How strong a recovery?

One line sometimes heard in the current New Zealand economic discussion is a suggestion that New Zealand has. or has had, a “robust” recovery.  I reckon “robust” is generally a good word to avoid, since it has connotations of something well-founded and sustainable which, in a sense, only time will tell.  But just how strong has our recovery been?

Official quarterly GDP data go back only to 1987 [surely, surely, we need rather better funding for core official economic statistics] but Viv Hall and John McDermott have generated a series, using earlier annual estimates by SNZ and other authors, all the way back to 1947.

The chart below shows the annual percentage change in real quarterly GDP (seasonally adjusted, since that is how Hall and McDermott present their estimates).  There are some oddities around the estimates for the first few years (if I recall rightly, having to do with the level of aggregation in export prices used in generating the original annual real series) so here I’ve shown the data only from the year to December 1952 (a version showing the data all the way back to 1948 is shown at the end of the post).  It is a long time series by New Zealand standards.


On these estimates, real GDP has been quite volatile over the years.  We’ve had five episodes in which GDP has fallen by 2 per cent or more between one quarter and the same quarter the following year.  The recession in 2008/09 was almost as deep as the deepest of these five contractions.  But what is noteworthy is just how subdued the recent recovery has been.  Annual growth has inched up to around 3.5 per cent, and few, if any, forecasters seems to be picking it to go any higher.  In past cycles, growth peaks in excess of 6 per cent have not been uncommon and periods of growth in excess of 4 per cent per annum have been the norm.

Of course, there is no doubt something to be said for some stability to growth rates. But there is probably more to be said – perhaps especially for those who became unemployed  –  for a quick rebound from a serious recession.  We haven’t had that sort of rebound.  Of course, most other advanced economies have not either but many of them have policy interest rates around zero and have largely exhausted the limits of conventional monetary policy.    Sometimes inflation doesn’t provide any leeway for an inflation targeting central bank to accommodate a strong recovery, but that hasn’t been a problem here.

One could mount an argument – reasonable people would differ on the point – that faced with a location-specific demand shock such as the Christchurch repair and rebuild process, it might have been quite reasonable to have expected a particularly strong rebound in GDP for a time, and perhaps even some overshooting in headline CPI inflation (since medium-term trends are what the Bank is instructed to focus on).

But whatever your view on that particular point, given the depth of the recession, how far below pre-recession trends GDP still is, and how low core inflation has drifted, peak GDP growth of 3.5 per cent should be counted more as a failure than as a success.  An economy firing on two, faltering, cylinders might be a better description than “strong” or “robust”.

One other argument I have heard against cutting the OCR now is the risk of a repeat of what is loosely characterised by my old colleague Rodney Dickens as “Alan Bollard’s go-for-growth experiment” of 2003/04.  That there was such an “experiment” is hard to disagree with –  the government had given Alan a higher inflation target, and he (and the then government) seemed to have a sense that the old-school Reserve Bank hardliners had been holding back New Zealand’s growth potential.  I think the characterisation is a little unfair on Alan, but even he later admitted that the policy approach in 2003 had been a mistake.

I could discuss the similarities and differences between 2003 and the current situation at some length (and I don’t feel defensive about 2003, as I working overseas that year), but the stark and simple contrast is captured in this chart, which I’ve run already this week.

core cpi

In 2003 and 2004, core inflation was well above the target midpoint, had increased materally over the previous year or so, and was increasing further.  Of course, the PTA at the time made no mention of the midpoint, but no one ever thought the top part of the target range was something to actively aim for.  This particular analytical series did not exist then, but it captures trends that were apparent in other ways of slicing and dicing the CPI.   Even allowing for the uncertainties (SARS etc), to have cut the OCR then and to have been so slow to move it back up when the initial scare passed, is hard to defend.  As Alan later said, it was a mistake.

What is the situation now?  The Bank has, as much by accident as by good planning, achieved something worthwhile in the last few years in finally demonstrating that core inflation will not always be in the top half of the target range.  But this is not a price level target regime, and the PTA is clear that the focus now needs to be on keeping future inflation near the 2 per cent midpoint.  Actual measures of core inflation have been falling for years, and are now well below the target midpoint.  A material increase in the (core) inflation rate would be highly desirable, given the target the Minister and the Governor have agreed.  It has been forecast for several years, but it has simply not arrived.  Perhaps it is just a “not yet”, but the case for OCR cuts now is very very different from the case in 2003.


The first chart above for the full period since 1948.


Why not?

The Governor’s press release this morning, leaving the OCR unchanged, was no surprise.

