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The following OECD assessment and recommendations summarise Chapter 1 of the Economic survey of New Zealand, published on 23 April 2007.
Macroeconomic imbalances are weighing on economic prospects
The New Zealand economy decelerated during 2005, after six years of strong economic growth of around 4% on average per year, and remained sluggish in 2006. But there is, as yet, little sign of spare capacity, and the labour market has so far been resilient. Nevertheless, a series of inter-related imbalances have accumulated in the economy and have started to unwind only very slowly. Strong household income growth and ongoing immigration flows have stimulated house sales and put upward pressure on real estate prices. Banks have met the resulting increases in demand for mortgage finance by borrowing offshore, a process that has been facilitated by ample global liquidity and low risk aversion. While the government has a high saving rate, the household saving rate is significantly negative and household debt has climbed sharply to around 160% of disposable income, a ratio that is higher than in most other OECD countries. The net result is a current account deficit that stood at 9% of GDP at the end of 2006. Despite headline inflation falling sharply with the drop in the oil price, the maintenance of fairly strong domestic demand has limited progress in curbing underlying price pressures.
The path to restoring internal and external balance is uncertain
It is still unclear whether the economy has reached the bottom of the cycle, and the mechanisms for moving back to a more sustainable growth path and their timing are uncertain. The present restrictive stance of monetary policy will eventually rein in household spending and lead to more stable house prices, while the high exchange rate has already put a considerable squeeze on exporters’ profits. Ongoing losses of export incomes would reduce domestic demand. A period of slow growth will be needed before inflation pressures dissipate and the Reserve Bank can cut interest rates, allowing the exchange rate to depreciate. Alternatively, a sharp reduction in foreign investors’ confidence and a fall in demand for NZ dollar-denominated assets could lead to an abrupt depreciation in the exchange rate that would chill domestic demand and improve the external balance. But the cold shower could generate financial hardships for some households.
The effectiveness of short-term stabilisation policy has been questioned
The task of monetary policy is particularly complex given the current uncertainties, and the Reserve Bank has been justifiably concerned by the persistence of inflation near the top of its target range. Moreover, sustained upward pressure on the exchange rate resulting from tight domestic monetary policy led to consideration of additional tools to manage inflation, with attention focused on the housing market given the role of house prices in this cycle. Various supplementary measures were examined. These included discretionary instruments such as a mortgage interest levy. But the case for instruments of this type is not compelling, as they are difficult to develop and enforce, and could blur the responsibilities of the fiscal and monetary authorities. Other measures included regulatory procedures affecting housing supply, the tax treatment of residential property and capital requirements on banks’ residential mortgage lending. Notwithstanding the possible support that such policy changes could contribute, conventional stabilisation instruments should remain the primary way to manage macroeconomic fluctuations. At this point, fiscal policy also has an important role to play. Tax cuts or spending increases beyond current plans could further exacerbate inflationary strains, thereby leading to higher interest and exchange rates than otherwise. Indeed, delaying the planned fiscal impulse for the next two years would reduce the strength of domestic demand and inflationary pressures and allow a lower interest-rate path than currently envisaged. This would facilitate a fall in the exchange rate and accelerate the external rebalancing process. Such restraint may be politically difficult, given the sizable budget surplus, but it could allow a smoother unwinding of the imbalances and avoid more painful adjustments in the future. In any case, any positive revenue surprises over the near term should not be used in a way that adds to domestic demand pressures. Furthermore, the stabilisation task, and policy advice more generally, could also be made easier at minimal budgetary cost by the availability of better official statistics.
There has been little progress towards the goal of lifting living standards to the OECD median
Despite strong growth performance since the early 1990s and the adoption over the past 20 years of structural policies that are, for the most part, consistent with OECD best practices, living standards have remained some 16% below the OECD median for some years. Labour utilisation has increased substantially, but total economy hourly productivity growth has been lacklustre. Several reasons can be offered that might explain this outcome. First, common to many countries, productivity measurement issues are important. Productivity growth has been stronger in the “measured” sector (where independent measures of both inputs and outputs exist) than in the total economy and has been comparable to that of Australia. Second, the large increase in labour absorption that New Zealand has achieved over the past decade partly in response to relative prices of labour and capital – may have come at the cost of a temporary decline in productivity growth as less productive workers were absorbed into the labour force.
Large exchange rate swings and systematically higher interest rates may have played a role.
While structural policy influences on productivity growth have been studied in depth, including in previous Surveys, it is still not well understood why the gap in living standards has persisted. This Survey examines whether two “stylised facts” about the New Zealand economy have played a role in holding back growth in per-capita GDP. First, the economy is subject to large medium-term swings in both nominal and real exchange rates. World prices for New Zealand’s export commodities play a role in explaining these movements, which provide some income-smoothing benefit for commodity producers. But on the other hand, such swings may deter investment in the export and import competing sectors and reduce incentives for small firms to grow or to remain in New Zealand. Second, New Zealanders have had to pay systematically higher bond and mortgage interest rates than those in other OECD countries, increasing the cost of capital and curbing investment at the margin. Further investigation of these features and their relationship to productivity growth is warranted. If there were structural policy measures that could attenuate these aspects of the economic landscape without creating other distortions, they might help the economy reach a higher growth path, but such options are not obvious.
The main challenge is to enhance longer-run living standards
Looking forward, the key challenges are to raise national incomes and to meet the fiscal pressures that are likely to arise over the longer term from an ageing population. The share of GDP devoted to health and pension spending could more than double by 2050 according to Treasury projections. Faster productivity growth is one important element in generating higher incomes and will become increasingly important as the room to further raise labour utilisation is limited. This Survey focuses on the following important issues:
Pursuing a consistent set of public pension and other retirement savings policies;
Facilitating the deepening of financial markets; and
Developing a long-term tax strategy that best meets the future challenges facing the economy.
Per cent of GDP, year to June
Source: Treasury (2006), Half Year Economic and Fiscal Update.
GDP and net national income per capita
USD current prices and current PPPs, 2005
Source: OECD, Annual National Account Database,
How to obtain this publication
The Policy Brief (pdf format) can be downloaded. It contains the OECD assessment and recommendations but not all of the charts included on the above pages.
The complete edition of the Economic survey of New Zealand 2007 is available from:
For further information please contact the New Zealand Desk at the OECD Economics Department at email@example.com. The OECD Secretariat's report was prepared by Deborah Roseveare, Annabelle Mourougane and Shuji Kobayakawa under the supervision of Peter Jarrett.