Planning for the next recession

In a post earlier this week, I made passing reference to a new opinion piece on Newsroom headed “Why we need a recession plan”.  The article is written by another former Reserve Banker, Kirdan Lees, who these days divides his time between the University of Canterbury and economic consulting.  His article is organised around a list of five reasons, although it combines his arguments about the form any such plan should take.

I strongly agree that we need some serious, credible and open planning for the next recession (whenever it comes, but it is now eight or nine years since the last one and neither the foreign nor domestic outlooks are looking particularly rosy).  Indeed, in respect of monetary policy, it is a case I’ve been making for about as long as this blog has been running.    The case might have seemed a bit abstract four years ago –  especially to anyone who paid much attention to the Reserve Bank’s pronouncements (that interest rates were rising, and inflation would soon be getting back to target).  It should be much more pressing now, as the growth phase has got old and yet (New Zealand) interest rates are at record lows and inflation still isn’t back to target.  But, unfortunately, there has been nothing serious from the Bank –  under Wheeler, (unlawful) Spencer, or Orr.  They claim to believe there just isn’t a problem; that monetary policy can do as much as ever.

This is, more or less, Kirdan’s first reason.

Reason 1: The outlook now points to recession risk with little room for interest rates to do much

But interest rates have never been so low, leaving little headroom for monetary policy to kick in. Mortgage and lending rates can’t fall by much if the big banks are to retain margins. 

As a reminder, the real obstacle is around wholesale deposit interest rates. By common consensus, official interest rates could be lowered to perhaps -0.75 per cent, but any lower and the strong incentives are for people (including particularly wholesale investors) to convert their assets into physical cash and use safe-deposit boxes and strongrooms.  Conventional monetary policy no longer works then.     That means our Reserve Bank could cut the OCR by up to around 250 basis points –  more than many advanced country central banks could –  but in typical recessions they’ve needed to cut interest rates by 500 basis points (575 basis points last time, and the recovery then was very muted).

There are ways around this lower bound constraint, but the Reserve Bank and the government have shown no signs of any action (or even any serious analysis).  In principle, things could be done in a rush in the middle of the next recession, but that is almost always a bad way to make good policy, and by failing to clearly signal in advance that the authorities have credible responses in hand they are likely to worsen the problem (see below).

Kirdan doesn’t seem to see much scope for doing anything to increase the flexibility of monetary policy.  His focus is on fiscal alternatives.

Reason 2: By the time Treasury calls a recession it’s too late to trigger a fiscal stimulus plan

Not just Treasury of course.  Economic forecasters and analysts are hopeless at recognising recessions until they are well upon us (among the reasons why no one at all should take any comfort from the latest IMF update –  international agencies are among the worst in recognising things before they break).

It would always be better to have good forecasts, even so-called nowcasting (where is the economy right now –  given that our most recent national accounts data relates to the July to September period last year, and even that is subject to revision).      Kirdan is an optimist and believes we can do (materially) better than just waiting for the GDP data.

Today, a myriad of timely data exists: across transport movements, customs data, privately held data on small businesses (such as Xero) and consumption (such as Paymark). A small panel of experts could use that data to gauge recession risk and tell us when to pull the trigger.

In principle, of course, all these data are available to Statistics New Zealand (which could require them to be provided under the Statistics Act), and if the data could be available to “a small panel of experts” it could presumably be available to the Treasury and the Reserve Bank.

But even if these data can provide a few weeks advance notice of negative GDP quarters, there are bigger questions which more-timely data can’t answer.   The first is how long any downturn will last.  That matters quite a lot.   A couple of weak quarters might sensibly lead the Reserve Bank to consider a cut to the OCR, and probably the exchange rate would be weakening anyway.   But that is very different from a couple of weak quarters foreshadowing a deep and prolonged recession.   Telling the difference isn’t easy.  And who seriously supposes that –  in a democracy –  we are going to hand over to a panel of experts (self-appointed or otherwise) decisions about when to trigger big fiscal stimulus programmes which –  whatever their composition –  have huge distributional consequences.  These are inherently political choices, which will benefit from technical input, but the accountability needs to rest with those we elect (and can eject).

