Cost-push pressure at a Whangārei café
Whangārei café and bakery owner Mere has kept a weekly set of figures since January. Her butter cost has risen from $7.20 to $8.60 per kg, chocolate buttons from $9.00 to $10.40 per kg after the NZ dollar fell from US$0.62 to US$0.58, and her two junior staff now cost 6% more after the minimum wage rose. Rent on her central site rose 9% at renewal. She has raised cabinet prices twice, by a total of 8%, and the local CPI shows food prices up 5.2% against headline inflation of 3.9%. Yet weekday foot traffic is down about 12% and several regulars have cut back to one coffee. Her neighbour, a hardware store, says sales are flat. The Reserve Bank has held the OCR at 5.5% and says inflation is still above the 1–3% target midpoint. Mere is deciding whether to put prices up again in March or absorb the costs and cut her own drawings.
1. Using the evidence in the case, explain whether Mere's inflation is mainly demand-pull or cost-push, and link your answer to the difference between food price inflation (5.2%) and headline inflation (3.9%).
Read the worked answer
Classify each cost:
- Butter +19.4% ($7.20 to $8.60): a food input cost, so cost-push.
- Chocolate +15.6% ($9.00 to $10.40) after the NZD fell from US$0.62 to US$0.58: an imported input cost, so cost-push through the exchange rate.
- Wages +6% after the minimum wage rise: a labour cost, so cost-push.
- Rent +9%: a fixed cost, so cost-push.
Demand-pull inflation would require rising demand that lets firms raise prices and still sell more. The evidence points the other way: foot traffic is down 12%, regulars are trading down, and the hardware store's sales are flat. Mere's 8% price rise is being tested by the market rather than pulled by excess demand.
Food inflation of 5.2% is above headline inflation of 3.9% because the food group is weighted towards items with rising imported and labour costs. Headline inflation includes other parts of the basket, such as some durable goods and fuel, where prices may be falling or rising more slowly. Mere's own 8% is above both measures, which suggests her local costs are above average or she is trying to protect her margin - and the falling foot traffic shows that is risky.
Judgement: cost-push dominates, with possibly a small demand element at peak tourist times. The distinction matters because cost-push inflation is not easily fixed by higher interest rates.
2. Explain the effect of 5.2% food inflation on the real income of a retiree whose NZ Super is fixed at $1,000 per week and a worker whose wage rises 4%. Use calculations and comment on who is worse off.
Read the worked answer
Real income = nominal income divided by a price index. Use the inflation rate that best matches the household's spending.
Retiree on a fixed $1,000:
- Using food inflation of 5.2%: real food purchasing power = 1000 / 1.052 = $950.57, a fall of 4.9%.
- Using headline inflation of 3.9%: real value = 1000 / 1.039 = $962.46, a fall of 3.8%.
Worker with a 4% wage rise:
- Nominal wage = $1,040. Using headline inflation: real value = 1040 / 1.039 = $1,000.96, roughly unchanged (+0.1%).
- If the worker spends a large share on food, personal inflation is closer to 5.2%: real value = 1040 / 1.052 = $988.59, a fall of 1.1%.
So the retiree is worse off in real terms under either measure, while the worker is roughly protected only if their spending pattern matches the CPI. Fixed nominal incomes lose from unanticipated inflation; wage earners with bargaining power or indexation are better protected.
Judgement: the distributional effect depends on which inflation measure matches each household's basket. The retiree bears more of the cost because NZ Super is fixed in nominal terms and food is a large share of their spending.
3. Evaluate whether the Reserve Bank should raise the OCR further, given Mere's situation and the 1–3% inflation target.
Read the worked answer
The OCR works mainly through demand. Higher interest rates raise borrowing costs, reduce consumption and investment, and lower inflationary pressure. That is appropriate when inflation is demand-pull.
But Mere's evidence is cost-push: imported input prices, wages, rent, and weak foot traffic. Raising the OCR would not lower butter or chocolate prices. It would reduce already-weak discretionary demand, risking closures and job losses in hospitality and retail.
There is a case for a modest rise if inflation expectations are becoming unanchored. If workers start bargaining for 6% wage rises to cover 5.2% food inflation, cost-push can become a wage-price spiral. The Reserve Bank must also meet the 1–3% target, and 3.9% is above it.
Judgement: on the evidence, a further rise is hard to justify; holding the OCR while fiscal and competition policy address supply constraints is more defensible. But if expectations data show second-round effects, a small rise is warranted. The answer depends on which cause dominates and on the credibility of the target.