Bits and pieces

Having highlighted the Reserve Bank’s late Friday afternoon pre-Christmas release of the results of its “regulatory stocktake”, it will be interesting to see what other material government agencies slide out in the next few days, hoping for little or no sustained coverage.    I had a reply the other day to an Official Information Act request to Treasury, in which I’d asked about the basis for Treasury’s enthusiastic endorsement of TPP in the Joint Macroeconomic Declaration.  What they released wasn’t very interesting or useful (although if anyone wants it send me an email) but they did note “that the official government assessment of the final TPP agreement is contained in the National Interest Analysis, which will be publicly released soon”, which may also mean before Christmas.    That document should be interesting –  and hopefully it will get some coverage – although coming from those who negotiated the deal  it is no substitute for a serious independent analysis and evaluation carried out by, say, the Productivity Commission.

This morning’s Herald was a bit of a surprise.   The editorial ran under the heading “Rates rise may be first step to true recovery”.   Last week’s Fed Fund rate target increase is, according to our leading newspaper, “the first confirmation confidence is returning to at least one major economy since the global financial crisis”.

Of course, central banks don’t usually raise interest rates unless they think their own economies are doing reasonably well and that inflationary pressures might otherwise be about to start gathering.  Perhaps curiously, neither the word “inflation” nor the idea appeared in the Herald’s editorial at all.

But perhaps the leader-writers have forgotten about all those other advanced countries that have raised interest rates in the last six years, only to have to cut them again.  Central banks that have set out to tighten generally found that they had made a mistake (with the benefit of hindsight) and have had to reverse course.  And it isn’t just the tiddlers.  The ECB raised rates back to 2011, no doubt thinking that the crisis was behind them.  They were wrong.    Business, so we are told, is likely to draw confidence from the Fed’s action last week, and be more willing to invest.  It is an interesting nypothesis, but one which bears absolutely no relationship to what has been seen in the various countries that raised rates in recent years only to have to cut them again.  Investment rates around the advanced world remain low.  It gets tedious to keep mentioning New Zealand’s two policy reversals in the last six years –  but there is no sign that either of those ill-judged sets of tightenings did anything very positive for our economy.

Time will tell whether the Fed’s tightening last week was really warranted or desirable.  But even if it does prove to have been appropriate, it seems most unlikely that it will have been because higher interest rates and a higher exchange rate combine to give fresh impetus to the entrepreneurs and other investors in the United States.  Surely we deserve better analysis than the Herald provided today?

As I noted, investment remains pretty subdued around the advanced world.   New Zealand is no exception.

Here are a couple of charts drawn from last week’s national accounts release.  The first shows various cuts of gross fixed capital formation as a share of GDP: total, total private, total private excluding residential investment (ie a proxy for business investment) and general government.

nominal investment to gdp

With the exception of government investment, all of these series are well below their pre-recession peaks (typically in around 2006 and 2007).  In some respects that is really quite surprising.  New Zealand has had:

  • High average terms of trade, which should typically spark new investment to enable the economy to take full advantage,
  • The Christchurch repair and rebuild process (which doesn’t make us richer, but does add hugely to gross investment),
  • No serious domestic financial crisis to materially disrupt the credit allocation process, and
  • Much more rapid population growth than we had in the last few years prior to the recession.

New Zealand’s population is estimated to have grown at around 1 per cent in 2006 and 2007. By contrast, it is estimated to have increased by 1.95 per cent in the year to September 2015.  As I pointed out last week,  faster population growth rates would typically be expected to have big implications for investment, since the capital stock is around three times annual GDP.   More people require more capital, and getting that capital means a lot more investment.

For good or ill, government investment has remained quite strong, and will be boosted a bit further by last week’s announcement.  But my business investment proxy –  the purple line –  at around 10.5 per cent of GDP (and showing no sign of strengthening) is still two full percentage points lower than we saw through the later pre-recession years, when population growth rates were much lower than they are now.  And recall that even this measure includes the non-housing non-infrastructure rebuild expenditure.

