A year on

24 January last year was the date of my first post on the coronavirus, specifically the potential for significant economic damage and disruption if it turned into something significant beyond China. At the time, there was no great prescience involved; it was simply that I follow China news reasonably closely, combined with the fact that I’d been fascinated by the economics of pandemics since I’d spent a lot of time on an earlier whole-of-government planning and preparedness exercise in the 2000s, when health authorities worried that an avian influenza would mutate into easy human-to-human transmission. For some time I’d had in the back of my mind to write a post about some of that work, about the potential scale of the near-term economic losses, and the sorts of economic interventions that might be called for.

A year on, I’m not really that interested in looking at how, for example, unconditional forecasts compared with outcomes (although as it happens I filled in my responses to the Reserve Bank’s Survey of Expectations the following day, and looking through those numbers now I must still have regarded widespread economic disruption affecting New Zealand as still being a very low probability). Rather I’m more interested in reflecting on what I’ve learned and what has surprised me, about economic behaviour and economic policy, given the way the virus itself has unfolded (the latter not being something economists had anything particular to offer on).

The thing I’ve found most surprising, given the severity of the virus, is the apparent resilience of private demand. My mental model 10 months ago was that private demand – consumption and investment – would fall quite sharply and stay quite low for a prolonged period (you can no doubt find me running that line in numerous posts through much of last year), and that that would be so whether or not a particular country was successful at keeping the virus out altogether, mostly stamping it out (eg NZ), or not. There were several reasons why that seemed plausible to me:

  • there were lost income-earning opportunities, which couldn’t be directly replaced while the pandemic persisted because –  for example –  people couldn’t travel internationally, or faced higher costs, more restrictions, and/or more uncertainty in doing so (eg I was supposed to be doing an overseas consulting trip in late Feb/early March 2020, and we cancelled not so much for fear of the virus in the other country, but from fear of having unknowable trouble/expense/disruption getting home again),
  • specifically, and for example, foreign students couldn’t come here, and although many were already here the longer the pandemic (and associated uncertainty) lasted the fewer were likely to be here (more go home, hardly any come).  Even if people were happy to study online from abroad, they wouldn’t be adding as much to demand here (food, travel, accommodation etc),
  • cross-border tourism was going to become all-but impossible, and if not impossible then that much more costly and uncertain,
  • inward immigration –  a key factor in New Zealand demand cycles –  was likely to be materially dampened for some time to come,
  • since no one knew how long the virus, and associated disruptions, would persist, private investment – the most cyclically variable part of GDP –  was likely to be particularly hard-hit.  Even allowing for some new spending on capital equipment directly associated with responding to the virus, it seemed likely that both from the demand-side and the financing side investment activity would fall away quite sharply –  perhaps especially in the sectors directly adversely affected, but more generally too.   Any disruptions to cross-border supply chains would only reinforce that
  • And even if New Zealand got more or less on top of things behind largely-closed borders, the economic losses in other countries that didn’t seemed likely to be severe.  The state of world economic activity typically matters a lot for New Zealand, including through commodity price channels. Investment, in particular, seemed likely to be hard hit.
  • more generally, uncertainty seemed likely to be a huge consideration, affecting households, firms, banks.  Pretty much everyone in fact, here or abroad.  At a household level, for example, even if a wage subsidy or similar protected your job in the narrow lockdown period, the economic environment had turned much more hostile and uncertain.  Losing a job, and finding it harder than usual to get another, was likely to affect spending and activity now.
  • (I also expected house prices to fall temporarily, perhaps by 10-20 per cent in real terms, as had happened in the previous recession, but unlike the Reserve Bank I’ve never believed that overall house price developments have much impact, one way or the other, on private consumption spending.)

