Monetary and financial issues

Economic Survey of New Zealand 2009: Macroeconomic adjustments in the current crisis


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The following OECD assessment and recommendations summarise chapter 1 of the Economic Survey of New Zealand published on 16 April 2009.




Global shocks have hit New Zealand’s economy hard

Like its OECD counterparts, New Zealand’s economy has been badly affected by the international economic crisis, but it also suffers from long standing domestic imbalances that were accentuated by the earlier period of excessive global liquidity and low risk aversion. In the early stages of the crisis, New Zealand seemed well positioned to escape its worst effects. Its banks had almost no exposure to sub prime mortgages or other “toxic assets”. When the recession began in early 2008 it could be attributed to domestic monetary tightening, the early stages of an overdue housing market correction and temporary drought conditions. As international turmoil intensified, however, it became clear that New Zealand would not escape a deeper recession, and in early 2009 macroeconomic indicators deteriorated significantly. New Zealanders had in fact been caught in much the same spiral of global excess liquidity, surging leverage, soaring asset prices and under valuation of risks by lenders and borrowers that had taken hold globally. Households’ indebtedness reached 160% of disposable income – and, in aggregate they cut their saving, possibly in the mistaken expectation that ever appreciating house prices would fulfil their future savings needs, notably for retirement. As already meagre personal saving fell further, and business borrowing increased strongly, even healthy corporate profits and steady government surpluses were insufficient to finance booming private consumption and housing investment. Hence, much of the financing came from abroad. The results were excess demand pressures, a widening in already unsustainable current account deficits and rising net foreign indebtedness (93% of GDP at end 2008).

The crisis has magnified the risks surrounding the high current account deficit

As a commodity exporter, New Zealand had enjoyed record gains in the terms of trade, especially late in the cycle, and these gains further nourished its asset income spending spiral. The inevitable bursting of the commodity price bubble helped reverse this cycle. In addition, the global recession is shrinking exports – although less so than for many countries – intensifying the domestic downturn and reducing the economy’s capacity to service its external debt (mostly denominated in NZ dollars). The largely foreign owned banks remain well capitalised, although they are heavily reliant on short term foreign wholesale funding. Heightened risk aversion and a global reduction in liquidity has led to a concern that banks may not be able to refinance foreign funding lines as they fall due. This underscores the country’s vulnerability due to its large current account deficit and high accumulated stock of foreign debt. Stabilising this debt in relation to GDP would require halving the current account deficit to 4 5% of GDP. Reducing it to a level that would lessen macroeconomic vulnerability would almost certainly require a larger adjustment.

A deleveraging process is reducing demand

The global crisis is contributing to a needed deleveraging by households and firms. Demand for credit has dropped away very sharply, and lending terms have tightened somewhat. Overall bank credit is now shrinking, and falling house prices are impairing households’ net worth. Steep declines in global commodity prices, potentially amplified by a revival of export subsidies in other countries, are hurting farm incomes and reducing the overvaluation of farm properties. Unlike most previous recessions, which tended to start in the business sector, this one is dominated by a drop in household demand. Balance sheet adjustments imply reduced consumption for as long as it takes to unwind excessive leverage. A second stage of the cycle is now beginning, reinforced by the downturn in global trade. Lower corporate profitability, increased uncertainty about the business environment and financing difficulties are leading to declining business investment and hours worked. Weakness in labour market outcomes and in household incomes could further aggravate the housing correction, intensify the drop in consumption and put further pressure on businesses.


Household debt and saving

Per cent of disposable income

Source: Reserve Bank of New Zealand and OECD.


Monetary policy is the first line of defence

Policy makers have moved aggressively to support demand and put a floor under a potentially vicious downward spiral. In this they have been helped by greater room for manoeuvre than in most other OECD countries, the result of relatively conservative monetary policy during the last phases of the boom and a very low level of gross public debt. The Reserve Bank has lowered its policy interest rate by 5.25 percentage points since July 2008, to 3% currently, and has facilitated access to bank liquidity through a series of other measures. New Zealand displays a structurally higher neutral rate of interest than most other developed OECD members, a reflection of its structural imbalances and comparatively high inflation expectations. The Reserve Bank still has room to go further in responding to deteriorating economic conditions. Despite widening credit risk spreads, borrowing costs for households and businesses are falling relatively sharply, and the currency has depreciated significantly, which will be critical for external adjustment. Falling core inflation and easing inflation expectations further increases monetary policy leeway. This should help set the stage for an eventual recovery.