For analysis over time, I tend to focus on ratios of nominal investment to nominal GDP.  That is partly on the advice of Statistics New Zealand, who point out that deflator problems –  which are particularly serious for investment –  make ratios of real investment to real GDP quite problematic over time.  But for those with a hankering for real investment measures, here is real private investment (excluding residential investment) per capita.  Even now, this series has only just got back to pre-recessionary levels, eight years on.  And with the unexpected surge in the population, if everything was working well –  and especially if the Reserve Bank was right about supply effects of migration exceeding demand effects even in the short-term –  we should have expected to have seen this series at new highs.

business investment per capita

Businesses invest to the extent that the expected returns to investment look attractive. In New Zealand, at present, there just don’t seem to be that many projects that have been  passing that hurdle. Unfortunately, it isn’t obvious why things should be any better next year.



Living in an age of diminished expectations

The latest quarterly national accounts data were out yesterday.  These December releases are particularly helpful because they take full account of the new annual national accounts data released a few weeks ago.

Understandably, there is a lot of focus on what the quarterly data might, or might not, mean for monetary policy.  I’d have thought the answer was not much –  the September quarter was a bit stronger than many had expected, and only time will tell whether that is more than a one-off, or whether (as I suspect is more likely) the economy will settle back to something more like the very weak growth (per capita) recorded in the first half of the year.

What about a slightly longer-term perspective?  Here is annual growth in real per capita GDP, for as long as Stats NZ has the quarterly data for.  I’ve used a series that averages the expenditure and production measures.

real gdp pc dec 15

Look how weak the recoveries since 2009 have been.  Peak growth was back in 2011, just after the double-dip recession.  Despite the record terms of trade, real per capita GDP growth got only briefly above 2 per cent at the end of last year –  even then only just reaching the average growth rate for the 17 years up to 2008.  For the year to September, per capita growth has fallen back to the average seen after 2008 –  and it would take another quarter at least as strong as September to stop that growth rate dropping even further in December.   (And as many commentators have highlighted, the more variable income measures have been falling in per capita terms, as real growth has slowed and the terms of trade have fallen.)

The second chart is similar to one I ran a few weeks ago.  It just puts a trend line through per capita real GDP for 1991 to 2008, and then compares how actual real per capita GDP has compared with that 1991-2008 trend.  The gap now is something like 15 per cent.

real gdp pc trend dec 15

Reasonable people might differ on where trend lines should be drawn – here I simply started at the start of the series, and choose the end of 2008 as the end since most people would reckon the output gap had closed by then.  But using almost any trend measure, the economic performance has been pretty disappointing.  Of course, it has been disappointing in most countries, but we’ve had the benefit of a record terms of trade and didn’t face the costs/distortions of a serious domestic financial crisis.

One of the striking aspects of the recent quarterly data has been the increase in the volume of services exports –  up by more than 20 per cent since the start of last year.  This seems to reflect both an increase in tourism volumes and in the number of foreign students.  Any exports increase resource pressures right now, and in an underemployed economy should generally be welcomed.  Nonetheless, it is worth keeping a longer-term perspective in mind.

services exports

Even after the dramatic increases of the last few quarters, real exports of services per capita have not even quite got back to the peaks reached more than ten years ago.

And one wonders just how much more good quality growth we can expect in this sector.   International guest nights data seem to have been going more or less sideways over the last few months, and it is difficult not to think that much of the growth in education exports (almost all at the bottom end of the market –  polytechs and PTEs) is resulting from the “export incentive” of the right to work in New Zealand and the desire to secure a residence visa –  the total number of which is more or less capped.



Weak expectations and accountability

The Reserve Bank released the results of its Survey of Expectations yesterday afternoon  – aggregated responses from 60 or so relatively informed participants.  For some reason, this quarter they have separated the release of the survey of household inflation expectations, which is now apparently not due until next week.

After the release of the previous results in August I wrote a post that provided a fairly downbeat assessment of the information in the two surveys, a little in contrast to the commentaries I saw at the time from market economists.

I’m a participant in the survey, and had actually revised many of my responses up a little from those I provided in August.  But my reading of the results suggests that the respondents as a group are about as downbeat as they were in August.  In particular, there is little sign of any sustained pick-up in inflation expected over the next year, despite the repeated Reserve Bank rhetoric.

This isn’t going to be a long post, but just a few highlights:

First, respondents expect the economy to do no more than limp along, beneath capacity, for the next two years.  The unemployment rate is expected to stay at or above 6 per cent throughout, and GDP growth of 2.2 per cent and 2.4 per cent is expected in next two years.  Those would be fine growth rates for Japan, with a slightly falling population, but New Zealand’s population growth was estimated at 1.9 per cent in the year to June 2015.   There doesn’t look to be much per capita growth envisaged by respondents, even with the lagged effects of monetary policy easing, unless respondents are expecting quite a sharp reduction in the net migration inflow.

