New Zealand has fallen deep into a per-capita recession and policymakers are likely to make it even worse with contractionary fiscal and monetary settings.
That was the conclusion of one New York-based economic strategist attending Waikato University’s Economics Forum in Hamilton a few weeks ago.
Dimitris Valatsas, the chief economist at US advisory firm Aurora Macro Strategy, said he found the presentations by NZ’s top policymakers to be “bizarre”.
“New Zealand has ample fiscal space to support the economy and it seems bizarre to me that it is not being used — and even more bizarre that the Government feels there is a need to reduce spending right now,” he wrote in an email.
In a later note to clients, he suggested shorting the NZ dollar and buying Government bonds.
“Policymakers have locked themselves into procyclical monetary and fiscal policy which, while deepening the slump, should support bonds,” it said.
Economic orthodoxy would suggest that governments should step in to provide support during downturns and save surpluses during periods of strong growth.
New Zealand has managed to do the opposite. The Labour-led Government threw huge amounts of money into the economy to offset the covid downturn.
And, it worked all too well. Economic activity came roaring back to life but Labour could not bring itself to switch off the support even as the ‘check engine’ light started flashing.
Surplus or stabilisation, that is the question?
Caralee McLiesh, Secretary to the Treasury, gave a speech at the forum arguing in favour of reducing government spending despite the downturn.
“Although the economy is expected to slow in the next two years, our assessment of current macroeconomic pressures and that the current fiscal deficit is structural meant we recommended … that the Government should prioritise a return to surplus”.
Interestingly, Finance Minister Nicola Willis has herself cast doubt on whether the Coalition Government will be able to deliver on its plan to return to surplus in the 2026-27 year.
She told Bloomberg she was not “optimistic” about the chances as the surplus position was “challenged”.
McLiesh said there were likely to be situations in the future when fiscal policy will be needed to stabilise the economy but any support should be “timely, temporary, and targeted”.
That may mean relying more on automatic stabilisers, which are linked to the economic cycle, and less on infrastructure and core Crown spending which are harder to withdraw.
“The asymmetry of fiscal policy (it is easier to spend than it is to cut) reinforces why fiscal policy should be used judiciously in macro stabilisation,” she said.
Valatsas, our New York macro-economist, thought this was a policy mistake that would result in lower growth for longer.
“We perceive virtually no opposition to this austerity political narrative among policymakers at present, meaning that fiscal headwinds are likely to persist until the next election”.
Some economists might argue the Government should hold spending steady, even if it means adding to the national debt, and wait for the economy to catch up.
But McLiesh was sceptical of this approach. Higher interest rates make it harder for a country to “grow its way out of debt” and the outlook on future growth was highly uncertain.
“Between population ageing, climate change, a global productivity slowdown and geopolitical fragmentation, prudence suggests we should borrow only what we could afford to repay in a modest-growth future”.
“We should not rely on favourable debt dynamics going forward,” she warned.
That said, she noted NZ could theoretically recover from debt levels of around 90% of GDP — five times higher than the current 18% and three times higher than the 30% ceiling.
An interesting dollar
Valatsas wrote his research note prior to the Reserve Bank’s decision last Wednesday, in which it held the Official Cash Rate at 5.50%, while the fear of further hikes was still in the air.
He felt this would be a mistake and worried the RBNZ had been overly influenced by being blamed for the inflation spike, despite being one of the first central banks to react.
“This means they suffer from a hawkish bias that has only been exacerbated by the new Government’s legislation moving the RBNZ to a single (inflation-targeting) mandate”.
In an email, Valatsas said he told a couple of government ministers attending the conference they would “bitterly regret” this decision when the labour market cracks.
Valatsas correctly predicted the Monetary Policy Committee would keep rates steady at the February meeting. Like most, he expects cuts to begin in the second half of the year.
Fixing the current account deficit, which was 7.5% last year, should be a higher priority.
“Though the New Zealand fiscal balance sheet is exceptionally healthy, the country itself remains highly dependent on international financing,” he said.
“Policymakers instead seem to be adopting a wait-and-see approach, hoping that inbound international tourism and international students will recover”.
In lieu of a policy strategy, it would eventually be a weaker New Zealand dollar that would do the work of narrowing the deficit.
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