Myth #1 – the $50bn recession

To put the recession into context, we now expect the New Zealand economy to permanently lose about $50 billion of output over the three years to 2012, compared with what would have happened without the recession.

Nominal GDP in 2008 totalled $179.8bn. Assume a potential real GDP growth rate of three percent per annum and inflation at two percent per annum. This would have resulted in GDP in the following three years of $188.9bn, $198.5bn and $208.5bn. But latest Consensus Forecasts for New Zealand for 2009 and 2010 expect real growth of -1.7 percent and +2.0 percent, with inflation also expected at two percent per annum. And conservatively adding another two percent real growth for 2011 yields a three-year track of nominal GDP of $180.3bn, $187.6bn and $195.2bn.

Quick subtraction suggests the recession causes a loss in nominal GDP totalling $32.9bn over the three years.

Incorporating a much gloomier forecast for real growth of -1.7 percent, 0 percent and 1 percent and lower inflation of 1.7 percent per annum, pushes the recession cost to $45.5bn.

But, don’t forget these calculations depend on the rather tenuous assumption that without the recession the economy would have immediately recovered from the anaemic 0.3 percent growth in 2008 to its growth potential of 3 percent per annum in 2009, 2010 and 2011. A rather more defensible assumption for the non-recession growth path of the economy would lead to a much smaller ‘hole’ caused by the recession.

Yes, the recession is bad. But we really can’t understand why some are proclaiming that the recession is worse than it actually appears.

Myth #2 – the growing size of government

The expansion of the number of bureaucrats in Wellington has resulted in a disproportionate growth in the size of government.

This chart is derived from the OECD database. In 2007 government consumption spending (i.e. the Government’s claim on the productive resources of the country) was 18.8 percent of total GDP, compared to Australia’s 17.7 percent, Canada’s 19.3 percent, the United States’ 16.1 percent, the Euro area’s 20.0 percent and the United Kingdom’s 21.2 percent. Furthermore, the average for the 30 years to 2007 was 18.5 percent.

But, let’s not spoil a good story with numbers based on fact.

Myth #3 – the invaluable stabilisation role of the floating exchange rate

The floating exchange rate is an invaluable automatic stabiliser for the New Zealand economy. It helps the economy slow down when positive external shocks means we might grows too fast and, gives economic activity a boost when faced with negative external shocks.

The problem with this version of the mechanism is that it places the burden of most of the adjustment due to shocks onto the export sector. That is, when global demand for our goods and services is buoyant, the export sector is stifled by a rising exchange rate.

Meanwhile, the domestic consumer enjoys cheaper imports (one of the fruits of a rising exchange rate), despite the brakes going on export earnings. In contrast, when global demand is subdued, the export sector is expected to rise up off its knees and lead a recovery with the help of a falling exchange rate.

Perhaps it might be better for the domestic sector to shoulder the adjustment burden, and leave the export sector to earn New Zealand Inc. an income. Just a thought.

Myth #4 –the New Zealand economy is well-placed to withstand the impact of the global slowdown

At $168bn and growing, New Zealand’s net debt stands at 93 percent of our annual GDP income.

Earlier advice had been that this debt should not concern us.

Firstly, because it was predominantly private debt and so was the result of the rational decisions of individuals who were fully entitled to make their own mistakes.

Secondly, the rest of the world was clearly willing to lend to us.

Further, the rest of the world was unlikely to say no to good old, respectable and stable New Zealand, given that we were so eagerly at the forefront of the OECD in adopting the correct policies.

Of course, now the rest of the world is not so keen to lend to anybody, let alone little old New Zealand.

And then there is the fact that New Zealand went into a recession in early 2008 as a result of four years of monetary policy tightening to rein in a house-price-fuelled spending splurge. Of course, our timing was impeccable as we succeeded in being in a recession just as the world’s financial systems imploded.

Sound well-placed to you?

 - reprinted from BERL Monthly Monitor, May 2009