Image: Tina Tiller

PartnersNovember 28, 2022

What inflation really means (and why it really matters)

Guest writer

Image: Tina Tiller

With the topic of inflation – and whether or not we can curb it – heating to a high boil of late, we asked Kiwibank economist Mary Jo Vergara for a 101 explainer on what it is, why it matters and how consumers can best prepare for it.

Inflation has been a hot topic for a while now. What is it exactly?

Inflation describes the general increase in the price of goods and services in the economy. Everything from food to fuel, and health to housing. And inflation is measured by the Consumer Price Index (CPI).

Every quarter (three months), Stats NZ samples the prices of a representative basket of goods and services. The (weighted average) price of today’s basket is compared to the basket of a different point in time. A positive change means a rise in prices – inflation. A negative change means a decline in prices – deflation. In 2022, annual inflation reached a 32-year high of 7.3%.

We’re also hearing a lot of the phrase ‘cost-of-living crisis’. What is it, and are we in one?

A cost-of-living crisis is a situation in which the rise in consumer prices is outpacing the rise in wages. At an annual rise of around 4%, wages in Aotearoa are clearly growing at a slower pace than inflation, and households are seeing their real incomes eroded. So it’s fair to say that we, like many countries around the world, are currently experiencing a cost-of-living crisis.

Unfortunately, households on low or fixed incomes are hardest hit. Food and fuel – both of which have seen the largest increases in price – make up a larger share of the budget, and these households typically don’t have as much wriggle room. Budgeting becomes that much more of a head-scratching exercise.

Kiwibank economist Mary Jo Vergara (Photo: Supplied)

How are prices for goods and services determined?

Some items in the CPI basket face foreign competition. Items including petrol, food and apparel, are vulnerable to international price movements and fluctuations in the local exchange rate. A weaker NZ dollar lifts the price of imported goods, and our exports become more attractive on the international stage.

More demand for what we produce is also inflationary. These items make up the tradable – or imported – component of inflation and account for around 40% of the CPI. The remaining 60% are goods and services that we produce here in Aotearoa for our own exclusive consumption. For items including council rates, rents and education, prices are instead influenced by developments in the domestic economy. These items make up the non-tradable – or domestic – component of inflation.

How did we get to a 7.3% inflation rate?

The recent surge in inflation certainly has its origins offshore. Covid disrupted trading ports which pushed up shipping costs. And the war in Ukraine sent commodity prices, especially oil, spiralling higher. Tradable inflation hit a high of 8.7% in 2022. That’s the largest annual rise since Stats NZ began reporting the domestic/imported split in 2000. We continue to import inflation from offshore. Around 46% of the overall increase in consumer prices has been driven by international price pressures. That’s an outsized move given it’s ~40% weight in the CPI basket.

The growing strength of domestically generated inflation however is more concerning. Because it’s the kind of inflation that stems from strong demand and so is harder to tame. Domestic inflation is sitting at 6.6%, which is also a record high. Demand is far outstripping supply in the economy. Excess demand and domestic capacity pressures are sustaining inflation. So while tradables inflation is big in terms of contribution to total inflation, non-tradables is still bigger. Around 54% of the annual jump in prices was domestically generated.

So where to from here for inflation?

Good news, the path for inflation looks to be downhill from here. Bad news, it’s likely to be a slow trek back to the Reserve Bank of New Zealand’s 2% target rate. Several indicators suggest that the pressure on global supply chains has eased materially. Global shipping costs have firmly turned south, and capacity is expanding with more ships being built.

Strong domestic inflation however risks an extended period of high inflation. We see inflation remaining stubbornly above 3% through to the middle of 2023. Inflation indicators continue to flash red-hot and there’s real risk long-dated expectations become unanchored from the target.

With a recession looming, Reserve Bank governor Adrian Orr warned of a need to curb consumer spending in the lead-up to Christmas. (Photo: Getty Images)

How does inflation affect interest rates?

