New Zealand. Economic and political structure in brief

Palley gives the reason why the curve is backward bending. It is because workers in high unemployment industries may agree to a small real wage reduction (for example, by having the same nominal wage for another year or two) at low rates of inflation. However, at higher rates of inflation reduction in real wage is unacceptable, therefore the curve bends backwards.

In Palley’s opinion, at low rates inflation is not a concern, and instead the unemployment is the real concern. Therefore, it is important that inflation targeting should be formalized in such a way, that the central bank has a responsibility for real economic performance22.

4. My own view is that this is a very bold and radical proposition, which the central banks will not like. However, this debate is far from over and ongoing. 
   Analysis and Interpretation of Data

 

This section of the paper will examine historic data of some of the key macroeconomic indicators, as they relate to the New Zealand economy, and are kept and utilized by Reserve Bank of New Zealand. RBNZ in each of its periodic Monetary Policy Statements holds the relevant data close to users’ hands, and has a download section with relevant material in the form of spreadsheets together with the Policy Statements themselves. As a rule, such spreadsheet material comprises the following data collected by the Government agency, Statistics New Zealand:

1. CPI, or Consumer Price Index – as the best indicator of the inflation rate. The data is given for the end of each calendar quarter. The example is illustrated below in Graph 1.

 

Graph №1 – Consumer Price Index23 (Graphical presentation and compilation by Nikita Stopnikov)

 

The CPI data is presented on the quarterly basis. As one can see on the graph, the Consumer Price Index was extremely high during the World Crisis of 2008 and then again for much of 2011. Although it has to be said, that these peaks in inflation (both times just above 5%) were nowhere near those peaks experienced by the developed economies in the 1970s during the oil price shock. The first peak of inflation in 2008 was again caused by the worldwide rise in price of commodities, it is then that the oil price exceeded $140 per barrel. Because New Zealand depends on imports for many of its resources, this rise in commodity prices was quick to illustrate itself in the increased CPI figure24. A typical monetary policy response would have been to increase interest rates to fight inflation, all other things being equal. However, because the GDP trend was then clearly on the way down, the Bank took the opposite step and reduced the OCR for the second time from 8.0% p.a., this time by the full 50 basis points, to 7.50% p.a. in its September 2008 Monetary Policy Review.

The second increase inflation in 2011 is again characteristic, because it was the result of the contractionary fiscal policy, and had nothing to do with the monetary policy. Contractionary fiscal policy in most cases means an increase in some taxes in the economy. For New Zealand at the time it was the increase in indirect taxation, i.e. taxes on consumer spending. The Goods and Services Tax was increased in October 2010 from 12.5% to 15.0% on most goods and services25. This would imply an increase of 2.2% (115.0/112.5 - 1)*100% in the prices straight away, as a unit of goods or services previously costing NZ$112.50 would cost NZ$115.00 on the next day. When the standard rate of indirect taxes goes up, immediately this is reflected in the retail prices, which are an important component of the CPI calculation, so the CPI goes up as well. Of course, these increases may take some time to work through the system and consumers often cut back their purchases or look for bargains. However, in the case of New Zealand we see almost an immediate effect – prices started to go up much faster in 4th quarter of 2010. Increases in indirect taxes are often seen as drastic measures, designed to correct serious imbalances. A similar example at the time was the increase of the VAT rate in Great Britain from 17.5% to 20.0%. Opposite cases do happen, but less frequently, such as in Russia with the abolition of the sales tax in the mid-2000s. Then, the sales tax with the maximum rate of 5% was taken out of the system totally, helping contain the retail price inflation in the 2000s.

To get back to New Zealand, we do not see any action by the Reserve Bank of New Zealand on such high inflation figures, precisely because this increase in prices was the result of only one factor - the fiscal policy26. The OCR, which was then 3% p.a., did not move until the February 2011 earthquake in Christchurch, when it was reduced to 2.5% p.a.

Currently the CPI stands at 1.6% (see Graph 1) – the comfortable level for the Bank. It is between 1% and 3% and close to the 2% midpoint.

 

2. Real GDP growth – as the measure of the overall progress of the national economy. It is notable that the GDP data (at quarterly intervals) is given not just for the country itself, but also for its main trading partners, namely Australia, the USA, Japan and the United Kingdom. Graphs 2 and 3 below provide the illustration for New Zealand alone, and also in comparison with the two closer neighbours from Asia Pacific – Australia and Japan.

The dip in the GDP dynamics is explained by the Global Financial Crisis of 2008-2009. During this period, GDP was moving in the negative territory, with the trough at -2.2% for two consecutive quarters. Compared with the main trading partners, New Zealand did quite well because the period of recession was not as long and the fall not as deep as in Japan, or the UK. It was only outplayed by Australia, which did not experience fall in GDP at all.