And all this was reinforced by a recognition that in typical recessions we see these sorts of demand contractions, increases in unemployment, increased caution by lenders (and by investors) even when –  as usually –  interest rates are cut a long way.  And this time, interest rates hadn’t really been cut by that much at all –  in some countries almost not at all, but even in New Zealand by some fairly-modest fraction of what we normally see (75 basis points vs, for example, the 575 basis points of cuts in 2008/09).  So monetary policy would be doing something but not very much….and I thought those effects would be mutually reinforcing as the private sector recognised how little monetary policy was doing.    As just another example, serious downturns here usually see the exchange rate fall a lot, which is helpful in buffering the downturn.

There was, of course, fiscal policy. Fiscal policy also typically turns somewhat stimulatory during the worst of recessions, and we could expect more this time round – as indeed we saw, whether in countries (like NZ) with no much initial government debt, or in others with historically high debt to GDP ratios.

And yet, and yet…..if one is to believe a variety of economic indicators, the level of economic activity now doesn’t seem far from what it was a year ago. GDP is a badly lagging indicator, but on both measures real GDP in the September quarter was a bit above where it had been at the end of last year. Treasury’s activity index is partial, but more timely, and for what it is worth suggests that in December activity was about 1.5 per cent higher than a year earlier, and this in a country where there are now fewer people actually physically here (people who need to eat, need accommodation, take holidays etc) than were here last year. (Of course, there was still a lot of lost output back in March/April 2020, and most of that will never be recovered, but that isn’t my point here).

Of course, the unemployment rate has risen – although we won’t know the Dec quarter outcome for another week or so. But even if the December number is a bit higher, no one seems to expect anything dreadfully bad now – I don’t think any projections for the unemployment rate are now as bad as those in any of the past three New Zealand recessions.

It is all a bit surprising, on a number of counts.

One thing I clearly got wrong was in assuming that when New Zealanders couldn’t travel abroad – a non-trivial chunk of total spending by New Zealanders – they would mostly save, at least for a time, what they couldn’t spend abroad. As I noted last autumn, it didn’t seem that likely that a week in Whangamata in July was going to seem that attractive if you’d been hoping to holiday in Fiji, the Sunshine Coast, or more far-flung northern hemisphere places. And no one seemed likely to take up skiing when they previously holidayed in the sun in midwinter. Add in the economic uncertainty – see above – and it seemed not very likely there would be a lot of expenditure-switching towards the local economy. And yet there clearly has been. Whether people have been taking more holidays at home – especially over the summer – buying a car or a boat, eating out more, or committing to house alterations etc, the expenditure switching seems to have occurred, on a quite large scale. So much so that despite the really dramatic loss of overseas tourist spending – and some dip in foreign student spend – and the weakness in the wider world economy, overall economic activity seems to have recovered surprisingly well.

Perhaps it won’t last. Perhaps it isn’t well-measured. But for now at least it is hard to dispute the overall story. There are still, clearly, sectoral holes – pictures of near-empty carparks/bus parks in former overseas tourist hotspots – but the overall story seems surprisingly strong. Not boom times of course: unemployment is up fairly materially, but right now it has the feel of a quite-mild downturn overall. Consistent with that, and even though inflation expectations themselves have fallen, core inflation in the year to December was right where it had been in the year to December 2019 – a bit below target, still, but not falling as one might have expected (as the Reserve Bank did expect).

What explains it? Well, clearly there was more scope for expenditure-switching than I’d supposed. And that is good to know. But it can’t be anything like the whole story. After all, the wider world economy continues to materially underperform (relative to, say, expectations at the end of 2019), and uncertainty remains high (recall all those optimists about trans-Tasman bubbles back in the middle of last year, and compare that with the current situation – where even when/if Australia unilaterally reopens again to us, you’d surely be hesitant about booking when you don’t know the regulatory climate at the time you travel out, let alone what you might face coming home. No one has a good sense of when major industries – foreign tourism or export education – will return to normal, no one knows when population growth will resume, no one knows when the world economy will again be firing on all cylinders.