The RBNZ’s primary tool in delivering monetary policy is the official cash rate (OCR). It’s the interest rate that sets all interest rates in the economy. Given the state of the economy, the OCR is accordingly shifted up or down. When economic activity is slowing and inflation is falling below target, interest rates are slashed to stimulate growth. Conversely, when the economy is heating up, interest rates are lifted to cool down the economy and rein in rising inflation.

With pandemic-induced disruptions and unprecedented amounts of fiscal and monetary stimulus, economies across the world find themselves in the latter environment. Central banks from Washington to Wellington are aggressively lifting interest rates in response to the rapid rise in consumer prices. The RBNZ has so far lifted the OCR more than 300 basis points from a record low 0.25%. That’s the fastest tightening cycle since the OCR was introduced in 1999, and the RBNZ is not yet done. More rate hikes are required to tame inflation, and more rate hikes are coming. We forecast the cash rate rising to a peak of 5% in 2023.

What do higher interest rates mean for me and my whānau?

The RBNZ is lifting interest rates to dampen demand, better balance the economy and ultimately bring inflation back to target. But it takes time for changes in monetary policy to take effect. Given the overwhelming preference among Kiwi mortgage holders for fixed rates, the impact of higher interest rates comes later. Monetary policy operates with around an 18-month lag in Aotearoa. But the tighter monetary conditions will be felt, and soon. The upcoming spring/summer period is setting up to be a busy one. A significant chunk of the stock of Kiwi mortgages is due to be re-fixed in the next 6-12 months. And they’ll be rolling onto materially higher rates.

Higher rates should have a profound impact on household budgets. We are far more sensitive to rising interest rates given the significant run up of household debt over the past two years. Supported by historically low levels of unemployment, household consumption is holding up for now. But a slowdown in 2023 is expected. With high cost of living and rising debt servicing costs, it’s an increasingly expensive environment.

This content was produced in paid partnership with Kiwibank. To learn more about how they could work for your business, visit Kiwibank today.

Keep going!

Illustration: Marc Conaco

PartnersNovember 24, 2022

Setting a standard: How our beef and lamb footprint measures up against the world

Liam Rātana

Ātea editor

Illustration: Marc Conaco

New research has found that the carbon footprint of Aotearoa-produced beef and lamb is among the lowest in the world. We took a deeper look at what the report says, and why it matters.

So what is this research?

Commissioned by Beef + Lamb New Zealand and the Meat Industry Association, and conducted by AgResearch, the Life Cycle Assessment (LCA) study looked at on-farm emissions – which allowed for direct comparisons with other countries – but also went further, looking at the full “cradle to grave” footprint (ie including on-farm, processing and post-processing emissions). The report’s findings showed that despite the additional emissions involved with exporting product, our total footprint was still lower than the majority of countries – even those who had domestically produced meat.

While the report acknowledges that differences in methodologies make it difficult to accurately compare countries’ footprints across the entire process, particularly notable is the difference in the liveweight footprint of our stock. This metric, used to measure emissions before an animal is processed, shows that New Zealand’s average carbon dioxide equivalent (CO2-e) per kilogram of sheep meat is less than half the international average, and about 30% lower than the international average for beef.

Liveweight emissions for New Zealand sheep and beef track well below international averages. (Illustration: Marc Conaco)

Why should I care?

As Andre Mazzetto, senior scientist for AgResearch, notes, this is an area of increasing importance to consumers: “People are very concerned recently about greenhouse gas emissions from products generally, and especially from food products. They’re making choices based on the level of greenhouse gas emissions.”

With the concerns around the state of our environment, conscious consumerism is quickly becoming the new norm and people want to know where their food comes from and the impact its production has on the world. With beef and lamb being so core to both our national diet and our national economy, it’s crucial that the sector strives to perform as sustainably as possible.

