Too Late for Complacency

Reality is beginning to catch up with complacency. We have consistently underestimated the severity of the recession; our forecasts have constantly had to be adjusted to take account of the ever-worsening outlook, but they still lag behind the true dimensions of the downturn.

A sign of the times is the fall in GDP for the first quarter of the year. What this figure tells us is, that despite the optimism expressed by the Treasury and others in the months before Christmas, the recession is well into its second year and is still building momentum. No one now believes that the second quarter of 2009 will show any reversal of the trend, and that means that we are now about to enter our seventh quarter of recession, with little or no relief in sight.

Why have our forecasts so consistently understated what has been happening, with the result that our policy response has been dangerously inadequate? The answer is a complex one.

The first part of the answer lies in the fact that we are experiencing a different recession from the one that has afflicted most of the rest of the world. Our recession has come in three phases; the first began at the end of 2007 with our own home-grown recession, when our domestic economic policies hit the buffers and the constant use of ever-higher interest rates and an over-valued exchange rate in a failing attempt to control inflation had done enormous damage to our wealth-creating sector.

Long before the rest of the world, we had already become accustomed to living with recession. We were therefore less panicked by the onset of the second – global – phase of recession, in the third quarter of 2008, when the world’s financial institutions were in free fall. We felt that we were already grappling with the problems, and we were in any case less affected – in the short term at least – by financial failures than most other countries. There was a sense of “phoney war”; people began to believe that the recession was not so bad after all.

But what they had not reckoned with was the third and most dangerous phase of recession – the price paid by our small, vulnerable, open economy when the financial crisis impacted the real (and not just the financial) economy around the world. What we are now discovering is that as growth turns negative, unemployment rises, credit becomes more difficult and expensive, and investment plummets on a global scale, there are very nasty consequences for our export markets and for the prices we are paid for our goods – and that is to say nothing of the increased cost of the international credit on which, in our indebted state, we are so greatly dependent.

The worst of our recession, in other words, is yet to come; as I warned in these pages in December “we are still looking to the early end of a recession that has barely begun.” We are likely to be first in to the recession, but last out. Our share of the pain from the global downturn will follow – at the end of the causal chain – as a consequence of the pain felt by others, but we are still behaving as though the measures thought adequate to deal with the first (home-grown) phase of recession will carry us through. Part of the reason for this, sadly, seems to be a continuing predilection for relying on monetary policy, and an ideological reluctance to accept the value of government intervention.

Our so-called “stimulus” package has been piecemeal and small-scale – scoped to deal with recession in early 2008 but inadequate to respond to what is now in store. And, it has been less effective than it might have been because it has been misdirected, taking the form of tax cuts for the well-off (who may or may not spend them) rather than direct investment in economic activity and in lifting demand.

We still seem to pay inordinate attention to the OCR, but that bolt has largely been shot. Monetary policy, once interest rates have been cut to low figures, is largely ineffectual to stimulate the economy. The Governor of the Reserve Bank’s insistence on keeping further minor cuts up his sleeve does have one consequence however; it is read by the foreign exchange markets as an invitation to pile in to the New Zealand dollar, so that a once again over-valued currency will ensure that any nascent recovery will be still-born. And, when we eventually do turn the corner, the odds are that we will be back on the same debt-fuelled treadmill that ran us into the buffers in the first place.

There will be some developments to help us – net migration figures and a stabilising housing market perhaps – but the most important factor depressing our immediate economic future is rising unemployment. We have only now started to see the full potential of job losses. The actuality and the fear of unemployment is only just getting under way. If we don’t want to see the recession deepen into 2010, we should be acting now.

Bryan Gould

28 June 2009