On which note

Reason 3: Economic theory can help: a fiscal plan needs to follow three principles
When it comes to fiscal stimulus principles, macroeconomists have their own triple-T: stimulus needs to be timely, targeted and temporary.

Which looks fine on paper, but is much less help in practice.  If you want “timely”. monetary policy can typically be adjusted faster than fiscal policy –  exchange rates, for example, adjust almost instantly to monetary policy surprises, and often in anticipation of monetary policy actions.   And monetary policy moves are designed to be temporary, but without tying anyone’s hands: you raise the OCR again when you are pretty sure inflation is going to back to target.

In the UK they tried what looked like a clever fiscal wheeze in the last recession: cutting the rate of VAT for a year, and only a year.  It looked like a fairly sensible move at the time it was announced –  encouraging people to bring forward consumption.  And it probably would have been if the downturn had been short and sharp, but it wasn’t.  More generally, people like the IMF championed fiscal stimulus in 2008/09, but again implicitly on the view that economies could rebound quickly.  When they didn’t, the mix of economic and political arguments about “austerity” took hold and only complicated the handling of the economy.

Of course, if you get can get your legislation through Parliament you can write cheques (electronic equivalent) quite quickly –  Kirdan is keen on focusing temporary additional spending on “poorer families” –  but you can’t do the same for the sort of infrastructure spending that those keen on fiscal stimulus often champion.

Kirdan’s reason 4 had me puzzled.

Reason 4: Trotting out the same tired approach will provide the same tired results 

One of the enduring traits of fiscal policy is tacking on extra spending in good times and taking away spending just when it is needed.

Hard to disagree too much with that second sentence –  pro-cyclical fiscal policy is a problem.

But even if you think there is a role for some active counter-cyclical fiscal policy, I wasn’t clear on the connection to what came next

Governments seeking a labour boost need a better targeted fiscal stimulus. That means targeting labour-intensive industries such as such as health and education, construction, horticulture, accommodation and retail industries. ….

But identifying labour-intensive industries is not enough. Maximum effectiveness comes from targeting the labour-intensity of the entire supply chain: labour-intensive industries that in turn use labour intensive inputs from other industries are the best bets for fiscal stimulus.

It seems to be an argument for, in effect, targeting reductions in average labour productivity –  by focusing on boosting industries that are (directly or indirectly) more labour-intensive.  Perhaps –  just possibly –  there is a case for something of the sort, as a pure short-term palliative, in a very deep economic depression, but in an economy where lack of productivity growth has been a decades-long problem (and particularly evident in the most recent growth phase) targeting low productivity industries doesn’t seem a particularly sensible medium-term approach.

Which brings us to the last point in Kirdan’s article

Reason 5: Articulating a trigger for the fiscal plan shapes the expectations of Kiwi businesses

I don’t think ministers can articulate a highly-specific trigger for action –  so much will depend on context (what is going on here and abroad) –  and attempting to do so is only likely to create a rod for the government’s back.  But where I do agree is that there needs to be a clear and credible commitment from both the government and the Reserve Bank that prompt and firm action will be taken if the economy turns down substantially, and particularly if that is in the context of a serious global event.

Kirdan’s focus is fiscal, and I have no problem with his points that (for example) debt to GDP should be expected to rise in a severe downturn, without threatening the medium-term commitment to moderate debt levels.  In fact, we would probably agree that there should be some public debate now about how the next downturn should be handled, as there is a risk that we get a serious downturn and the government is still fixated on its medium-term debt target (and avoiding leaving a target for National to attack them), even if that isn’t what is needed in the short-term.

But in my view, the argument generalises.  One of the problems we face going into the next severe downturn –  whenever it occurs –  is that (a) every serious observers knows that monetary policy has limited capacity, even in New Zealand and much more so in many other places (in the euro-area for example, the policy rate is still negative), and (b) that there are real political/social constraints on the flexibility of fiscal policy in many places (partly because debt levels are often high, partly because of distributional considerations, partly memories of post-stimulus austerity).  I’m not necessarily defending these constraints, just attempting to identify and describe them.