Of course, some will credit monetary policy. All those people talking up the “money printing” theme, and tying that into the unexpected surge in house prices. I don’t buy that story because – like the Reserve Bank – I think quantitative easing works mostly by changing interest rates and – see above – interest rates just haven’t changed by unusually large amounts. Perhaps there are some headline effects that neither the Bank nor I have paid enough heed to, but even if so such effects are unlikely to last for long. Oh, and of course the exchange rate – usually a key part of the monetary transmission mechanism – is no lower now than it was a year ago.

What about fiscal policy? There was, of course, a lot of fiscal support provided in the middle of last year, mostly in direct income support. A small amount of that is permanent (boost to household demand), notably the increases in welfare benefit levels, but by far the largest chunk was the wage subsidy. And large as that was (a) it has long since ended, and (b) it wasn’t large enough to replace all the private sector income loss (see how much GDP fell in the June quarter, even as jobs and basic household demand were supported by the wage subsidy payments. And as far I can tell there isn’t a lot of fiscal stimulus happening now (beyond what was already in the works and forecasts a year ago) – I’m sure there are some specific projects getting underway, but since little is ever really “shovel-ready” it just can’t be much relative to the scale of the wider economic challenges.

I don’t have strong conclusions, just puzzles. Why are people spending as strongly as they are, especially when we are reminded every day of our own vulnerability to new Covid outbreaks, lockdowns etc etc? It isn’t obvious that people have adequately factored in the real level of uncertainty.

Among the puzzles is that if unemployment is up and yet GDP is also flat or a bit up on a year ago, and the number of people here is a bit less than it was – that seems to suggest a boost to productivity that doesn’t make a lot of sense. When there was talk of really big job losses, people recognised that a lot of lowly-skilled people might lose their job, averaging up productivity even if no actual person was more productive, but now we are dealing with quite modest job losses. Even if GDP hasn’t fallen we’ve had material dislocations in individual sectors and those usually take time to work through. And – even with all the advances of technology – if we’d been told people couldn’t travel for a year – work and leisure travel – most would have assumed that would be a drag on productivity. Perhaps not instantly, but over time. And certainly not a boost. Business travel took place for a reason – and not the “joy” of long haul flying.

So some things don’t seem quite right. And in some cases not that sustainable. But quite what gives and when, who knows.

As for policy, my own position is that more macroeconomic policy support remains warranted. The case is simple: inflation and inflation expectations are below target and the unemployment rate is above any sort of NAIRU. I’d focus on monetary policy, which is the tool best-suited to short-term demand stimulus (as distinct from the income replacement imperative in March/April). If anything, over the last year I’ve become more wary of fiscal policy for countercyclical purposes. It gets presented as some sort of free lunch when it isn’t, and involves whichever lot holds power at the time making real resource commitments – to their own ideological biases – that are difficult to change later and which often don’t stand close scrutiny re the quality of the spending. By contrast, monetary policy attempts to mimic what real economic forces (savings, investment) would be doing to market interest rates, and involves no politician or public servant committing any real resources, or controlling anyone’s spending. Those best placed to spend more do, those more hesitant don’t, and interest rates can – or should be able to – be adjusted without limit (if central banks had done their jobs) to provide what support is needed, including drawing demand towards New Zealand (whereas fiscal policy focused on government spending) only tends to further increase the real exchange rate, and the excessively inward orientations of the New Zealand economy.

26 thoughts on “A year on

  1. In percentage terms interest rates have had huge falls, like over 50%. And deposit rates now make putting money in the bank a losing proposition!

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    • The large fiscal stimulus of $13 billion in direct wage subsidies actually allowed businesses to keep staff employed. Many businesses ended up making a profit as NZ went through a V shape recovery. My employer would have a loss this year if not for the $800k wage subsidy which actually turned the loss into a profit for the year.

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  2. Good article Michael. Two points of extra caution:
    – unemployment rate is a bit misleading because people have dropped out of the labour market and had hours reduced.

    – more anecdotally, there are a lot of empty and boarded up shops in Wellington. If more generally true, it explains the low inflation. I wonder if this will start showing in unemployment?

