It is a while since I’ve done a real interest rate post, so here goes.
You’ll see stories from time to time about how low the New Zealand government’s borrowing costs are.
But it is still worth reminding ourselves of New Zealand’s long track record of having among the very highest average real interest rates in the advanced world. Here, for example, are New Zealand, Australia, and the G7 countries for the last five years (the period chosen a bit arbitrarily, but a different set of dates wouldn’t substantially alter the relative picture). I’ve just used average bond yields and average CPI inflation, from the OECD databases, but using (say) core inflation also wouldn’t materially alter the picture.
Among these countries, we have one crisis-ridden hugely indebted euro-area country (Italy), one country with new substantial political and economic uncertainty – and quite a lot of debt (the UK), one with extremely high levels of public debt (Japan), and one with recklessly large fiscal deficits and rising debt (the US). And our real long-term government bond rates have been higher than all of them.
If we look at the situation today, the picture isn’t a lot different. Italy has gone shooting past us, which should be no consolation to anyone (crisis pressures re-emerging there). The gap between New Zealand and US real interest rates has narrowed quite a bit, as one might expect from the sequence of Fed interest rate increases in turn driven partly by unsustainable late-cycle fiscal expansion, but a 10 year US government inflation indexed bond was trading this week at 1.04 per cent, and a 10 year NZ government inflation indexed bond is trading at about 1.25 per cent. Even that gap is substantially larger for 20 year indexed bonds.
As a reminder, our interest rates don’t average higher than those abroad because of:
- superior productivity growth rates (we’ve had almost none in recent years),
- macroeconomic instability (we have low stable inflation and low stable public debt),
- public sector credit risk (see above – and of the countries in the chart only Australia has comparably strong public finances),
- weak banking systems (the Australian banks and their NZ subs have some of better bank credit ratings in the world),
- risk around high levels of external indebtedness (not only is much of the external indebtedness on bank balance sheets – see above – but the New Zealand exchange rate has been persistently strong, not a feature you expect to see when risk concerns are to the fore).
Oh, and of the small OECD countries with floating exchange rates, over the last five years only Iceland (recently emerged from serious systemic crisis) and Hungary (IMF bailout programme as recently as 2008) had higher real interest rates than New Zealand.
At the heart of any explanation for this persistent real interest rate gap – which has been there, on average, for decades – must relate to factors influencing pressure on resources in New Zealand. At some hypothetical world interest rate, there is some mix of more demand for investment (housing, business, government) and a small supply of savings (households, business, government) than in most other OECD countries. That incipient excess demand on resources is absorbed by having a higher domestic interest rate than in most other countries, and a higher real exchange rate. That mix of adjustment will then squeeze out some of the incipient excess demand. Global evidence suggests that overall savings rates aren’t very sensitive to changes in expected real returns. Governments tend not to be very responsive to price signals, and people have to live somewhere (so although residential investment is highly cyclical, in the end everyone gets a roof over their head). Much of the adjustment pressure is felt around genuinely discretionary, and market sensitive, investment spending: business investment, and especially that in sectors exposed to international competition. It is the stylised story of New Zealand: moderate savings rates (overall), quite high rates of government and residential investment, modest rates of business investment, and a tradables sector which has managed little per capita growth for decades, and where international trade shares of GDP are stagnant or falling even a period when world trade blossomed.
And that is where my immigration policy story fits in. Savings and investment pressures are aggregates of all sorts of forces and preferences, and so one can never say that a single factor “explains” the whole picture. But if one is looking for areas where government policy – a non-market or exogenous influence – plays a part, then New Zealand immigration policy over decades seems likely to be a significant part of the story. Lots more people means lots more demand for investment just to maintain existing capital/output ratios. New people need houses, and schools and roads and so on. If this were a country where domestic savings (flow rates) were abundant – and domestic savings are different from foreign savings because the act of saving domestically takes some pressure off domestic resources (incomes generated here not spent here) – it wouldn’t be a particular issue. But that isn’t so in New Zealand. Government policy choices may have influenced those outcomes to some extent – I certainly favour a different tax treatment of savings – but my reading of the international evidence leaves me sceptical that reforms in that area would make very much difference to desired savings rates (if only because income and substitution efforts tend to offset).
Instead, conscious and deliberate government policy drives up ex ante investment demand (at the world interest rate), and in the process tends to drive out the sort of investment that might have enabled those of already here to achieve better material standards of living.
(In a very small sample, it is perhaps worth noting that there are four OECD countries where policy is set to favour high rates of immigration. They are New Zealand, Australia, Canada and Israel. It should at least prompt a moment’s reflection among the immigration champions, that not one of those countries has been a stellar OECD productivity performer – Australia and Canada have done better than New Zealand and Israel, but are nowhere near the OECD frontier, despite the abundance of fixed natural resources those two countries have.)