Faced with these limitations, the quite-rational response to a downturn will be to assume that there isn’t that much authorities will be able to do about it.  That, in turn, will deepen any downturn, and be likely (for example) to lower inflation expectations, making the recovery job even harder (it is going to be even harder to generate inflation in the next recession than it was in the last one).   Perhaps the general public don’t yet recognise these constraints, but many more-expert observers already do, and the news will rapidly spreads if and when a serious downturn gets underway.  What, people in Europe would reasonably ask, can the ECB do?  How much, Americans will reasonably ask, will the Fed be able to do?  And what appetite will there be for much large scale on the fiscal front.   These things matter to us, even if our government has more fiscal leeway than most, precisely because recoveries from serious recessions often result from the combined efforts of many authorities at home and abroad.  Many engines are likely to be missing in (in)action next time round.

I’m critical of our own government and Reserve Bank on these issues.  It isn’t clear that other countries’ authorities are doing anything much more –  there seems too much of simply hoping the situation will never arise and interest rates will get back to “normal” first.   But we can’t do anything about other countries, and we can get ready –  and have the open conversations – ourselves, taking account of the probable constraints other countries will face.     There may well be a place for some fiscal action in the next serious domestic recession, but monetary policy is better-designed for stabilisation purposes and we could be taking action now that would give people and markets much greater confidence that the lower bound won’t bind.      To the extent there is a role for fiscal policy, it is more likely to be used well if there is open debate and contingency planning now –  although my expectation is that, however much advance discussion there is, political constraints (community tolerance) will bite quite quickly.  We shouldn’t need discretionary fiscal policy in a short sharp recession, and it is unlikely to be there long enough in a deep and prolonged recession.

Finally, to anticipate comments about quantitative easing programmes.  Reasonable people can interpret the evidence about those programmes differently (I tend towards the sceptical, once we got out of the midst of the immediate crisis) but I’m not aware of anyone who regards even large scale QE programmes as more than pallid supplements to what conventional monetary policy could usually be able to do.

A serious Reserve Bank would be engaging –  indeed leading, given its role in stabilisation policy –  this sort of discussion and debate.  At our Reserve Bank the Governor has now been in office for 10 months and we’ve had not a single speech on monetary policy issues.  Quite extraordinary really.

(UPDATE: In my post last Friday about stress tests and the Reserve Bank’s plans to increase bank capital requirements, I referred to a letter the Governor had sent to a journalist who had written a critical article.  I noted then that I had lodged an OIA request for the letter, and that the Bank is legally required to respond as soon as reasonably possible.  Given that the letter was already in the public domain (the recipient being a private citizen) there were no obvious grounds for any deletions, except perhaps the name of the recipient.  The letter had been written only a couple of weeks ago, so there were no search problems, and no good “holiday period” grounds for delay.  That request was lodged nine days ago and I’ve still not had a response (and we also still haven’t seen the background papers the Governor promised in the letter that he was just about to release).     As it happens, the recipient of the letter –  Business Desk’s Jenny Ruth –  has now sent me a copy, which I appreciate, but that doesn’t justify this small scale Reserve Bank obstructionism around a major public initiative –  capital requirements –  in which the Governor will act as a one-man prosecutor, judge and jury in his own case –  at potentially large cost to the rest of us.)

 

17 thoughts on “Planning for the next recession

  1. Simple question: why does a recession matter? Defining a recession as a significant drop in production for a significant period.

    The history of the Motu people (Polynesians who settled in Papua) reports them having a drought about every 30 years and many died by starvation and related epidemics and warfare.
    My parents told me about the great depression in the UK with the Jarrow hunger marchers and my unemployed grandfather being told he would not get unemployment benefit because he had a brotther with a job (too proud to ask his brother). People were hungry but did not die but with WW2 many failed the army medical because of the effects of poverty. My family would have mostly fed themselves for most of the year from their vegetable garden.
    2008 – was that a recession? – I barely noticed it. Did it did cause a drop in prices that let me buy a city apartment for half price – on of my best investments.
    When I stop typing I ought to be clearing my excessive number of clothes and tidying our over-crowded garden. How would a recession hit me?