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    • THanks Tony

      On the first, I’m still taking the HLFS with a great pinch of salt – the Dec numbers will be the first with no lockdown (incl Aug Akld) direct effects – but for what we have seen so far participation and hours don’t seem to have fallen unusually.

      – yes, interesting point re Wgtn. One hears that lots of public servants are now working, say, 2 days a week from home, so some of what is visible in town may be primarily a reallocation towards the suburbs. I was surprised to find in Whakatane and Gisborne a v small number of empty shops – Whakatane in partic had the double-whammy of White Island and Covid more generally.

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  3. Thanks Mike for your thoughts I look forward to reading. The local spending and level of local tourism was not something I factored in and have just returned from a S Island road trip. QTown lacked the usual buzz but not deserted, I did notice the jet boats and shops selling adventure stuff were pretty quiet .Invercargill was quiet although the Transport Museum had plenty of visitors as did Larnach Castle and Oulverston house in Dunedin. I felt local prices had dropped marginally and roads were quiet making the driving pleasant. I wonder if peoples expectations of rising inflation combined with the lack of return on deposits a factor in spending aligned with the disruption to supply chain making fresh supplies of goods uncertain?
    The B& B in Dunedin told us their bookings had been and continue to be well down and a friend who runs a small upmarket Campervan business has no booking until April although some long term ones over the holiday period will see him through a couple of months. I strongly suspect that NZ is a long lag due to our economic structure and geographical location so likely to follow other economies as the Global effects arrive here.

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    • Thanks for those observations. Yes, it is clear that NZer’s tourism spending isn’t fully replacing lost foreign spending – we are planning to go to the glaciers in the July school holidays and noticed a story last week talking of various firms at Fox closing down- but then our builder was telling us this morning there are long waits for subcontractors for quite small jobs (eg retiling our bathroom), suggesting the “additional renovations/upgrades to houses” is part of the displacement story.

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  4. There’s another factor I’ve observed. It may just be an anecdote but also not: my kids’ summer reading programme had just ended for good. Apparently the trust that pays for it is pulling out. That raises an interesting question perhaps some other readers could answer: does the extreme reduction in term deposit rates mean that the many community trusts that rely on interest income to maintain their community grants levels will start to curtail or cease their operations until their imagine streams increase? There’s an awful lot of money distributed each year by these trusts that may just dry up.

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    • I guess it is the same story as retirees having to spend more of their capital rather than rely entirely on income. Not an easy hurdle to get over – for individuals or (eg) trusts, and sometimes in the case of the latter there may be trust deedl obstacles – and yet fairly inescapable given the v long running downward trend in real interest rates (ie not just a whim of central bankers).

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      • That trend must come to end at some stage – it is like house prices, they can’t keep going up faster than incomes forever! And the end point can’t be too far away – years rather than decades?

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      • Probably true, altho there is no very natural lower bound to real interest rates, so it isn’t clear that rates could not settle around current levels for decades, or even settle around something a per cent or two lower again.

        (Neither is my prediction, but economists don’t have a unified compelling story for why real rates have fallen so far to date.)

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      • Anthony, you need to separate out house without land prices versus land with a single house prices. Most houses at this time has around 1000sqm of land, however increasingly as we are seeing in Auckland, a 1000sqm plot will now allow 5 terraced houses. The house with 1000sqm is therefore increasing at faster than 10% a year. That trend will continue as more and more councils allow 5 terraced houses per 1000sqm site. The average that you pay for a house may not rise as fast or even fall dependent of the build cost with Terraced houses.
        .

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  5. Why are people spending as strongly as they are ? A signifcant factor must be the wealth effect from very strong rises in house prices.

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    • My wife is happy to loan me money ever since the interest on her term deposits became negligible. Are there stats for similar easy to access savings? And has credit card debt increased?

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      • Usually I would spend $50k on a holiday overseas. This year stuck in NZ with a spare $50k. Invested that into the NZX and ASX and made $35k. I now have spare cash of $85K with a job that still pays $200k and a property portfolio that have increased by $1.5 million to now $10.5 million. Of course I would be spending up more than usual.