The Reserve Bank response to the crisis had been standard and decisive – it had reduced the OCR by 50 basis points in September 2008, then by a full 1% point in October 2008, and then two times by 150 basis points each in December 2008 and January 2009. The Bank did not stop at that and continued with two further cuts of 50 basis points each in March and April 2009, bringing down the OCR to the historic low of 2.5% p.a., where it stands today. The Bank’s efforts appeared to have paid off, and GDP growth returned to positive in the second quarter of 2009, as can be seen on the graph.

It must be noted here, that the Reserve Bank of New Zealand did not break world records in its policy rate decisions. During the World Financial Crisis, the developed nations’ Central Banks had to resort to drastic and unconventional measures. For instance, the Federal Reserve in the US had lowered the target rate to zero or close to zero. The European Central Bank recently set the policy interest rate for the Eurozone at 0.25% p.a. and only days ago said that negative nominal rates are possible. We can conclude from this, that the Reserve Bank of New Zealand chose to leave some room for itself in case the situation got worse, and that the depth of the crisis was not as severe as in some other countries.

 

 

Graph №2 – New Zealand GDP growth27 (Graphical presentation and compilation by Nikita Stopnikov)

 

 

Graph №328 (Graphical presentation and compilation by Nikita Stopnikov)

 

3. Mortgage interest rates (floating and fixed). These are the rates that households pay on their perhaps single biggest investment in their lifetime – their residence.

Graph 4 below shows us the mortgage interest rates in New Zealand. The dotted blue line is floating rate, the solid red line is 2-year fixed rate. Simple logic tells us that when interest rates start to fall, floating rates are better. However, if it becomes clear that interest rates will be going up in the medium term, the households are better off with the fixed rate mortgages, and have certainty at least for the 2 years. In New Zealand the majority of mortgages are fixed-rate mortgages.

Graph №4 – New Zealand mortgage interest rates29 (Graphical presentation and compilation by Nikita Stopnikov)

 

The differences, between the floating and the fixed rates are twofold:

• The floating rate is more volatile because it reflects all movements in the money market.
• The fixed rate tends to lag a little bit in its movements compared to the floating rate.

However, it is obvious that in all periods, both the floating and the fixed rate on mortgages closely follow the main OCR rate. Also, the mortgage rates are second closest to the main policy rates, after the interbank lending rates. The main reason is that these mortgage loans are secured on property, and the risk of default is greatly reduced. The OCR rates can be observed in Graph 11.

 

4. Housing data. Because the house price index is included in the overall CPI and is one of its major components, the Reserve Bank of New Zealand pays particular attention to the developments in the housing market.

 

Graph №530 – New Zealand housing data (Graphical presentation and compilation by Nikita Stopnikov)

 

In this section, two sets of data are given – the total value of housing, in NZD billions, and the annual rate of change of house prices at quarter ends.

The following must be pointed out in connection with observation of this data:

• The housing price index entered the negative territory in the 2nd quarter of 2008. This was when the World Financial Crisis was fully developed. As a reminder, the crisis was caused by mortgage lending practices in the USA, and quickly covered many other countries with house price bubbles, such as Spain, Ireland, and the UK.
• It should also be noted, that in the five preceding years before the first index reduction, the housing stock value more than doubled from 298 to 616 billion NZD (see Q1 2003 and Q3 2008 points on the graph, respectively). Naturally, this cannot be just the reflection of the new construction (too fast), and is obviously the result of price acceleration.
• To prove the point above, in the six years after the housing stock value peaked in Q1 of 2008, the total value has only increased by 15% from 616 to 708 billion NZD at present (see Q1 2014 data on the graph).

 

 

5. Household debt – as a measure of the financial strain, which is carried by the ordinary people.

Graph №631 - New Zealand Household debt

Household debt is given as a percentage of annual disposable household income (called nominal disposable income, or NDI, in RBNZ terminology), which is a useful measure in cross-country comparisons. In addition, average interest rate for the household debt is given. This average takes into account all known debts, including credit card debts, car loans and mortgage loans. The third indicator is the proportion of household nominal disposable income spent on debt service (principal and interest).

