Reserve Bank Governor Alan Bollard says one of the key lessons for the central bank from the spate of earthquakes in Canterbury over the past year is that earthquakes should not be thought of as a short sharp event, but rather as a rolling set of shocks with a long period of continuing after-shocks.
In a speech entitled Organisational Effectiveness in Times of Seismic Risk made at a conference held by the Rotary Club of Wellington and Victoria University today, Bollard said this long running period of after-shocks can cause ongoing damage to land and buildings, plus continued disruption, delay assessment, and slow reconstruction.
Part of the Reserve Bank's response to the quakes has been researching how other countries have responded to similar earthquakes, added Bollard. Here, it has seen that rapid recovery of communications infrastructure, speedy decisions on rebuilding, and availability of finance, has created rapid bounce-backs in industrial production, confidence and growth.
"Where the New Zealand situation looks most different is in the lingering seismic instability," he said.
"We have also learned that some earthquakes cannot be thought of as a short sharp event, but rather are a rolling set of shocks with a long period of continuing after-quakes. These can cause on-going damage, delay assessment, continue disruption, and slow reconstruction."
"The impact of ongoing seismic instability on insurance and construction can be very marked," said Bollard.
Cost hard to calculate
Bollard noted it had proved very difficult to calculate the cost of the damage from the quakes, which is likely to be more than NZ$20 billion, he said, with most of this involving damage to housing, plus commercial buildings and infrastructure.
"Of course estimates of damage, estimates of insurance claims, and estimates of reconstruction can all differ somewhat. Our working assumption is that there will be approximately NZ$20 billion of rebuild. This is equivalent to around 10 percent of GDP, which represents a very large shock in relative terms," said Bollard.
That said, there is "considerable uncertainty around these numbers" and revisions are likely to continue for some time.
"Indeed, we frequently note that our working assumption is to the nearest NZ$5 billion. It is also important to note that this assumption relates to the current replacement value of damaged assets. The nominal cost of rebuilding these assets could be larger as construction costs and prices for materials may well increase over the coming years, and as reconstruction incorporates quality improvements," said Bollard.
The Reserve Bank's immediate focus following the earthquakes was the soundness of the financial system, he added, including the maintenance of medium-term price stability. Central bank staff were also conscious the substantial reconstruction required in Canterbury would provide a large boost to economic growth over five years or longer, and during this period residential investment spending is likely to rise to a share of GDP similar to that seen during the mid-2000s construction boom.
"But in contrast to that earlier period, there will be a much higher concentration of work in one geographic area," Bollard said. "Combined with increases in business investment spending, this will boost medium-term activity and inflationary pressures for an extended period."
'Inappropriate for monetary policy to be stimulatory during the reconstruction period'
"It would therefore be inappropriate, all else equal, for monetary policy to be stimulatory during the reconstruction period," said Bollard. "This concern was balanced against the negative impact of the earthquakes on near-term activity. In the Canterbury region, activity certainly reduced. In addition, there were declines in nationwide consumer confidence, as well as investment and hiring intentions among businesses economy-wide."
He said it was difficult to know how large or long lasting such impacts would be and there was a risk of a marked deterioration in economy-wide activity. And although GDP growth was likely to be higher than it otherwise might've been during the reconstruction phase, the destructive effects of the earthquakes meant New Zealand would still be worse off.
"Given these risks, the Bank reduced the official cash rate by 50 basis points (to 2.5%) following the February earthquake. We described this as an insurance measure, one that aimed to avoid a significant and persistent deterioration in activity," Bollard said.
"We were conscious, however, that depending on wider economic conditions, this insurance would need to be removed as rebuilding, and a recovery in activity more generally, drew the economy's resources into production."
"Since that time however, monetary policy has had to account for a number of significant developments. These include the continuing sovereign debt concerns in Europe and related developments in financial markets. Business confidence appears to have now recovered well nationwide, and to a large extent also in New Zealand. We believe the cuts in the Official Cash Rate assisted this."
Following the September and February quakes the Reserve Bank eyed a number of concerns related to protecting the soundness of the financial system, Bollard said. Here, three distinct phases in economic activity were considered, being disruption, stabilisation and reconstruction.
'NZ$150 mln of extra cash sent to Christchurch in week after February earthquake'
Meanwhile, the central bank's immediate tasks included the supply of additional cash to keep payment systems working, and to ensure banks and insurance companies were able to continue operations.
"Only two hours after the February earthquake the Reserve Bank started receiving orders from banks for more cash for delivery to Christchurch. Ensuring cash was available required us to work closely with banks and Cash in Transit companies to meet the spike in demand," said Bollard. "This task was complicated by damage to roads that meant travel, where possible in Christchurch, was taking about three times as long as normal. The public also needed information about where cash was available."
"To ensure this, Bank staff used Google maps to provide a live feed of operational and accessible ATMs. Overall about NZ$150 million of extra cash was sent to Christchurch in the week of the earthquake, representing about NZ$350 per resident. There was a big drop in electronic payments and increased demand for cash, initially in the form of NZ$20 and NZ$50 notes through the surviving ATM machines."
Nonetheless, the banking industry hasn't been subject to significant financial risks from the earthquakes, Bollard added, with losses on residential mortgages expected to be relatively light due to insurance coverage and the Government's earthquake recovery packages. On top of this, many smaller commercial businesses weren't based in areas where major damage occurred.
"Bank provisioning for credit losses totalled nearly NZ$100 million. Nevertheless, there remains a great deal of uncertainty in quantifying the effects of the earthquakes."
Learning continues ahead of 'NZ's largest ever construction project'
Meanwhile, given uncertainty about the state of the economy after the earthquakes has been very high, the Reserve Bank has been "engaged in a process of ongoing learning" about the state of the economy, with this feeding into its policy deliberations.
"This process will continue for an extended period, even as the economy continues to recover, although our focus will gradually shift."
Although the quakes resulted in severe disruptions to short-term economic activity, and a loss in balance sheet values, the rebuild will create significant stimulus in the medium-term. Sectors most affected most by the quakes have been tourism, education and central business district retailing, said Bollard.
In contrast some of the significant contributors to Canterbury's economy, notably agriculture, manufacturing and professional services, were remarkably resilient after the first few weeks.
"Construction and related services have been through a frustrating period of disruption and prolonged wait. But next year they will enter an era of huge expansion, New Zealand's largest ever construction project, big enough to drive the nation's growth by an extra 1 to 2 percent, but with the potential to also cause bottlenecks, skill shortages, cost increases and planning problems," Bollard said.
"Already there has been some population loss to the region, but next year this may turn around."
But although disaster preparedness is necessary and desirable, Bollard noted it's not costless.
"Increases in safety standards (such as seismic strengthening) can result in significant costs for an economy that linger long after the risks they aim to address have occurred. They can also create a complicated regulatory environment that may result in significant impediments for activity."