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  6. Great to see another post,You have been missed.
    Underlying inflation surely now must become measurable as real inflation.

    Goods are becoming in short supply but there seems to be no shortage of money.
    There appears to be little restraint on money supply ,( and credit )

    Examples include new vehicles, white wear, housing ,land food and others.
    Buy now has become pay now and collect later,That is pay the full price now and collect when it arrives.
    Inventories are in short supply and prices are rising.
    An example from the motor trade where some used vehicles are now priced higher than new and the first of next month will see a substantial increase in the new price.
    The house price boom has started more and more strident calls for wage and salary increases.
    A wage / price inflation spiral is a high risk now.

    What solutions do we have left?

    Thanks
    Rosecevans

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    • I have been looking at a 2013 Porsche Cheyenne with 133km for $40k sitting in a car sales yard for 3 months already. Brand new was $160k. Similarly a 2015 Lexus RX450 hybrid with 68km priced at $42k. Brand new that was a $130k car. Can’t see any 2nd hand cars priced for more than brand new.

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      • Get great stuff,
        Suggest you take a look at the more common SUV / 4wd markets.
        Toyota’s Landcruiser etc pretty commonly in excess of 100k now.. 2nd hand Land cruisers and Hi lux in some cases in excess of new price.
        There is shortage in supply which has driven the price of some of these less exotic marques second hand vehicles over the price of new.
        Delays in supply mean 3 or 4 month waiting list for some.And have also been told there is a substantial price increase on the way for the Toyota’s.
        Also to three weeks delay for a major NZ whiteware retailer to supply a fridge, and they wanted payment with the order not on delivery.
        Retailers inventory is reducing.
        And inflation is happening.

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      • Rosecevans, all this comes down to Port of Auckland being unable to clear its logjam. Price rises are temporary due to Container ships unable to offload in Auckland, Many have just bypassed Auckland and dropped their goods off in Tauranga or just bypassed NZ completely and dropped into Australia. Can’t see inflation when there is the option of alternatives like GreatWall and Mahindra to keep prices in check.

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      • 2 weeks ago, export grade cherries were $30 a kg. Now they are $20 a kg available in the local Chinese grocer picked yesterday. Looks pretty deflationary rather than inflationary.

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  7. GGS,
    We can all cherry pick individual prices and reasons ,but overall ,whatever the reason shelves are not full, and the plentiful NZD won’t buy when or what it used to.
    Some more food for thought.
    How about ,Council rates / charges etc.
    And land prices.eg Forestry land has doubled in about 3 years.
    .Labour contracts etc, The list goes on.

    I and many others believe inflation is happening.

    Liked by 1 person

    • A year ago NZD was $0.65 against the USD. Today it is $0.72 against the USD. This is a very strong NZD which means cheaper imported products. Also we are known as New Xi-land after our Trade Minister told Australia to show more respect to China. Expect cheaper products on the shelf. China will fund and double our Port capacity if we allowed a Port extension. But views are more important to Aucklanders. But you and others are mistaken about longer term price rises. This is a Ports of Auckland driven short term price increase.

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  8. GGS,
    It is correct that land prices are exempt from the inflation index.
    Challenged Alan Bollard on why,some years ago, and his answer was far from clear.
    However the effects of land prices are certainly felt and measured through the economy.
    The NZD does fluctuate but at .72 USD the expectation of lower imported prices is real.

    Why then are vehicles and other imports now actually increasing in price?

    Inflation perhaps ?

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    • Port of Auckland logjam. It is temporary. Still can’t see your vehicle inflation. That $42k 2013 Porsche SUV is now offered at $39k, 125 interested people are just watching on Trade me. A 2016 Lexus SUV latest shape which is pretty much a Toyota just came up for $48k which is far cheaper than the $130k new price tag. Still looks like more bargains coming up. Notice I have not yet bought because my expectation is falling prices and I have cash to burn having just made $1.5 million in increased property value to now $10.5 million plus a 30% increase in my NZX share portfolio.

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