Second, inflation expectations remain very subdued. Fortunately for the Reserve Bank, two-year ahead expectations have done no more than reverse last quarter’s slight bounce, and are still at 1.85 per cent.  But one year ahead expectations are only 1.5 per cent, and expectations for the second six months of the one year period (beyond the immediate “noise” of oil price fluctuations) are no higher than those for the first half.  In the whole period since the recession started in 2008 only once have those second six month expectations been materially lower than they are now,     Respondents still appear to loosely believe that the Reserve Bank is aiming for 2 per cent, but they aren’t seeing any signs that suggest the Reserve Bank will get it there soon.  Since the various core inflation measures are 1.5 per cent at most, at best they seem to envisage a continuing undershoot.

inflation expecs

Third, respondents don’t appear to expect much more of an OCR cut.  Even a year ahead, respondents expect the 90 day bill rate to be 2.79 per cent, probably not even consistent with a full expectation of the OCR being cut to 2.5 per cent.

However, the survey also asks respondents about their expectations for monetary conditions, both currently and a quarter ahead and a year ahead.  Each respondent can decide for themselves what counts for assessing monetary conditions –  the exchange rate, the OCR, equity prices, retail lending rates, LVR restrictions, or whatever.  Since the survey began in 1987 there have only been two quarters when respondents thought conditions were easier than they are now.  But typically when respondents think conditions are easier than neutral they don’t expect that state to last for long –  looking a year ahead they typically expect things to tighten.  For the last year or so that hasn’t been the case.  The extent of the extra easing isn’t large, but the fact that is expected at all in unusual.  It is not a sign of confidence that the Reserve Bank has yet got on top of things.   Expectations a year ahead are for looser conditions than they’ve expected at any time since this question was first asked in 1999.

expected mon con.png

The OCR is still 25 basis points higher than it was at the start of last year (as are the floating retail rates the Bank reports).  Over that period, inflation expectations (at least measured by this survey) have fallen by about half a percentage point.  Inflation expectations implied by the spread between indexed and conventional government bonds appear to have fallen a bit further (to only around 1.3 to 1.4 per cent).  So real short-term interest rates are at least 75 basis points higher than they were at the start of last year.  Why? For what?

Since that time, we’ve seen little or income growth, little real per capita GDP growth, the unemployment rate stop falling and start climbing, and inflation continue (on a core basis) to be well below the 2 per cent target midpoint (focal point) that the Governor explicitly signed up to only three years ago.

As I noted in my post yesterday about Stan Fischer’s speech, effective accountability in any area of life isn’t just about talk: it  has to imply that there is potential for adverse consequences for the independent decision-makers themselves. As in any area of life, a single mistake is usually not a safe signal of anything much.  But established patterns of error must raise more serious questions if the much-vaunted accountability is to have any real meaning.   This is looking quite like a repeated pattern of errors, compounded by a reluctance to acknowledge errors or to learn from past mistakes.

Some snippets from the annual trade data, with a China tinge

Statistics New Zealand released yesterday the annual data on New Zealand’s overall foreign trade (goods and services) by country.  It is a nice summary set of tables for people who don’t spend lots of time looking at trade data, and the services data are only available annually.

Since the end of last year, these have also been the data the Reserve Bank now uses to calculate the weights in its trade-weighted index measure of the exchange rate.  Those weights are calculated on a total trade basis (imports and exports, goods and services) for 17 currencies, covering countries that currently account for a bit over 80 per cent of New Zealand’s foreign trade.  The weights are updated annually, and when they are updated in December there will be a few changes.  After much noise about China becoming our largest trading partner (which it has not yet been on a total trade, or even total exports, basis), China’s share in New Zealand’s foreign trade dropped back quite a bit over the last year.  By contrast, the United States’ share rose.  Whereas this year, the weight on the Australian dollar was only 2 percentage points more than that on the Chinese yuan, both well ahead of the US dollar, next year the weight on the yuan will be around halfway between those on the Australian and US dollars.

twi weights

There is no easy right answer as to how to weight an exchange rate index.  My own sense is that the current weighting structures overstates the importance of Australia, and understates the importance of the United States and the euro area (or the EU more broadly).  These latter two economies/regions are a huge share of total world production/consumption, and are major competitors in our largest (net) export products, particularly dairy.  Neither element is captured in the current weighting scheme.  And while Australia is our largest export market, those numbers are flattered by the fact that still more than 12 per cent of our exports to Australia are crude oil and precious metals (presumably mostly newly-mined gold), which have nothing to do with wider economic conditions in Australia, or movements in the Australian dollar.