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  2. Recessions matter very unevenly. I tell the story sometimes about my grandfathers, in their 20s when the Great Depression started. Both bought new homes – one in one of the best streets in Fendalton – during the recession, and one never lost a job and the other’s business apparently didn’t just fine. On the other hand, many many people lost jobs and struggled for years. For people who (a) kept their jobs, and (b) didn’t have much debt, their material living standards probably improved in the early 30s, even as the overall economy shrank substantially.
    https://croakingcassandra.com/2016/11/16/new-zealand-and-the-great-depression/

    Recessions aren’t much different. The 2008 recession made no difference at all to me – except perhaps having to work a bit more intensely in some crisis responses – and neither did the 1991 recession. But 2008 appears to have affected Getgreatstuff rather severely. In the 1991 recession, 11% of NZers were unemployed at peak, numerous businesses failed and the losses in substance collapsed the BNZ. My wife – younger than me – reckoned that even looking for her first graduate job a couple of years later, the search was tougher, the worry greater, than it would have been in normal times.

    For you, the threat of a new recession is probably to your family. They might be lucky – most people don’t lose jobs, but many do, and even find it hard to get back into the workforce.

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    • My argument wasn’t that they didn’t matter just that they matter progressively less as we become encumbered with possessions. Your point is that an unexpected (as always) recession results in a lottery with some diligent workers suffering and some idle people available funds getting lucky. A severe extended recession would leave the govt with less revenue and with many unavoidable expenses so possibly my superannuation would be cut or means tested.

      If unemployment is the main negative result of a recession isn’t NZ lucky to have so many immigrant workers on work permits? If demand drops NZ can change supply. A world wide recession would mean we were returning immigrant workers to countries in difficulty.

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    • 2008 recession was unnecessary. It was engineered by the RBNZ whilst busy sipping champagne and in a deluded mindframe all was booming well in NZ and raising interest rates as if every 0.25% increase in rapid fire succession was just tossing dice in a game of monopoly. Oh too bad those hundreds of families just lost their houses in a mortgagee sale and as a consequence their marriage on the rocks. Hahaha.

      $6 billion was wiped from mum and dad depositors when 60 plus finance companies providing risk finance to developers went under. The RBNZ virtually wiped out the entire building industry and the equity of thousands of mum and dad investors. Farmers had to load up heavily with debt as Farm interest rates rose to 12% to 15%. If you are wondering why our farmers are so heavily indebted, just point the finger at the RBNZ. Personally I burned $400,000 between 2006 to 2008 in equity paying higher and higher interest rates on my property investments.

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      • GGS: I didn’t mean to disparage those who lost out. Just saying a bankrupt in 2008 was better off than a hungry family in 1932. Agree with you that too many finance companies went bust – not all 60 were shakey with dubious owners and the failure of both good and bad has been a handicap for NZ since.

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      • What the RBNZ fails to understand is the relationship of debt with businesses in NZ. The idea that you can slow down household consumption and therefore reduce or increase price inflation by increasing or decreasing interest rates in NZ is just a nonsense. It does not work when NZ household Savings almost equate to NZ Household debt as savers stop spending, borrowers start spending and vice versa. But where it makes a huge difference is to businesses that borrow to fund their operations and to fund growth. Every interest rate increase hits businesses bottom line profit immediately. More so in the building industry that borrows 100% to fund their activities.

        Debt is particularly important to NZ businesses because we do not have sufficient depth in our equity markets. Everytime the RBNZ goes through their trigger happy rapid succession increases in interest rates it damages our industries severely. Successive RBNZ governors have in the last 30 years decimated NZ industries. Point the finger again at the RBNZ for not keeping NZ industries in NZ. Successive NZ governments and New Zealand have been let down by NZ economists in Treasury and in the RBNZ.

