The current situation reinforces our story.  Remember, the world is in the midst of a financial and credit crises, and signs that the next year or so will see a sustained period of sub-potential economic performance by New Zealand.  Meanwhile, the Reserve Bank is stuck with its mandate that the primary target is inflation and, first and foremost, inflation risks are to be mitigated.  Thus, our monetary framework is rendered impotent in the face of potentially damaging shocks from abroad.

Consequently, ,monetary policy remained “on hold” over the past month and there was very little change on the markets, with 90-day and 10-year bond rates remaining at 8.9% and 6.4% respectively and the TWI also unchanged at 71.  Despite continued turbulence overseas, the RBNZ has adopted a relaxed approach and will probably hold its OCR at 8.25% at its next review on April 24.  In a speech on April 9, Dr Bollard showed little concern that the New Zealand economy was facing anything more than a cyclical downturn, and seemed to suggest that, if anything, the likely decline in growth would be healthy in helping to curb inflation.  He did call on banks and firms not “to hibernate” but to continue to lend and invest which suggests he believes it is enough simply to “pass the buck” to them.

Less sanguine views were being expressed abroad at the same time.  The Bank of England was reducing its benchmark rate from 5.25% to 5.00% with the Chancellor of the Exchequer calling for an internationally co-ordinated plan to handle the problem; the IMF was forecasting zero US growth this year together with a 25% chance of an eventual world recession; and world financial leaders at their G7 meeting had the financial crisis at the top of their agenda. 

It may be true that the NZ economy is better placed with favourable terms of trade from dairy and oil exports and low unemployment, but we are no different from the rest of the world in facing a similar degree of unwinding from eight years of excess liquidity.  This unwinding will proceed in a four stage process: firstly, an increasing number of over-priced assets decline in price and loan obligations fail to be met;  secondly lenders exposed to losses on associated loans that would not have been made in normal conditions tighten up on credit as they struggle to protect their balance sheets; thirdly the wealth effect impacts on the real economy via consumer demand; and fourthly, reduced demand and credit availability contracts the level of investment.  Left to itself, negative growth is likely by the end of this process.

This process is already working out to stage four in the US while the UK is at stage two.  Hence the US is probably experiencing negative growth and Britain is getting close.  New Zealand is at the beginning of stage two and, on current policy attitudes and settings, there is little reason to expect us not to follow the US all the way, albeit with the customary year or so lag.

The time for the RB to act is now with a reduction in the OCR.  And not a small reduction.  At the very least, New Zealand’s rate needs to decline to match the Australian 7.25%.   This would lead to a fall in the exchange rate and would give a fillip to our tradable sector which would counter the fall in consumer demand.  Unhappily, we doubt that the RB will respond as required.  As a result, the chances of New Zealand following the path towards negative growth increases by the day.