Is the Economy Heading Into a Recession?

Whatever the answer, what are we going to do about it?

Steven Joyce, Minister of Economic Development and most other economic things, was hardly helpful when he dismissed talk of an economic recession on a recent TV3 The Nation on Saturday. Economists outside officialdom can guess what his officials were generally telling him. It probably goes something like this (although I may be presenting it a bit more informally). .

Minister, growth rates in an economy fluctuate over a business cycle. We are pretty sure that New Zealand’s are slowing down at the moment. The immediate cause is the fall-off in dairy prices, which is impacting on dairy farmers and some rural parts of New Zealand very hard. There is an offset to these downward pressures from lower oil prices but their impact on the economy is much more diverse.


We are also worried, Minister, about the state of the world financial system. Greece is a bother but unless there is an international meltdown – heaven forbid – it should not upset New Zealand too much.


Harder to fathom is the state of the Chinese financial system. As Churchill might have said, it is a riddle wrapped in a mystery inside an enigma. But the little we do know is that it is under great stress. The Chinese financial authorities are doing their best to relieve the stress, but we cannot recall a similar occasion when actions by the authorities have been totally successful. Aside from the impact of the financial stress on the Chinese economy, which is now our largest market – some of our other large markets such as Australia are exposed to China too – there is a mysterious connection between the Chinese financial system and the Auckland housing market which may result in the latter coming off the boil..


Will the growth slow-down turn into a contraction – a fall in production? We cannot be sure. In any case there is a high degree of noise in the data of a small economy like New Zealand so the statistics can jump around from quarter to quarter for no apparent reason (journalists make up the reasons but we duck). We should also warn you, Minister, that there is almost an iron law of economic forecasting which says that, at this stage in the cycle, forecasters almost invariably underestimate the depth and length of a downswing.


Even so, we are reluctant to say there will be a recession. Part of the problem is the term has two distinct meanings. One is that the late downswing during the standard business cycle is called the ‘recessionary phase’ – the economy may be still expanding, but slower than average and layoffs and unemployment may be rising. The other meaning of recession is a longer period of negligible and even negative growth. Here the term ‘recession’ was adopted to distinguish the economic track from the depths of a depression.


So, Minister, we expect soon to be in the recession phase of the business cycle (if we are not in it already). We don’t yet know if we will be going into a contraction and one of these longer and more uncomfortable recessions.


Our advice, Minister? We think one should acknowledge that there is a growth slowdown. Of course that may mean some businesses will cut back on investment, which will intensify the growth slowdown. But better that than going ahead and finding themselves with excess capacity and additional debt to service. Delaying the slowdown may ultimately make it worse and damages your credibility. Short-term talking up (or down) the economy does not work in the long run. Ask Alan Greenspan.


I thought the Prime Minister handled the issue better a few days later (presumably he was listening to his officials). He acknowledged the slow down, but advised us not to panic, although I imagine a number of businesses and households have adjusted their plans in response. But he showed an awareness of the possibility of some sort of negative growth rate and hinted that if things deteriorate too far, the government would speed up its infrastructure spending. Better that than a short-term (and difficult to reverse) tax cut which temporarily boosts consumption, increasing government debt with no corresponding long run gains.


(Yes, the infrastructural spending will increase the fiscal deficit, in my view a perfectly sensible thing to do during a downturn. I just wish the government had been running more of a surplus during the boom. Earlier comments here.)


Spending programs involve implantation lags. Hopefully the instruction has gone out to officials to start looking for suitable investment programs. In the late 1970s, Muldoon wanted to start some infrastructural spending immediately. I recall officials scrambling around to find programs that could be got rapidly underway, knowing in their hearts that much of the spending would be ineffective.


I wonder what the officials are looking at. Hopefully an upgrading of poor quality housing and better connecting struggling regions to growth hubs (certainly not widening narrow road bridges to nowhere – a result, almost certainly – of officials scrambling around). More effort meeting realistic greenhouse emission targets? I would not mind a bit more on conservation and heritage, more spending on health prevention and early detection and isn’t it bloody time we took the leaky school buildings seriously – it is over a decade since we learned about the problem.


No problems then about there being a list. What officials will be looking for is spending that can easily be turned on in a year or so, easily turned off when it is not required for stimulation and which adds to the capacity of the economy and which enhances the welfare of the nation.