Covid inflation and Adrian Orr’s resignation

He became an easy target for the political right

After Adrian Orr resigned on 5 March 2025, many media outlets and think tanks, such as the New Zealand Initiative, started criticising Orr’s role as governor of the Reserve Bank of New Zealand. Although he indeed hired many additional staffers who served different roles than the core of a typical central bank, Orr’s responsibility in creating an inflationary environment during the pandemic is minimal, less than 25%.

Orr’s critiques mention that the Reserve Bank accumulated a $9 billion loss on asset (government bond) transactions during 2020 and 2021 owing to changes in asset prices. Also, an often-mentioned criticism is that the Reserve Bank printed money in too large quantities, $55 billion in Large Scale Asset Programmes (LSAP) and $28 billion in Funding for Lending Programmes (FLP), however, these programmes were commensurate with the Government’s fiscal stimulus packages. In March 2020, Finance Minister Grant Robertson announced a $12.1 billion Covid-19 response package. Later this package was included in the Covid-19 Response and Recovery Fund (CRRF) which had $70 billion until its closure in 2022. The monetary policy measures amassed $83 billion altogether, and their size cannot be considered overly stimulating. Besides, as defending Orr’s performance in reducing inflation, it is relevant to note that New Zealand’s inflation in recent years followed the trend in peer countries, for example, Australia.

This piece attempts to answer three main questions. First, it is crucial to see what was possible to forecast at the outbreak of the pandemic. Second, we should identify what mistakes, if any, the Reserve Bank committed. Third, it is instructive to identify what domestic economic policy measures contributed most to creating inflationary circumstances.

Before we dive into the analysis, we need to highlight two significant rules of thumb. First, when fiscal policy is expansionary, monetary policy has little or no room to manoeuvre because it either faces a non-cooperation problem if it does not fund the fiscal expansion or, it can easily overfund the economy that can appear dominantly in asset prices, for example in housing costs. Second, whenever inflation is rising, the monetary measures to tame inflation can have a significant effect after a one-and-a-half years delay only. The reason is simple, when interest rates are rising, that can influence households’ spending on consumer goods (housing is not consumer goods such as bread and butter). However, this influence appears only after mortgage payments are rising and mortgage rates are typically fixed for one or two-year terms. This explains that inflation was apparent by the second half of 2021, the significant effect of monetary policy could have an impact on inflation only after the first quarter of 2023. New Zealand’s inflation walked this path indeed, in the March 2023 quarter, it was still 6.65%, following an elongated plateau in three consecutive quarters when inflation was between 7.2% and 7.3%.

What was possible to see in advance?

There are various approaches to define the types of inflation. One simplified version of these classifications is whether inflation is demand-pulled or cost-pushed. The appearance of inflation during 2021 was caused by both forces, demand and costs. On the costs side, however, it was not possible to assess the consequences of supply chain disruptions owing to lockdowns in most countries. The lockdowns were different in their lengths, the Chinese lockdown measures were in place for exceptionally long periods. The disruptions increased transportation costs and insurance costs too. The extent of these cost increases was not possible to forecast.

At the onset of the pandemic, it was easy to identify that the pandemic measures would affect both the supply side and the demand side of the economy. Supply was about to decrease simply because people were not allowed to go to work as before. Demand was about to decrease because people were expected to change their behaviour, they chose highly defensive tactics, and they would spend only on essential goods and services. Nevertheless, because of the government restrictions, governments were expected to provide various forms of financial assistance to people who were stranded and could not work. These financial assistance measures were creating additional demand in the economy that surpassed the supply side.

The financial assistance programmes (for example the wage subsidy in New Zealand) were components of fiscal stimulus packages. Central Banks should cooperate with governments, and they had to fund these programmes. Without essential monetary support, economies would have had to endure much larger economic depressions. For this reason, although this side of the inflation was possible to see, it would be unfair to hold central banks including the Reserve Bank of New Zealand responsible for this inflationary effect.

In New Zealand, inflation first went above the target range of 1-3% in the June 2021 quarter, it was then 3.3%. During the pandemic, I was working as a community support worker, so I was performing an essential job. In this sense, I was lucky because I did not have to feel the depressing effects of the lockdown. At the time, I did not yet cook my lunches and usually bought fast food. The lockdown stopped the operation of fast-food chains in New Zealand. Grocery stores were quick to respond, and they started serving warm lunch boxes. At the time, in the first and second quarters of 2020, it was already possible to experience price gauging, namely, supermarkets attempted to increase prices given their increased market power. Yet, inflation did not increase above the Reserve Bank’s target range.

The Reserve Bank’s mistake

This piece does not argue that central banks, and the Reserve Bank of New Zealand specifically, did not commit serious professional mistakes in creating inflationary circumstances. However, the main mistake that contributed to inflation occurred before the pandemic. And this mistake was that they overlooked the liquidity trap that characterised most developed economies during the 2010s.