It is interesting how much of our trade with Australia is now dominated by travel.  Excluding oil and precious metals, 28 per cent of our exports to Australia are travel and transport.  No other single category exceeded 7 per cent of our exports to Australia last year.   The picture is similar on the import side, where travel and transportation account for 27 per cent of our Australian imports.

And, finally, I was interested in the dairy export data.  The media has been full of discussions around dairy exports to China, which had surged in 2013/14.

Here are our milk powder, butter and cheese exports for the last five years to China on the one hand, and the ASEAN countries on the other.

dairy exports china and asean

It highlights both how unusual last year was, but also how important those other countries are in New Zealand’s dairy trade.   In a typical year, New Zealand firms export as much milk powder, butter and cheese to these countries as to China, and yet these countries in total have annual GDP not much more than 20 per cent of China’s.  Actually, the data also illustrate just how diversified dairy exports are in a typical year.

dairy exports 2014 15

By contrast, in the 1950s almost all our dairy exports went to the United Kingdom, and there were few other export markets anywhere for dairy products.

None of this is to suggest that China is unimportant.  China is now the world’s second largest economy, with a very large foreign trade for a country of its size.  And is a badly-managed, highly non-transparent, economy, at the tail end of one of the bigger, least-disciplined, credit booms in history.  What happens in China matters a great deal to most countries, but there is no reason to think it matters abnormally more to New Zealand.

(As one perspective on the lack of transparency –  and, worse, outright misrepresentation –  that plagues the rest of world making sense of China, I’d recommend the latest from Christopher Balding, who takes on those who want to defend China’s data as providing a broadly accurate and representative picture of what has been going on).

Can Steven Joyce’s confidence be taken entirely seriously?

I watched Q&A’s interview yesterday with Minister of Economic Development, Steven Joyce. He was resolutely upbeat, rather beyond the point where his case could be taken entirely seriously.

The Minister tried to reassure us by observing  that he’d taken a look at New Zealand’s previous four recessions and we weren’t facing anything like that. In particular, he assured us, the world economy was different.

I’m not sure which recessions the Minister had in mind. But here is the chart of six-monthly growth in real GDP back to the start of the official series. Six-monthly because of the popular lay definition of a recession as two consecutive negative quarters of GDP growth. It has never been entirely clear why that measure enjoys such popularity. Apart from anything else, it means something quite different in all those European countries or Japan with flat or falling populations than it does in, say, New Zealand, with 1.9 per cent estimated population growth in the last year. Two quarters of zero or negative GDP growth in New Zealand is a quite material hit to per capita GDP.

gdp 6 mth changes

My first observation about past recessions, or marked growth slowdowns, is that they almost always take officials (and probably ministers) by surprise. I reflect sadly on having been in policy/analysis roles in the Reserve Bank in each of the episodes in this chart where growth got to zero or negative. I’m pretty sure we didn’t expect or anticipate a single one of them. To take just the most recent examples:

  • The 2010 double-dip recession was such a surprise that the Reserve Bank had raised the OCR twice just as it was happening.
  • It wasn’t until several months into 2008 that the Reserve Bank recognised even the initial domestic recession

But you could go through published material from the Bank around each of these episodes and the story will be much the same. And I’m not trying to pick on the Bank. I’m pretty sure Treasury’s record would have been no better, and nor (consistently) would that of any of the market forecasters/economists. There would be nothing very unusual if, by the time the September or December national accounts numbers came out, it turned out that real GDP had been going backwards for some time, even as ministers and senior officials had been running the usual upbeat story.

My second observation is that while severe world downturns are bad for New Zealand, we haven’t needed global recessions to have a downturn in New Zealand. Our 1991 recession and our 2008/09 recession were part of common global (or advanced country) events, but our 2010 double-dip recession, our 1997/98 recession, and our 1988 recession were largely home-grown. The Minister wanted to take comfort from the state of the world economy, but I’m not sure why.   World growth rate estimates are no better than mediocre, and they rest on estimates of China’s growth which few people now take seriously. Growth in many other emerging market countries has been slowing, as their credit-booms exhausted themselves, and there is no sign of acceleration in the anaemic growth in most of advanced world. Commodity prices have been falling very sharply, and monetary authorities in many countries have been easing policy in the last 18 months. Perhaps the US Federal Reserve will raise interest rates next month, but if so it seems to be as much as response to the siren call of getting back to (questionable estimates of) a neutral interest rate, rather than because demand growth is putting much upward pressure on inflation.

