress policy of having interest rates jacked-up to levels higher than they would be if left to the market. Businesses, needing to reduce their selling prices, then act to cut their costs by paying workers and suppliers less. Those businesses with a decree of market power, such as supermarkets, lead the way by reducing the real wages of (mainly female) low-wage workers, and reducing the prices they pay to their suppliers of fresh foods. If anyone has a case for a pay-equity wage increase it is supermarket checkout workers; but policy in New Zealand – shared by recent National and Labour governments – is to press down the costs of supermarkets.
I have suggested that currently in New Zealand real costs are increasing at about plus two percent per year, and monetary inflation is plus one percent. An overly-engineered recession might see real costs rising by plus five percent a year, and inflation at minus three percent. That would show up in the official statistics as a CPI-inflation of two percent. Policy target achieved?! We note that such a policy would fail to address the ‘real cost’ problem – indeed it would exacerbate that problem – while trying to claim success by hiding the problem through monetary constriction and deflationary wage settlements.
A monetary deflation (or inflation) is very difficult to engineer, however (because of the ‘secondary’ nature of such processes); what usually happens instead, and as a result of the policy attempt, is a recession or depression. In order to engineer an offsetting deflation, monetary policymakers have to aggravate the supply stress; they have to aggravate the ‘cost-of-living’ problem in order to deliver their monetary ‘solution’.
Money is an economic lubricant, not a fuel. Neither the family car nor the national waka (aka NZ Inc.) will function well if decision-makers choose to economise on lubricating oil.
The Great Depression, in contrast
During the Great Depression of the early 1930s, real costs were decreasing (for the most part, though much of that was labour short-time), and there was a difficult-to-stem monetary deflation, aggravating a problem of growing wealth inequality. The main problem was one of deflationary demand-stress; insufficient spending. That spending problem was substantially aggravated by most of the world’s governments; a big shortfall in government outlays – whether reduced government benefits, reduced government spending on core services, or reduced government investment in economic capacity – creates future supply stresses.
In the mid-2020s in New Zealand, the present crisis is morphing from a cost crisis into a demand crisis more like the Depression; a crisis of too little spending, aggravated by government retrenchment. Australia, on the other hand, is about two years behind New Zealand; while it’s going through a greater supply stress from monetary policy, the government and consumers are forestalling such demand-stress by maintaining spending levels. Australia, if its government policymakers continue to be wise, will not choose to starve the economy of the public contribution to demand. Australia, by being more relaxed about its fiscal deficits, has upheld its fiscal revenue base; indeed, it has achieved fiscal surpluses in 2025 through more government spending rather than through less. New Zealand, on the other hand, cannot achieve fiscal surpluses because the fiscal policy wonks have generated a downwards expenditure-income spiral.
The next global economic depression will be different from the 1930s and the GFC (global financial crisis). Expect a combination of global supply shocks aggravated by national (policy-induced) supply stresses, and demand shocks in the western world as the older population cohorts seek to spend their retirement savings on the kinds of goods and services that older people most require. It will be a depression without the CPI-deflation which characterised the early 1930s. Most likely it will be what economists call ‘stagflation’. Nevertheless, there will be hidden (monetary) deflation amidst substantial real cost increases. It will not be pretty, and the world is unprepared.
Finally
The notion that jacking-up the cost of credit – interest rates, a critical cost which permeates the whole economy – is a cure for a ‘cost-of-living crisis’ is one of the all-time-great confidence tricks humankind has been subjected to. Let’s challenge the people who intimidate us, wittingly or unwittingly; they intimidate through the use of agenda-appeasing weasel-word narratives.
There is a solution, in addition to ending so-called anti-inflationary policies, and it’s called Public Equity. (See my Public Equity and Tax-Benefit Reform, a report prepared for The Policy Observatory, Auckland University of Technology, December 2017. Or see Public Equity and Tax-Benefit Reform – Scoop, 14 December 2017 – for a summary.)
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Keith Rankin (keith at rankin dot nz), trained as an economic historian, is a retired lecturer in Economics and Statistics. He lives in Auckland, New Zealand.