It can be seen that the ratio of debt to annual NDI has been steadily on the increase between the end of 2003 and the end of 2009 (from 124% to 153%, see graph). This situation is typical of the households of many economies. This was the result of the easy credit policies by the banks, which encouraged borrowing against rising asset prices (including property prices). The rising property prices made people feel richer, and able to afford bigger loans. After the rates went back up, many borrowers found themselves unable to pay their mortgage debts, and started the process of deleveraging – cutting back on spending and sharply increasing savings, which perhaps was good for each individual household, but, as we know from theory, bad for the overall economy. The process of deleveraging is clearly visible from start of 2010 and until the first quarter of 2012 (from the graph, the ratio fell from 153% to 142%), i.e. it lasted for more than two years, and after that households started accumulating more debt again.

The interest rate and the proportion of NDI spent on debt servicing peaked at the same time as the overall household debt levels (at 9.5% and 14.4% respectively). However, after the 3rd quarter of 2008 both ratios began a steady decline, and were 5.6 and 3.4 percentage points, respectively, below their peaks (at 8.8% and 6.1% respectively at Q3 2013). This reflects a significant easing of the interest rates from the start of the financial crisis. The debt service ratio continued to decline even as the overall debt levels went back up (to 148% of NDI), because the interest rates became much lower.

 

6. Current account status – a deficit or a surplus as a percentage of GDP. These figures are given for complete financial years, and measure whether a country is a net borrower or a net lender to the rest of the world. New Zealand current account has been in persistent deficit for the last forty years, so the country has been the net borrower.

Graph №7 32 NEW ZEALAND CURRENT ACCOUNT POSITION (Graphical presentation and compilation by Nikita Stopnikov)

 

7. 90-day lending rates – these are a useful indicator of the lending risks perceived by the market.

Graph №8 90-day lending rates33 (Graphical presentation and compilation by Nikita Stopnikov)

The 90-day rates are closely tracking the OCR with minimum variations, which can be seen on the graph below. They never deviated from the OCR by more than 0.8 percentage points (from the graph – around April-May 2008), which is a very narrow spread.

 

8. Exchange rates – as an indicator of the foreign trade environment and the relative perception of the strength of the New Zealand economy. Two rates are given – the New Zealand dollar versus the US dollar, and a trade-weighted index (TWI) of the New Zealand currency against the basket of currencies of its main trade partners. I will only present the USD/NZD exchange rate history, for ease of visualization. Naturally, the exchange rate is influenced in part by the level of the interest rates in the economy – when interest rates in New Zealand rise, this increases demand for assets denominated in New Zealand dollars and the currency value goes up. The opposite is usually also true – when the interest rates are reduced, the currency becomes less attractive and often depreciates.

 

Graph №9 – New Zealand Dollar rate to the US Dollar34 (Graphical presentation by Nikita Stopnikov)

 

The horizontal axis of the graph displays the points in time (with four-monthly intervals). The dates begin with the time point ten years ago, December 2003, and cover the period until now. The vertical axis of the graph shows actual monthly average rates of the New Zealand dollar (NZD) against the United States dollar (USD). The scale is inverted, that is, the higher the purchasing power of the New Zealand currency, the higher the position of the data on the graph. This would mean there are fewer New Zealand dollars to spend to buy one unit of the American currency, and the weaker the NZD, the more has to be spent to buy 1 USD, the corresponding value will be higher (and the point – lower on the graph). As one can see on this graph, the New Zealand currency has displayed a relative stability, with some peaks and troughs against the USD. Overall, the trend appears to be upward, that is, the NZD has gradually strengthened against the American currency over the 10-year period under review. The most recent data (over the last twelve months, for instance) shows the New Zealand dollar trading against the USD at somewhere between 1.30 and 1.20 NZD for 1 USD. The most recent market quote was 1.2035.

In the past, because of the World Financial Crisis in 2008, its value decreased from 1.2485 (see period March-April 2008 on the graph) to 1.9383 (same period in 2009). This was the case for many currencies of the countries whose economies depended on the export of one commodity or a limited number of commodities. The Russian Ruble also lost at least 20% of its value against the US dollar as a result of the crisis. The difference from the New Zealand dollar is that the Russian currency has not regained its previous position for a number of reasons – principally because of structural problems in the Russian economy, and has on the contrary depreciated rather rapidly in the beginning of 2014.

The New Zealand currency however, is stronger today against the US dollar than it was before the financial crisis. This is explained by the belief in the country’s economic outlook from the markets. As was outlined previously, the strength of the currency is good news for importers and bad news for domestic demand and exports. The Reserve Bank of New Zealand, although does not directly monitor the exchange rate levels through interventions, does take into account currency considerations when making policy decisions.

 

9. Unemployment data – another key indicator of the macroeconomic performance, as well as indicator of conditions in the labour market. As will later be shown on the combined graph, lower unemployment is associated with higher levels of interest rates (although the Bank points out that no direct relationship exists), and higher unemployment rate is associated with lower levels of interest rates.