There has been plenty of talk of New Zealand maintaining growth at around 2 or 2.5 per cent. But remember that in the last six months for which we have official data, real GDP rose by only 0.8 per cent. And that was the six months to March, when sentiment was still pretty upbeat, employment was growing strongly, and so on.   It is hard to believe that “true” growth in the rest of this year – and we are now half way from March to the end of the year – will have been stronger than it was in the six months to March. If it is only as strong, that produces an annual growth rate of not much more than 1.5 per cent. With building activity starting to go sideways, unemployment rising, and consumer and business sentiment down – and as the sharp fall in the terms of trade has grabbed the consciousness of many people – a much safer bet would seem to be lower growth. It isn’t clear to me why, say, one would bet on an average of anything more than zero growth for the next few quarters.

There has been talk of the “automatic stabilisers” working. Perhaps, but lets look at them. Fiscal automatic stabilisers are not particularly strong in New Zealand – which just reflects the fact that our maximum marginal tax rates are low, and our unemployment benefits are modest and at a fixed rate. Interest rates are falling, but they probably shouldn’t have been raised last year, and so far only half the increase in the OCR has been unwound. As I’ve noted previously, by the standards of past cycles in short-term interest rates, even a cut in the OCR to, say, 2 per cent by early next year would not be remotely aggressive.   And it is quite possible that medium-term inflation expectations are still falling – there have been suggestions of that from the bond market, for example. If so, real interest rates aren’t falling much at all.

iib infl expecs

And, of course, the exchange rate has fallen. As I noted last week, the fall over the three months to July was one of the largest short-term falls we’ve seen in the floating exchange rate period. But we’ve had one of the largest falls in commodity prices (and probably the terms of trade) on record, and I don’t think anyone would regard the TWI at just over 70 – where it has been for the last month or so – as particularly stimulatory. It is back at around the levels prevailing in 2010.

So combine subdued world demand growth, very deep falls in commodity prices, a levelling off in one of the biggest construction booms in modern times, continuing modest fiscal consolidation, subdued credit growth (except among distressed dairy farmers), real interest rates that remain very high by world standards, and a real exchange rate that has only dropped back to around the average level of the last 15 years, and it isn’t clear what is likely to hold up growth in New Zealand this year.

Of course, that migration-driven 1.9 per cent population growth helps boost demand. But since even at the peak of the migration inflows there was barely any real per capita GDP growth (and the level of the real per capita measure of income (ie allowing for the terms of trade) peaked in the March last year), that might be cold comfort. And the influx of people (especially the non-citizens) may well start to wane if the labour market conditions facing prospective employees keep on deteriorating.

Here’s one final chart. It shows annual growth in nominal GDP: already down to 2 per cent in the year to March, before this year’s fall in the terms of trade has been reflected in the national accounts. Only in previous recessions has annual growth in nominal GDP got any lower than it is at present.

ngdp apc

With the combination of mismanaged monetary policy, ebbing activity in one of the world’s largest economies (and major source of demand growth in recent years) and the very deep fall in commodity prices, it might be better to ask not “can we avoid a couple of negative quarters” – the technical recession question – but to ask instead what makes us confident we are not already in a renewed recession (real, as well as nominal), perhaps already deepening? I don’t purport to do quarterly GDP forecasts, and would be happy to be wrong on this one, but presented with the raw New Zealand data it looks like the sort of conclusion a visiting analyst from Mars might easily reach.

Downturns, recessions, corrections don’t last for ever.  And they don’t, in the end, make that much difference, to the longer-term (rather disappointing) performance of the New Zealand economy.  But for individuals –  particularly the 148000 unemployed, and the others likely to be joining them –  and business owners they can matter a great deal.  Some variability is natural and unavoidable (the two aren’t the same thing) but macroeconomic management should have been able to have prevented unemployment rising again before it ever quite recovered from the last two recessions, and to have avoided any new recession.  It looks to have failed already on the first count, and the outlook doesn’t seem promising on the second.