Matt Nolan

Three open economies walk into a bar …

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There has been an interesting discussion comparing the recession in three open economies, Australia, Canada, and New Zealand.  It started with the Canadians, but a couple of New Zealanders then became involved.

The facts are that:

  1. Headline inflation in all three countries is currently close to target (implying that we all made our inflation targets),
  2. New Zealand experienced the largest declines in GDP – Australia the lowest,
  3. The relative price of NZ housing declined, it was stable in Canada, it rose in Australia (all three countries were seen as “over-valued”)
  4. Canada hit the “zero bound” on monetary policy, and it didn’t seem to matter.  New Zealand had room to move, but we stopped and got beaten around the head.

This list of facts suggests one of two things to me:

  1. Demand management in NZ was poorer then in other countries
  2. NZ faced a larger supply shock.

Now, I’m willing to rule out the first one – as we did keep inflation near the target band, and to be honest inflation expectations have held up a little too well …

So this implies that NZ had a larger supply shock.  Here are some reasons I think was the case:

  1. New Zealand’s recession started with a drought, and the required restocking of agricultural breeding stock following the drought.  This was a pain.
  2. New Zealand’s national net debt position is worse than the other two countries (Note:  In NZ when I say national debt I mean private debt + public debt).  With a lot of our debt on a relatively short maturity this was problematic for a few quarters there.
  3. On that note NZ’s financial sector was more strongly hit than the other regions.  It started back in 2005/06 with the “finance company collapse” and got heavy just before our drought induced, striking in late-2007 (here and here).
  4. Terms of trade:  New Zealand’s terms of trade fell to its lowest level since 2004, Australia’s fell to its 2007 levels.  I do not know about Canada – however, the decline in our terms of trade can be seen as a massive supply side shock.
  5. Trade exposure:  Here I am conjecturing, as I am tight for time, but it is possible that NZ could be more trade exposed then the other countries.  If NZ is, it would only be a minor matter anyway I suspect.

Now while these factors explain why NZ declined more sharply than other countries, I don’t think they explain why we are still lagging behind.  Our TOT is recovering fast – it will be back at its peaks mid year.  The drought is over and restocking has been completed.  And our debt position is less of a hazard than it was 12 months ago.  Interesting.

If NZ doesn’t recover to trend (which is very much the consensus forecast out here), it is because New Zealand faced a permanent supply side shock BEFORE the global crisis – we were struggling before things hit the fan overseas, with only a strong lift in the TOT saying us.  When that flooded out at the closing stages of 2008 New Zealand dropped like a stone.

So for Australians and Canadians looking for a point of comparison with New Zealand, just remember that NZ faced a few other issues 😉