New Zealand has several greenhouse gas emissions reduction targets, including both domestic and international targets up to the year 2050. The government has also partnered with the primary sector and iwi to equip farmers to measure, manage and reduce on-farm agricultural greenhouse gas emissions and adapt to climate change. This includes collaboration on the detailed development of an appropriate on-farm emissions pricing mechanism, which will come into effect in 2025. He Waka Eke Noa is working towards all farmers and growers knowing their emissions number, including measures to mitigate greenhouse gas emissions and adaptation to climate change in their farm business and environment plans.

That all sounds great, but what actual measures are we talking about here? And why do they matter?

Scientists have struggled over the years to standardise long-lived gases (like carbon dioxide) and short-lived gases (like methane) into a single equivalent measure. One of the most commonly used metrics is GWP100, which considers the global warming potential of a particular gas if measured over 100 years. As the science evolves however, the Intergovernmental Panel on Climate Change (IPCC) has found that this metric overstates the impact of methane when this gas is not increasing, as is the case for sheep and beef cattle in Aotearoa.

We now know that although it has an initially stronger impact on the environment, methane gas breaks down and is reabsorbed by plants in around 20 years, while carbon dioxide molecules from fossil fuel combustion are part of the long cycle of carbon, heating the atmosphere for thousands of years before coming back full circle. In an LCA, GWP100 tells you what are the emissions of that product if that product didn’t exist. In GWP*, it instead tells you what the warming impact of that product has been over the last 20 years. Both have a valid place, even if GWP100 does overestimate the impact of methane when it’s not going up – and while emissions are important, that warming impact is generally considered to be a far more meaningful metric for our climate targets.

Adapted from Clear Centre at UC Davis. (Illustration: Marc Conaco)

What did the report tell us, besides that we’re doing a pretty great job compared with other nations?

The calculation using GWP* for the period 1998 to 2018 showed that when taking into account sequestration – trees and other vegetation on farms absorbing emissions – New Zealand’s sheepmeat is arguably “climate neutral” and New Zealand beef is also well on the way towards that. This means that over the last 20 years, New Zealand sheepmeat has not added any additional warming, while absolute greenhouse emissions from New Zealand sheep and beef farming have decreased by 30 per cent since 1990.

Although the signs are promising, the report also acknowledges there’s still a lot of work to be done. With Aotearoa sheepmeat producers having reduced their emissions by 32 percent since 1990 and sequestration on sheep and beef farms absorbing a proportion of the remaining emissions, the average carbon footprint of sheepmeat is now -0.34kg of carbon dioxide equivalent (CO2-e) per kilogram of meat. However, as noted by the Food and Agriculture Organisation, some account also needs to be given to ongoing warming. It’s also important to note that for this number to remain low in future, it’s dependent on either no increase in sheep numbers, or reductions in greenhouse gas emissions per kg of liveweight stock on our farms.

On-farm measurements can only tell us so much about our meat’s emissions footprint – all of the above also factors in. (Illustration: Marc Conaco)

This is good news for my next Sunday roast, but what happens from here?

Beef + Lamb New Zealand and the Meat Industry Association want the sector’s methane targets amended to be similar in effect to the CO2 target – that is, no additional warming by 2050. The two organisations also want the government to start reporting on annual warming and annual emissions for the sector. And while they understandably want to celebrate the world-leading footprint of New Zealand beef and sheepmeat, they’re conscious that the work isn’t yet done. To that end, the report acknowledges the need both for ongoing efficiency gains and for improvements in the science itself – increasing the sophistication of the way we make (and interpret) these measurements, basically.

Despite that need, the parties involved see this report as a watershed moment for the beef and lamb production industry in Aotearoa – the first time that we’ve had a meaningful measure of the actual impact of the sector, rather than one extrapolated from overseas numbers or less-useful metrics. The conclusion of the report puts it in simple terms: “New Zealand farmers, and consumers domestically and internationally, can have confidence that New Zealand red meat is among the most efficient in the world.”