By Bernard Hickey
It's amazing what you can promise when you forecast strong growth.
If you went to your bank manager and promised your salary would increase 10% next year there's a good chance they would lend you more money. The bank manager would probably ask for proof, but a letter from employer would do the trick.
This is exactly what John Key and Bill English will do this Thursday when they release the 2011 budget. They will forecast strong economic (GDP) growth and explain to our ratings agencies and creditors that this growth means our debt to GDP ratio over the next couple of years will stay relatively low at below 30%, even though debt is growing at a record rate.
As long as the denominator (GDP) is growing almost as fast as the numerator (debt) then that ratio will stay under control. These growth forecasts will in effect be the letter from the employer to show bank manager's representative, which in our case is Standard and Poor's. New Zealand will probably avoid a downgrade in our credit rating because the budget's economic growth figures for the next three to four years will look extraordinarily strong.
They will argue the Christchurch earthquake rebuild and an historic boom in commodity prices will power GDP growth to over 4% over the next couple of years.
This all seems sensible until you look at the track record of these forecasts in the last three years since the global financial crisis. Every economic forecast by the Treasury under-estimated the impact of an epic change in the way New Zealanders think about debt and spending since the crisis. In May 2008 Treasury forecast growth rates for the next three years of 1.5%, 2.3% and 3.2%. Instead we got -1.1%, -0.4% and -0.1%.
The inaccuracy of these forecasts isn't just Treasury's doing. All the economic forecasters have missed out on a structural shift.
New Zealanders have stopped borrowing overseas to pump money through the housing market into consumer spending, which makes up almost 70% of the economy. It has been stalled for three years and there is no indication it is picking up quickly. New Zealand households have got the message, even if the government hasn't, that they can't live beyond their means.
Lending growth has stalled and the banks are increasingly desperate in their efforts to encourage households to borrow. This time it is different. An extremely influential book titled 'This time is different: Eight centuries of financial folly" written by US economists Kenneth Rogoff and Carmen Reinhart demonstrates that heavily indebted economies almost always grow much more slowly after a financial crisis and that this slowdown can last 7 to 10 years. A process of de-leveraging after a credit-fueled boom in asset prices drags down on economic growth, particularly when financial crises continue to reverberate through the system.
New Zealand is not unique in this, which helps explain why every economic forecast by Treasury since May 2008 has overestimated actual growth by between 2% to 3%. John Key and Bill English will argue that somehow growth in the next three years will be different. Rogoff and Reinhart's work indicates growth will continue to be at least 1-2% below 'normal' for another three to five years as we deleverage. We have a long way to go. Household debt to disposable income is still above 150% and will have to drop down to something closer to 100% before we return to 'normal'.
Meanwhile, our government keeps borrowing as if growth is continuing normally. Luckly for us our bank manager's representative, Standard and Poor's, will simply rely on these forecasts and not ask for a letter from our employer. The banks themselves, global credit markets, may not be so relaxed in years to come as growth continually disappoints.
That's why we should all take this Thursday's growth forecasts and John Key's smiling confidence with a grain of salt.
This time is different.
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