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  3. I’m not a fan of fiscal stimulus in general. But if there has to be one, the Rudd Government’s Australian stimulus, where everyone earning under $80k got $950, was quite efficient. Most of the money was quickly spent and it stabilised consumer confidence.

    Regarding QE, I would hope the RBNZ would be looking to buy up pretty much all the highly rated debt in the country, all the domestic ETFs and very large quantities of offshore sovereign debt. I’m curious why you don’t think that would be effective.

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  4. …sounds like 100k Kiwibuild houses remains the target so perhaps the next downturn can’t come soon enough!!

    that aside, in general, seems politicians/central banks with own currencies and floating FX will do ‘whatever it takes’ to avoid debt deflation which seems the ‘worst of the worst case’: the domestic political consequences are too great; what are the other options? debt restructuring for the domestic sector that has the largest imbalance? (e.g. some kind of debt write off for NZ homeowners). A barter economy?

    I guess we follow the Japanese example if need be and wish the Greeks the best of luck…

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    • What poor Phil Twyford (and previously Nick Smith) is faced with is for either government or Council to have to spend $20 billion as a minimum for infrastructure. Without that infrastructure spend then you simply cannot build those houses. A lot of people point at the Special Housing Areas and label it a National government failure. But this is just stupid comments because those Special Housing Areas were the early draft versions of the Auckland Unitary Plans which the National Government pushed forward. The building did not go ahead because the infrastructure was not available to go ahead.

      Planning to spend $2 billion to build 100,000 houses and not $20 billion is just gross negligence, again a failure by 7 economists that failed to make it clear that Labours budgetting was foolishly short of the mark which Steven Joyce correctly pointed when he conservatively pointed to a $11.7 billion hole in Labours budgetting.

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  5. State Job Guarantee at the minimum wage – timely – you show up at the office and sign on without any government needing to vote on it – temporary – you have the job until the private sector starts hiring again at a bit above minimum wage – targeted – it helps those at the bottom who can’t afford not to work most.

    It’s like a helicpoter drop but it involves giving ordinary people dignity and something to get up for.

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  6. The Germans did something in the 2008 crash which I thought was sensible, which was to subsidise (somehow – I’m not clear on the details) an arrangement for companies to hold on to workers they would otherwise lay off, but to keep people working on reduced hours. I.e. if you have 100 FTEs at the start of the recession working 40 hours PW, but only need 80, you keep 100 employed but reduce the total hours to 32. The trick of the subsidy was to somehow make that economic for all concerned.

    The merits seem to be that you don’t lose skilled workers (a greater risk in NZ given the propensity to migrate) – and when the upturn comes you are better placed to resume full operations quickly.

    It evidently worked quite well for Germany, although for all their preaching within the EU, their success is mostly

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  7. (hit post before I was finished)… their success in the last decade is mostly down to the cheap Euro plus China directing its economy towards needing the kind of things the Germans make (like Australia a bit).

    But at least this meant they were well positioned to take advantage of the upswing when it came and avoided some of the social dislocation that would come with massive redundancies…

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  8. A recession will knock on our door soon and the Fed will most likely answer by lowering the interest rate and start QE4. The best preparation I can think of is simply buying gold and silver. You’ve probably heard the case for gold many times before, however, I am a firm believer that hard real money is the easiest and best hedge against the next recession/depression. What’s your thoughts on that?

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    • Gold and silver has no associated income which means that the investment is considered speculative and subject to income tax on any increases.

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      • In Auckland I would still favour property as a physical storage of multi millions. Physical gold in the multi millions is difficult to store. Digital gold is like digital cash and reliant on the stability of the bank or institution that holds it.

        A property as your primary residence attracts no CGT and is fundamentally supported by a growing population. An investment property may attract a CGT in the future but given the limited supply that even a hardline communist like Comrade Jacinda Ardern, Comrade Phil Twyford and Comrade Grant Robertson struggle to get houses built. A $2 billion accommodation supplement continues to support and underpin rising rental income.

        Property has 2 types of income. Rental and Capital income.

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