But it continues to seem out of step with the data, and with his responsibilities under the Policy Targets Agreement. The statement has the feel of being written by someone who really really does not want to cut the OCR, but who won’t explain why.  It is if the current level of the OCR were being treated as an end in itself, or being held up in pursuit of some other goal, rather than being a tool for influencing the (rather too low) medium-term rate of inflation.

Fortunately, the statement corrects what must have been a mis-step in John McDermott’s speech last week.  Today the Governor states that:

It would be appropriate to lower the OCR if demand weakens, and wage and price-setting outcomes settle at levels lower than is consistent with the inflation target.

Last week, that criterion was expressed in terms of lower than the “target range”.

But there is no reference anywhere in the statement to the 2 per cent midpoint, even though the Governor and the Minister explicitly agreed that the midpoint should be the Bank’s focus.  And wage and price-setting outcomes are already inconsistent with the target midpoint and have been now for some years.  This statement offers no tangible basis for expecting that to change, just the limp observation that underlying inflation “is expected to pick-up gradually”.  Why?  When?  What is about to change that will now reverse a slide in core inflation that has been underway, more or less continuously, since 2007?  It has to be something more than just a belief that monetary policy is “stimulatory”.

Once again, the Governor anguishes about the exchange rate.  I agree totally with the substance of his references to New Zealand’s long-term economic fundamentals and how out of step the exchange rate is with them (it was the heart of this paper I wrote for the Treasury-Reserve Bank forum on exchange rate issues in 2013).  But……this is a press release about the nominal OCR, not about the real factors that shape New Zealand’s longer-term competitiveness.  And while the Governor observes that “the appreciation in the exchange rate, while our key export prices have been falling, has been unwelcome”, he seems unwilling to take the obvious step in response.  Exchange rates are largely influenced by expected relative risk-adjusted returns, broadly defined.  When New Zealand interest rates have been rising while those in most of the rest of the world have been falling, and we have a Governor who appears very reluctant to cut those interest rates, it is hardly surprising that we end up with a cyclically strong exchange rate.  Cutting the OCR won’t solve the long-term economic challenges:  they are about real factors, not monetary policy. But a strong sense from the Bank that the OCR was heading back towards 2.5 per cent over the coming year, or perhaps even lower, would be likely to make a useful difference.

And why not do so?  Core inflation is very low, the number of people unemployed (and underemployed) lingers uncomfortably high, inflation expectations are falling, farm incomes are falling, credit growth is pretty modest, and so on.  So why not cut?    Of course, no one can be totally certain that, with hindsight, cuts will prove to have been the right policy, but on the New Zealand and global data as they stand today –  and without a compelling case to suggest the inflation picture is about to change materially –  not doing so increasingly looks negligent.  In time, it is the sort of stance that also risks further undermining public and political support for the broad monetary policy framework, and the Governor of the Bank’s powerful position within it.

The Bank’s take on the rest of the world, as reflected in the press release, is both puzzling and disconcerting.  The Governor reiterates what appears to be one of his favourite lines, that trading partner growth is around its long-term average.  This is true, but largely irrelevant.  First, it simply reflects the fact that China is a more important trading partner than it was, and its growth rates are higher than those in our other trading partners.  But even China is slowing, probably quite sharply.  And commodity prices –  a key way the rest of the world’s economy affects New Zealand –  have fallen a lot.

In addition, in almost all of our trading partners – and in most countries that are not our trading partners –  GDP remains well below pre-crisis trend levels. Not all of that is excess capacity, but a significant proportion is likely to be.  Again, the Governor makes much of the low interest rates abroad, but seems not to put much weight on why those rates are so low.  There are all sorts of idiosyncratic factors in individual countries, but across the world interest rates are low and falling not because central banks have arbitrarily put them there (it isn’t some “monetary policy shock” in the jargon), but because markets and central banks both judge that underlying demand and inflation pressures require interest rates be at least as low as they are.  That is a very worrying perspective on the world, not a comforting one.

Finally, the Reserve Bank likes to claim that it is highly transparent, citing for example its scores in papers like this one.  But in many of the more transparent central bank we could look forward to the minutes of the meetings that led to the decision being published. In some central banks, even the range of views is extensively outlined.  The Governor has noted he now makes his OCR decision in the so-called Governing Committee, with his three senior colleagues.  But we do not have access to the minutes of these meetings, even with a lag, or to a summary of the advice provided to the Governor by his wider group of advisers, including the external advisers.  Transparency and open government are not just about announcing and explaining final decisions, but about the process whereby those decisions were reached.  Some other New Zealand government agencies are quite good at pro-active release of background material (for example, papers leading up to the Budget).  It is a model the Reserve Bank could look at emulating.  In the next few days, I am expecting a response from the Reserve Bank to my OIA request for background papers to an OCR decision from 10 years ago.  It will be interesting to see how they interpret the Act is deciding how to respond.