The following is a Special Topic in the latest (March 2020) Monthly Economic Indicator report from Treasury. The original is here.
With the onset of the global COVID-19 pandemic, the economic outlook has become increasingly uncertain. Despite the uncertainty, it is becoming more likely that New Zealand will see a deeper economic contraction in the June quarter than we have seen in our recorded history. Global spread of COVID-19 has already severely curtailed activity in New Zealand's services export sectors. The move to Alert Level 4 in New Zealand put most of the country in lockdown for a number of weeks. This will have an unprecedented impact on economic activity. Government support, including wage subsidies, increases in welfare benefits, business tax relief measures, the business finance guarantee scheme and industry support packages will cushion the impacts on households and businesses.
As restrictions are lifted, we expect economic activity in many sectors to bounce back quickly. Some though, including those exposed to international markets will take longer, possibly years, to recover. The recovery will also depend on the ability of the governments of our trading partners to limit the spread of the virus and restore the confidence in their economic outlook.
In this special topic we look at the possible impacts of COVID-19 on the New Zealand economy, describing the likely transmission channels and possible size of impacts we may see.
The situation is rapidly changing ...
The number of COVID-19 cases globally is rising exponentially. It took around three months to reach the first 100,000 confirmed cases; the next 100,000 took twelve days, and the next just three days. On 19 March, the cumulative number of deaths registered in Italy exceeded deaths in China as the epicentre of the virus shifted from Asia to Europe and the United States. As of writing, there were 1,346,566 cases worldwide, and 74,697 deaths. The number of confirmed and probable cases in New Zealand stands at 1160 as of 7 April (Figure 11).
Activity will be weaker …
The move to Alert Level 4 in New Zealand put most of the country in lockdown for a number of weeks. Given the spread of the virus and the accompanying social distancing measures taken to save lives, the resulting shutdown of New Zealand businesses will constrain economic activity in a way never seen before. This analysis provides a rough guide based on our current understanding of essential services and the nature of COVID-19 transmission.
Under the current classification of “essential services”, “accommodation and food services”, “trade” and “construction” components of GDP are likely to be particularly affected, while the public (education, health, and central government agencies) and primary sectors will be less impacted.
Forecasting sharp downturns
Another way to assess the possible impact of COVID-19 is to look back at past recessions as a guide. What we learn from reviewing past recessions is that economic downturns are inherently difficult to forecast as the typical economic relationships may not hold. This makes forecasting models less useful, and increases the reliance on professional judgement. We also see that in past recessions annual growth typically declines by less than 5% and activity recovers to post-recession levels within eight to twelve quarters (Figure 12). The measures to combat the spread of COVID-19 will curtail activity more acutely than we have seen in the past.
Transmission channels of COVID-19
The pandemic is creating a combination of supply and demand shocks to the economy, with complex interactions between the two.
Demand shocks arise from global and domestic travel restrictions and social distancing measures, resulting in lower tourism and non-essential consumption of both goods and services. Higher consumer and investor uncertainty and weaker export demand abroad lower aggregate demand further through lower investment and consumption.
Social distancing measures will have direct impacts on activity in the short run, but if successful in limiting the spread of the virus, will have benefits in the long run. The more stringent the “social distancing” measures, the greater the impacts will be in the short-run, but also the lower the infection and death rates, lowering the adverse long-run effects of the pandemic on New Zealand’s economic activity.
Weaker demand for New Zealand’s exports of goods and services
Recent data shows a sharp fall in tourist arrivals to New Zealand, while goods exports are expected to weaken in the face of falling international demand. Prices for many of the commodities New Zealand exports will also decline as demand weakens. It will take some time for this to turn around.
Lifting the border controls for tourists is unlikely to result in a quick resumption in arrivals as we may anticipate that travellers would be cautious about travelling abroad until the global pandemic has been controlled. The depreciation in the New Zealand dollar, as investors shift into safe haven commodities and currencies, will provide a partial offset.
Consumer confidence lowers private consumption
Discretionary spending, which includes non-essential purchases like restaurant meals, recreation and motor vehicles, is expected to fall sharply due to the ongoing measures to limit the spread of COVID-19. Discretionary spending makes up around 38% of private consumption (Figure 13). Nondiscretionary spending, which includes essential purchases like food and housing, makes up around 55% of private consumption and is forecast to remain fairly stable.
Much of the decline in activity due to COVID-19 is likely to come from weaker demand. And the supplyside of the economy, including the effective labour force, will also be adversely affected.
The reduction in demand will directly flow into the labour market, particularly due to the near-total shutdown of the tourism sector in the near term. A high share of employees in the tourism sector tend to work on casual and temporary contracts.
The closure of non-essential businesses will also have direct impacts, although the wage support measures that have been announced will lessen the effect of weaker demand on unemployment. Forced work closures, sicknesses, and caring for others will result in fewer hours worked. If the labour market outlook remains weak for a long period, job hunters will leave the job market as they believe their chances of being hired are low as more job seekers chase fewer jobs. This will lower the labour force participation rate.
Production in some sectors like agriculture and horticulture will continue, and won’t be as adversely affected by the downturn in demand. Agricultural sector jobs, including primary manufacturing are considered essential, and will endure.
As more long-term and permanent migrants arrive into New Zealand than leave, restricting people’s movement will result in lower net migration. Migrants are more attached to the labour market as they tend to be younger than the average Kiwi. A reduction in migration will therefore impact adversely on labour supply and lower demand, particularly in sectors like housing.
The policy response will mitigate the shock
The impact of the initial shock will be cushioned through monetary and fiscal policy, although this may have a limited impact on activity while social distancing measures remain in place. Supportive macroeconomic policy will play a significant role in influencing how the recovery period will play out.
Although interest rates are near zero, the Reserve Bank’s quantitative easing programme will provide support to the economy through lowering long-term interest rates.
The New Zealand government’s low net debt provides capacity to increase spending to mitigate the impacts of the pandemic on both the supply and demand sides of the New Zealand economy.
Highlighted in the recent fiscal stimulus packages are allocations of funding towards wage subsidies and provision of guarantees for working capital support. The measures are intended to decrease the likelihood of business failures, maintain household incomes and support attachment to the labour market. These are expected to lower the impact of the pandemic on business and consumer confidence and underpin a quicker recovery.
4. Hall, V. B. & McDermott J C. (2016), Recessions and recoveries in New Zealand’s post-Second World War business cycles. New Zealand Economic Papers, 50(3), 261-280.