 

Graph №10 – New Zealand Labour Statistics35 (Graphical presentation and compilation by Nikita Stopnikov)

It can be noted from the above graph, that the total employment (in thousands of people having jobs or self-employed) was on the constant rise for 5 years from Q4 of 2003 through Q4 of 2008 (from 1975 thousand to 2210 thousand). Then it fell to its local minimum of 2155 thousand by Q3 of 2008 (height of the crisis) but then started rising again and it is still on the way up at almost 2300 thousand jobs at the end of 2013.

From the unemployment rate data, this indicator in New Zealand is lower than in many developed countries including the United States. In the US during the Crisis the unemployment rate was at the level of more than 9%. Nowadays US has the 7% unemployment rate. One percent higher than in New Zealand. The position of the Reserve Bank of New Zealand is that unemployment cannot (and therefore should not) be addressed by the monetary policy instruments, and therefore should be outside the scope of Central Bank responsibilities. This view is being challenged by those who believe that the Central Banks have a much broader role in the modern economy than traditional tuning of the interest rate market or inflation targeting. This view will be covered in brief in the Conclusion section of this paper. 

Graph №11 – New Zealand Official Cash Rate (OCR)36

 

 

The graph above shows the development of the level of OCR since the date of start (March 1999) to this day (the latest Monetary Policy Statement for the complete year is dated 11 December 2013). In this section, I will briefly describe some of the more notable changes in the level of OCR. Before that, however, I would like to point out that overall level of OCR since the beginning has remained relatively low and not subject to wild swings which characterized, for instance, the interest rates in some other countries.

 

The graph has one X axis and two value (Y) axes.

• The X axis has points in time, when the Reserve Bank of New Zealand was considering the changes in the Official Cash Rate (OCR).
• The first Y axis (on the left) shows the actual OCR rates – these are set at least eight times per year. The Bank is not obliged to change them every time or indeed, at any time.
• The second Y axis (on the right) measures the direction of the change. Everything above the Zero line on the second Y axis represent an increase in the OCR. Everything below this line is a rate reduction. Points at the level of the line represent decisions not to change the OCR.
• The actual OCR values are represented by shaded columns, and the changes in OCR at the same point in time are represented by the green line.

The following sections comment on the more significant moves by the Reserve Bank of New Zealand in the conduct of its monetary policy:

1. December 2005. This is the first rate change I would like to examine in more detail. In December 2005 the Reserve Bank of New Zealand increased the OCR to its highest level on record, 7.25 per cent. As it was stated in the Monetary Policy Assessment of the time, there were considerable worries by the Bank that the dangers of inflation were persisting37. Although the exporters were already suffering from the relatively high exchange rate (around 1.44 New Zealand dollars for 1 USD), still the overall demand was very high and big pressures on productive capacity existed. The main source of pressure was household demand38. From the Keynesian cross proposition, this results in running down of inventories because of the inability of the producers to cope with the demand.

This situation can be proved by the official statistics taken from the site of the Reserve Bank of New Zealand which is shown on the graph below39. On this graph there are two value (Y) axes. The primary (left) Y-axis shows production-based and expenditure-based GDP. Expenditure-based GDP can be assumed to equal aggregate demand. The secondary (right) Y-axis shows the changes in inventories. Time period is on the horizontal (X) axis.

Graph №12 Production and Expenditure-Based GDP (Graphical presentation and compilation by Nikita Stopnikov)

 

It can be observed from the data, that for most of the time except September 2004 and September 2005 quarter ends, expenditure-based GDP was consistently higher than the production-based GDP. I have specially taken a longer period to demonstrate that demand pressures were not one-time but long-term. High inflation was also evident in the labour costs. The Bank saw this as a danger because inflation expectations could become locked in (embedded) in the economy and disinflation would be especially difficult if this happened. The Bank further stated that further increase in the OCR might be needed depending on how the housing market and demand in general respond to the increase40. If the demand did not slow down, the rates could go up again. The Bank also said that it did not see any prospect of the rates going down in the foreseeable future. It specifically mentioned the situation to the left of the Keynesian Cross, where household and business demand have been very strong in recent years, outstripping growth in the economy’s productive capacity. The labour market was also very strong, with the unemployment rates dropping to their “20-year low of 3.4 per cent”41. Note that currently the unemployment rate in the Russian Federation is around 5 per cent, in the USA – around 7 per cent, in the UK – around 7.2 per cent, and in the Eurozone as a whole – over 10 per cent. The Russian Federation rate of unemployment is considered very moderate against some other G-8 countries. Accordingly, in this context, New Zealand figures can be considered zero unemployment.