Further fiscal stimulus should be avoided

Fiscal measures can increase employment and demand fairly quickly by way of infrastructure projects and the like, provided they can be implemented in a timely fashion. Tax cuts are less potent as demand boosters but could bolster confidence and assist balance sheet adjustments. Already, recent and planned tax cuts and accelerated infrastructure spending will provide a fiscal expansion equal to approximately 5% of GDP over the two financial years ending June 2010. The government has also helped shore up confidence in the banking sector by introducing an optional retail deposit guarantee, providing explicit depositor protection for the first time in New Zealand’s history. To help secure access to term funding the government also offered temporary opt in insurance for wholesale bank funding. Such policy support will attenuate the downturn, but substantial downside risks remain. The banking system’s ability to secure foreign funding is currently reliant on the government’s wholesale guarantee. The effectiveness of this guarantee depends on the perceived creditworthiness of the government as guarantor. Heightened risk around the sovereign credit rating due to a projected sharp rise in indebtedness implies that, despite the public sector’s net financial asset position and a still moderate budget deficit this year, there is little room for further fiscal expansion. If, however, any measures were to be undertaken, they should be carefully designed to provide timely support, while being easily reversible, with a path back to a fiscally sustainable position clearly laid out. In assessing the scope for any further policy stimulus, either fiscal or monetary, the authorities will need to be conscious of the risks of triggering a disorderly or severe exchange rate adjustment.


Central government gross debt projections present a risk to New Zealand’s country rating

Per cent of GDP

Source: The Treasury, Economic and Fiscal Forecasts December 2008 and Fiscal time series.


Policy makers should be beginning to devise exit strategies

With the world’s central banks pumping vast amounts of liquidity into money markets and many Treasuries flooding the international bond markets with new issues of sovereign debt, policy makers everywhere, including in New Zealand, need to begin to plan for a withdrawal of stimulus and other extraordinary measures when the recovery takes hold. While the financial shock is likely to shrink global potential GDP growth, at least for a time, a significant output gap is likely to open up. As it begins to close, the overall degree of stimulus will have to be reined in. Fiscal consolidation is likely to have to start first in light of the outlook for public finances. Although the OECD’s projected low of 2% for the official cash rate would be exceedingly expansionary in normal times, it will be important to ensure that the eventual recovery is firmly established before material amounts of monetary stimulus are withdrawn. The twin challenges will be to avoid moving too soon and stalling the recovery as against keeping the policy stance too loose for too long, leading to a strong pickup in inflation. Furthermore, once the financial crisis has passed, the wholesale and retail deposit guarantees should be removed. Consideration should then be given to implementing a well-structured, self financing retail deposit insurance scheme that minimises moral hazard.

Fiscal policy expansion in the short term needs to be embedded in a consolidation plan for the medium term

The recession, combined with current policy settings, ends 14 years of continuous surpluses. In December 2008 the Treasury projected, based on unchanged policies, a period of structural deficits, with gross debt rising to 57% of GDP by 2023. The new government has stated that such debt levels would be imprudent. As a first step it committed to reviewing the efficiency of all public outlays, eliminating unnecessary expenditures and cancelling any unfunded spending commitments of the previous government. A more substantive response will need to be set out in its first budget in May. This will be particularly challenging, given the deterioration in the economic outlook in the intervening months. It is nevertheless vital to present a credible medium term programme that will re establish a structural surplus. Either this surplus would need to be sufficiently large to ensure significant net public sector assets before demographic pressures intensify or else the government would need to begin to scale back future health and pension spending. Central government spending caps have been shown to be a particularly successful means of fiscal consolidation in OECD countries that have adopted them, and should therefore be considered by New Zealand. Adjusting the revenue baseline for terms of trade cycles would likewise help to prevent temporary revenue increases from translating into permanent spending obligations.

How to obtain this publication


The complete edition of the Economic survey of New Zealand is available from:

The Policy Brief (pdf format) can be downloaded in English. It contains the OECD assessment and recommendations.


Additional information

For further information please contact the New Zealand Desk at the OECD Economics Department at

The OECD Secretariat's report was prepared by Alexandra Bibbee and Yvan Guillemette under the supervision of Peter Jarrett. Research assistance was provided by Françoise Correia.




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