The liquidity trap is the phenomenon when the decrease in interest rates cannot trigger growing investments because entrepreneurs do not see any profitable investment opportunities. This was the case during the Great Depression between 1929 and 1933. The pivotal economist, John Maynard Keynes noticed that in such circumstances, it is governments that should increase their purchases so these would create the necessary demand (alongside investment opportunities) in the economies. Keynes could rely on underutilised capacities, mainly unemployed workers, who could create value in employment.

During the 2010s, a very similar situation was present in developed economies. Interest rates were unusually low. Before the pandemic, the main interest rate, the OCR was 1% in New Zealand. In the United States, the main interest rate was between 0% and 0.25% between 2010 and 2015. Then it increased to 1.75%-2.-% by the end of 2018. After the beginning of 2019, however, the US interest rate was decreasing again. Owing to this phenomenon that despite historically low interest rates, inflation did not increase, central banks started to believe that the traditional and empirically proved trade-off between unemployment and inflation (the Phillips-curve) ceased to exist.

Importantly, however, it is crucial to say that the 2010s were exceptional circumstances: the increased money supply did not trigger significantly higher investments into new businesses; it only caused asset price bubbles as the mushrooming of crypto-currencies and the high real estate prices showed (the liquidity trap). Besides, there was a unique phenomenon: the detachment of underemployment (the proportion of people who were employed but wanted to work more hours) and the unemployment statistics. Before the Global Financial Crisis in 2008, underemployment and unemployment moved together. However, during the 2010s, when investments in working capital finally grew, underemployment decreased quicker than unemployment. This meant firms offered more hours to those already employed first, and they recruited new workers later.

Owing to this opportunity to employ already hired workers in more hours (the feature of flexible labour markets), central bankers believed that inflation would never return. This misbelief relied on the crucial assumption that workers were easily available. Once the lockdowns hit, this underlying assumption was not true anymore. Not noticing this problem was indeed the mistake of the central banks, including the Reserve Bank of New Zealand. In this context, when the Reserve Bank decreased the OCR from 1.0% to 0.25% on 27 March, the Reserve Bank committed a mistake. They should have known that there were tough limits to explore underutilised capacities in the economy. After this, it should be no surprise that by the end of 2020, housing prices increased significantly. (In many countries, housing prices are not accounted for in the consumer price index, however, in New Zealand, the consumer price basket includes housing costs, so overall the interest rate decrease contributed to inflation.)

What other decisions led to inflation?

In the previous section we identified one element that was a mistake by the Reserve Bank of New Zealand that contributed to inflation. This section discusses those factors that were the other drivers of inflationary forces.

Previously the amount of additional money supply was presented as commensurate to the fiscal stimulus packages. In “normal circumstances” it is possible to see that fiscal stimulus packages do not cause inflation because they can be directed into infrastructure investments that would not increase households’ consumption directly. Nevertheless, during the pandemic, the government made such decisions that contributed to increasing the purchasing power of households. I would even call these steps economic high crimes because, despite the identified severe uncertainties, namely the pandemic, the government made decisions that might have become too large of a burden for the economy. There were at least three steps that were similarly severe as the Reserve Bank’s interest rate reduction.

First, we can mention the increases to the minimum wage. Before the 2017 election, Labour promised that within five years, they would increase the minimum wage significantly. This policy included the increase of the minimum wage from $17.70 per hour to $18.90 per hour in 2020. The increase was effective since 1 April, however, by March 2020, it was obvious that the pandemic would hit New Zealand too. In 2021, when it was again more than obvious that Labour’s original plan to significantly increase the minimum wage was facing uncertainties, the government went on and increased the minimum wage to $20 per hour. The increase in the minimum wage was inflationary because it improved the financial situation of those people who were more likely to spend the extra income on goods and services rather than saving them.

The divergence of the nominal GDP growth and the growth of the minimum wage is presented in the next figure:

The second element of the government’s problematic policies was the mechanism of the wage subsidies. This was problematic from at least two angles. The first angle was that the wage subsidy was double the amount of the unemployment benefit (Jobseeker Support). The second problem was that the wage subsidy was paid to enterprises to maintain the employment contracts, so businesses did not have to shut down and build up from scratch. In this mechanism, those businesses received wage subsidies which could have kept employment contracts ongoing without the additional government support. Similarly to means- and income tests regarding benefits, these subsidies should have been means and income tested too!

The third element of the government policies that caused inflation was the implementation of the recommendations of the Welfare Expert Advisory Group (WEAG) regarding the levels of benefits in the 2021 Budget. Although the WEAG presented its recommendations in 2019, the government did not implement them because they believed the economy was not yet ready for that significant increase in benefits. The question arises as to why the government believed that the economy was better equipped for such an increase in 2021, in the middle of the pandemic. This measure naturally contributed to inflation because it increased the purchasing power of a societal cluster that is by definition non-productive either temporarily or permanently and the likelihood that they would spend the extra income on consumer goods was probably the highest.