Three open economies walk into a bar …

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 😉

  • Miguel Sanchez

    I don’t think it’s at all obvious that we are still lagging behind. Australia had 0.3% growth in the September quarter; we had 0.2%. They had 0.9% growth in the December quarter; forecasters are picking at least that much here. Aussie unemployment is falling, but it’s been partly masked by a drop in the participation rate which is atypical of a recovery, and it’s only in the last few months that the growth has been in full-time jobs; we of course don’t have any figures for the start of this year.

    If there is a performance gap opening up recently, it’s because people here are (rightly) worrying that the government is going to try to squeeze more tax out of their most important asset. In Australia, the government has been largely indifferent to the housing bubble that they themselves have played a role in feeding.

  • Miguel Sanchez

    Also, if you’re thinking of going down the “terms of trade” line of argument, there’s an interesting point of difference between the two countries. Most of Australia’s terms of trade boost came from iron ore prices, where most trade is done at contracted prices that are fixed once a year. During the boom period around 2006-07, Aussie iron ore producers were locked in at prices that were about half of what proved to be the peak in spot prices. (They were very upset about this, and are determined that it won’t happen this time around). So in that sense, Australia had a smaller let-down because they failed to ride the pre-crisis commodity boom to the same extent that NZ did.

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  • @Miguel Sanchez

    “I don’t think it’s at all obvious that we are still lagging behind. Australia had 0.3% growth in the September quarter; we had 0.2%. They had 0.9% growth in the December quarter; forecasters are picking at least that much here.”

    Levels. We have fallen a lot further than they have, as a result we would need stronger growth just to be standing still against them. As our growth is the same, we are lagging behind.

    “Aussie unemployment is falling, but it’s been partly masked by a drop in the participation rate which is atypical of a recovery, and it’s only in the last few months that the growth has been in full-time jobs”

    The Aussie labour market is still a lot stronger than ours – our employment is still declining, hell even hours worked is still declining!!!

    “If there is a performance gap opening up recently, it’s because people here are (rightly) worrying that the government is going to try to squeeze more tax out of their most important asset”

    I buy this uncertainty for the start of 2010, but not for us lagging over the second half of 2009.

  • @Miguel Sanchez

    “Also, if you’re thinking of going down the “terms of trade” line of argument, there’s an interesting point of difference between the two countries. Most of Australia’s terms of trade boost came from iron ore prices, where most trade is done at contracted prices that are fixed once a year”

    The terms of trade figures actually count the amount that people receive right. Hence why the export price index in the countries viciously lags spot prices and the such. I was comparing these realised terms of trade figures, so even though neither country got the juicy spot prices the relative comparison still holds.

  • Andrew Coleman

    Why rule out the first option Matt?

    NZ went into recession first quarter 2008, in part because of a drought.

    In July 2007 the RB raised the OCR to 8.25: the highest in the world, excluding Iceland. It didn’t start cutting until July 2008 – 6 months into a recession. And while it cut quickly – about the same speed as not-in-recession Australia – average mortgage rates declined very slowly, because most borrowers had moved to fixed term rates in response to the steeply inverted yield curve imposed on the economy for most of the previous 5 years. (After 12 months average mortgage rates had only dropped by 1.2% – in contrast to a 3.2% drop in not-in-recession Australia. )

    This doesn’t seem to be very effective demand management . In fact, serious questions need to be asked just how effective the RB has been at managing the idiosyncratic shocks that have hit NZ in the last few years. It inadvertently tightened policy in response to the 1997/8 drought; it loosened policy despite the migration surge in 2002/3; and it kept interest rates at world highs despite the drought and recession at the start of 2008. Perhaps Australia is the lucky country because they had Governors McFarlane and Stevens in charge.

    All this fine-tuning makes one appreciate Friedman’s view that rules might be better than discretion when it comes to monetary policy. Giving a central bank the ability to fine tune the economy is only useful if they are good at it.

  • @Andrew Coleman

    “In fact, serious questions need to be asked just how effective the RB has been at managing the idiosyncratic shocks that have hit NZ in the last few years. It inadvertently tightened policy in response to the 1997/8 drought; it loosened policy despite the migration surge in 2002/3; and it kept interest rates at world highs despite the drought and recession at the start of 2008”

    There have been policy mistakes, for sure. I do not believe that the recent recession was the result of a policy failure. However, in time we will be able to find actual objective evidence on this, rather than relying on arbitrary conjectures such as the one I’ve provided.

    “All this fine-tuning makes one appreciate Friedman’s view that rules might be better than discretion when it comes to monetary policy.”

    I’ve always preferred this idea myself in any case.

  • @Andrew: If I recall correctly, we were looking to be outside of the target range for quite a while going forward even at 8.25 in July 2007. Wasn’t clear at all that rates were too high, even if highest in the world.

  • @Eric Crampton

    Although, it is possible to make the argument that, in the face of a supply shock, the central bank should not lean fully against the increase in the price level. The reason why we were so far outside the target band was:

    1) Drought (temporary supply shock),
    2) Petrol price increase (assumed to be a permanent supply shock, and really just an increase in relative prices).

    As a result, we could say that rates went up too far.

    However, I think it is important to look back a bit further – the real issue is that rates didn’t go up quickly enough through 03/04. Yet, ex-ante they were doing the best they could given their expectations for how a change in OCR would impact on interest rates and thereby on inflation. Ex post, the OCR had a much weaker impact on underlying interest rates then was expected.

    Overall, the conclusion is that discretionary monetary policy is hard methinks 😛 I have no doubt RBNZ policies were ex-ante optimal, but our information is just so crap that often these choices may have been ex-post suboptimal …

  • Miguel Sanchez

    @Matt Nolan

    If you want to talk levels, then we’ve been lagging Australia since before you and I were born. 🙂 You have to remember that Australia’s mining boom means they would be outstripping us with or without the financial crisis; if you’re simply trying to explain the recovery from the crisis then it’s not at all obvious that we have lagged.

    “The Aussie labour market is still a lot stronger than ours – our employment is still declining, hell even hours worked is still declining!!!”

    As I said, we have no official data for NZ since December (and I’ve teen told that’s surveyed in November). But private sector measures like job ads are on the way up.

    “I was comparing these realised terms of trade figures, so even though neither country got the juicy spot prices the relative comparison still holds.”

    Actually NZ did get the juicy spot prices; Australia didn’t. It’s not a silly argument when you remember that the NZ/AU exchange rate – as good an indicator as you’re going to get of the market’s perceptions of relative performance – went above 90c in that time.

    “I buy this uncertainty for the start of 2010, but not for us lagging over the second half of 2009.”

    Back to my first point: it’s not at all obvious that we did lag in the second half of 2009.

  • @Miguel Sanchez

    “If you want to talk levels, then we’ve been lagging Australia since before you and I were born”

    Hehe, too true.

    I was thinking more along the lines of “output compared to estimated potential”. Australia has no output gap, we have one of 3%. However, I do buy your point that our gap may be overestimated.

    “As I said, we have no official data for NZ since December (and I’ve teen told that’s surveyed in November). But private sector measures like job ads are on the way up.”

    Indeed. However, we also have the “registered job seeker figure” which continued to climb in December (I should double check whether this was significant in SA terms).

    Overall, the much higher UR in NZ suggests that we have a lot more spare capacity – and as a result that our actual deviation from output is more significant.

    “Actually NZ did get the juicy spot prices; Australia didn’t. It’s not a silly argument when you remember that the NZ/AU exchange rate – as good an indicator as you’re going to get of the market’s perceptions of relative performance – went above 90c in that time.”

    On the first point, the TOT figures use realised prices, so the realised relative price we received did head down in this way. Furthermore, the spike to 90c was very temporary, for most of the period we were actually below average against the AUD.

    I cannot remember why we spiked temporarily against the Aussie in early 2009 – do you remember? It would be a useful thing to know methinks.

  • Miguel Sanchez

    “However, we also have the “registered job seeker figure” which continued to climb in December (I should double check whether this was significant in SA terms).”

    I would think that they’re extremely seasonal. But the Stats website only has them up to 2002; do you know where to get the recent history from?

    “On the first point, the TOT figures use realised prices, so the realised relative price we received did head down in this way.”

    I’m not disputing that. My point was that Australia’s terms of trade didn’t fall as far as ours because the annual price-setting meant that their realised prices were more shielded than ours from the big swings in spot prices.

    “Furthermore, the spike to 90c was very temporary, for most of the period we were actually below average against the AUD.”

    Average is about 85c. We were above that for about a year – hardly temporary.

    “I cannot remember why we spiked temporarily against the Aussie in early 2009 – do you remember?”

    I don’t see a spike in early 2009 – are you thinking of late 2008? That was, I think, due to a perception that Aussie banks were more vulnerable in the post-Lehman crisis – NZ banks have strong parents as a backstop, Aussie banks don’t. Perverse logic, I know, which is why it didn’t last long.

    Anyway, I may be getting bogged down in the details, so I’ll try to make one general point. The original Canadian article, as I read it, was about how monetary policy responses could produce such different outcomes across three similar-ish economies – so it’s about cyclical factors. Australia’s mining boom is a structural factor; it needs to be set aside as part of this particular discussion. And when you set that aside, it’s not at all obvious that NZ’s recovery from the financial crisis has been weaker.

  • @Miguel Sanchez

    “I would think that they’re extremely seasonal. But the Stats website only has them up to 2002; do you know where to get the recent history from?”

    Yar, but it twas a big increase. In SA terms it was up over 3%, largest monthly increase since August. Still, volatile series, I do think its nearing a peak.

    Think DOL sends them too us, I’m not the person involved in getting that data so I don’t know for sure.

    “I’m not disputing that. My point was that Australia’s terms of trade didn’t fall as far as ours because the annual price-setting meant that their realised prices were more shielded than ours from the big swings in spot prices”

    That is cool. However, my only point was that our TOT fell to 2004 levels while their one fell to 2007 levels – so our external income “in some sense” regressed to an earlier level than their one did, hence why it might explain some of the difference.

    “Average is about 85c. We were above that for about a year – hardly temporary.”

    According to RBNZ figures, the monthly average of our dollar has been below 0.85 since April 2008, except for a sudden boost in October and November 2008. Over 2009 the dollar has average 0.8.

    “I don’t see a spike in early 2009 – are you thinking of late 2008? That was, I think, due to a perception that Aussie banks were more vulnerable in the post-Lehman crisis”

    Yes, I misread a graph – you are right on the timing.

    “Australia’s mining boom is a structural factor; it needs to be set aside as part of this particular discussion. And when you set that aside, it’s not at all obvious that NZ’s recovery from the financial crisis has been weaker.”

    Agreed if we were looking outside the crisis. Furthermore, even during the crisis the composition of exports should be looked at – you are completely right.

    However, I think there are specific supply side factors that have made NZ differ from these other nations – those were the ones I wanted to mention in the post.

  • @Matt Nolan If it was just petrol, then the biggest component ought to have been in tradeables, not in non-tradeables, unless there’s a huge oil/petrol component in haircuts, restaurants and property. Yes, hindsight, good that RBNZ didn’t go above 8.25. But sure didn’t feel that way at the time.

  • @Matt Nolan I’ll disagree on ex ante right for 03/04. They thought they could push output beyond what we’d normally consider inflationary – an experiment.

  • @Eric Crampton

    The biggest contributor at the time was tradables.

    I also have reservations about how high non-tradables is allowed to be. I may have to post about it at some point.

  • @Eric Crampton

    I’ve been looking through the survey of expectations today, and on average the respondents were telling the Bank that monetary conditions were normal – I get the feeling that, at the time, people didn’t seem to understand how loose conditions overseas were impacting on us.

  • @Matt Nolan
    Are we looking at the same series?

    I’ve got March 03 through Dec 04 tradeable inflation (Fig 5.16) never above 1.5% and usually negative; on non-tradeable, it’s never below 3.

  • DATE Tradable Non-tradable
    Mar-02 2.1 2.9
    Jun-02 2.2 3.2
    Sep-02 1.4 3.5
    Dec-02 1.6 3.8
    Mar-03 1.5 3.4
    Jun-03 -1.1 3.6
    Sep-03 -1.5 3.8
    Dec-03 -2.0 4.2
    Mar-04 -2.3 4.5
    Jun-04 -0.7 4.7
    Sep-04 0.0 4.5
    Dec-04 0.7 4.3
    Mar-05 0.8 4.2
    Jun-05 0.7 4.4
    Sep-05 1.9 4.4
    Dec-05 1.7 4.3
    Mar-06 2.1 4.1
    Jun-06 3.8 4.1
    Sep-06 3.0 4.0
    Dec-06 1.2 3.8
    Mar-07 0.9 4.1
    Jun-07 -0.5 4.1
    Sep-07 -0.3 3.7
    Dec-07 2.8 3.5

  • @Eric Crampton

    Sorry, I thought the first comment was talking about the period where they actually broke the target. As that was the point when the bank was responding by lifting rates to 8.25%.

  • Oh, I’ll totally agree that they broke the target whenever tradeables was high — they needed tradeables to be near negative to meet the target!

  • @Eric Crampton

    Annualised transport industry price growth had been 10% in the June quarter of 2007, they lifted rates to 8.25% in July that year.

    Even with the economy going into recession rates were not cut until June 2008 as a result of high tradable good price growth (apc was 4.8% by this point).

    Andrew’s comment regarding RBNZ failure was to do with them keeping rates elevated when we were already in a recession, and the increase in tradable goods could be taken as a relative price shift (and also only a movement in the price level not inflation) – in fact global credit markets had been broken for a year before they cut rates.

    Of course, if we take tradable price movements as a relative price shift we should really be asking why we are willing to have non-tradable price growth consistently outside the target band …

  • @Eric Crampton

    According to their forecast they will have average inflation of about 2.7%, with non-tradable growth of 3.2% and tradable of 2.2%. This excludes the ETS and GST changes (as they are just price level shifts).

    My issue is that non-tradable inflation is sticky, tradable inflation isn’t. Surely this places an asymmetric upside risk to the inflation profile.

  • So, shy from being far too doveish 05, they might have hesitated a bit longer than they should have in 08. I can buy that. I wouldn’t have seen it at the time, mostly ’cause I didn’t see the credit market problems. But can take that as a hindsight view now. I’d still put more fault on the former problem than the latter – if I recall correctly, Bank of Canada was even talking about raising rates at the time.

    Non-tradeable is sticky, sure. That means it’s the one that needs longer term battering down.

  • @Eric Crampton

    Agreed on all fronts.

  • @Matt Nolan
    Aren’t we such agreeable people?

  • @Eric Crampton

    Bound to be something wrong when economists agree. At least the RBNZ obviously does not agree with us.

  • Interesting. I hadn’t known about the NZ drought, or the difficulties with financial markets/institutions. Canada normally has exports and imports around 40% of GDP. Most (around 80%) of our trade is with the US.

    I still am surprised at how high NZ’s interest rates need to be to keep inflation on target. We currently have the overnight rate target at 025%, and 5-year closed mortgages around 4.5%.

  • