The government needs to be more supportive of industries facing temporary headwinds, and the Reserve Bank should lean against the rising New Zealand dollar to counter shifts in the global economy as central banks around the world 'break all the rules,' JBWere economist Bernard Doyle says.
Doyle says the RBNZ should be very worried about the financial stability of the New Zealand economy, as it faced a widening current account deficit which would not be as readily accepted as before the global financial crisis.
He suggested one option for the Bank was to cut the Official Cash Rate further from its record low 2.5%, although accompany this with housing lending restrictions to diffuse the risk of runaway house prices.
Alternatively, the central bank could follow in the Bank of England's footsteps and channel cheap loans through the banks into non-financial business or to those building more houses.
Doyle also suggested the Reserve Bank impose a soft cap on the New Zealand dollar, where it would buy foreign exchange at pre-set bands.
He also said the review announced by SOE Solid Energy into its mining operations last month was an important precedent for the government when it came to dealing with sectors of the economy facing temporary headwinds.
While he cautioned against governments 'picking winners', targeted temporary help could counter a hollowing-out of the productive sector due to the imbalances which had been created in the global economy.
Help could be targeted at specific industries or regions. Doyle also suggested the government actively attract resettlement of New Zealanders who had emigrated to places like Australia as the mining boom there cooled off.
In a note released on Monday, Doyle said the global financial crisis had lead to a fundamental reshaping of the global economic landscape.
"Growth around the world is lower, less stable and more reliant on policy support. To date, New Zealand, a small open economy, has been surprisingly immune to these forces. But developments over the past month suggest to us that is changing," Doyle said.
He pointed to Solid Energy's review of its mining operations and the announcements of job cuts recently at both Norske Skog's Kawerau paper mill and Rio Tinto's Tiwai Point aluminium smelter as examples of how the crisis was affecting New Zealand.
"There are some obvious common threads amongst these developments. The role of the high New Zealand dollar in undermining industrial exporters is not a new phenomenon. Neither is the reality that commodity exporters face price volatility that will regularly threaten the viability of NZ based producers," Doyle said.
"However we believe the reshaping of the world following the financial crisis has implications for New Zealand that will challenge policy makers to think creatively," he said.
Breaking all the rules
New Zealand was a rarity in the global economy, with positive interest rates and no quantitative easing
"In other words, relatively orthodox monetary policy. Unfortunately, in a world where the major central banks are breaking all the rules, this is not an advantage," Doyle said.
• The Federal Reserve about to print an unlimited quantity of money in an effort to boost growth and lower unemployment;
• The Bank of England printing money and providing cheap loans to households and businesses;
• The European Central Bank is making cheap money available to banks and sovereigns;
• Asian Central Banks, which typically have pegged currencies, are diversifying reserves, we suspect including into NZD and AUD.
• Most controversially of all, the Swiss Central Bank has had a hard ceiling on its currency for the past year.
"Against this backdrop, the RBNZ has been playing with a straight bat. This has the impact of importing other countries’ problems. Money printing in the US is artificially depressing the USD," Doyle said.
"Similarly the increasingly exotic tactics of the other major central banks to pump prime growth is weakening their respective currencies. This is keeping the NZD above where it would otherwise be given our economic fundamentals," he said.
"The outgoing RBNZ Governor has described monetary policy as in a "reasonably sweet position”. This is partially true – the RBNZ has rate cuts to use if required – a luxury many Central Banks no longer have. However we think the RBNZ should be very worried about financial stability in the New Zealand economy. The combination of the rapid retrenchment we are seeing in parts of the manufacturing sector combined with a resurgent housing market is a red flag.
"Left unchecked, we could be heading back into current account difficulties. New Zealand got away with large, persistent current account deficits pre-GFC. Post-GFC, this will be a riskier scenario," Doyle said.
What to do?
The major central banks around the world were bending or breaking the rules of economics, which meant the RBNZ needed to respond in a way that leant against the imbalances washing up on New Zealand shores.
• Cut rates further. This would spark up the housing market, so would need to be accompanied with policies that inhibited borrowing growth – the RBNZ is already looking at these sorts of tools (for example LVR limits). Alternatively, explicitly including a rate of house price inflation in policy deliberations (eg 10% annually or less) would help defuse the risk of runaway house prices.
• Don’t cut rates, target lending. Take a leaf out the Bank of England’s book and channel cheap loans via banks into non-financial businesses or those building homes. This would deliver rate relief to those who need it, while avoiding the housing market excesses that could emerge from a rate cut.
• Soft caps on the NZD. Establish pre-set bands that would see the RBNZ accumulate foreign exchange (eg 0.8250; 0.8500; 0.8750; 0.9000). These alone won’t stop currency appreciation, but would make it clear to NZD buyers they were trading against the Central Bank.
Govt needs to step in
Meanwhile, the RBNZ could only do so much to mitigate the impact of the post-GFC environment on the NZ economy.
"Increasingly, we see a role for Government. This is particularly the case when it comes to nurturing the productive economy – something the RBNZ can only target with relatively blunt tools. The Government has far greater flexibility to provide targeted support," Doyle said.
• Continue to keep pressure on Government spending. This is one of the most effective ways the Government can contribute to financial stability; but
• Target support of industries that are facing powerful, but possibly temporary headwinds;
• Target support for regions that are most exposed to the manufacturing downturn (eg Central North Island, West Coast of the South Island)
• With the mining boom cooling in Australia, actively attract resettlement of New Zealanders that have emigrated.
"The Government and Reserve Bank cannot completely insulate New Zealand from the forces reshaping the global economy. However they can work against the most insidious side-effects: NZD overshoot; hollowing-out; and housing market overheating," Doyle said.
"Currently, we feel the response of both the RBNZ and Government is too passive."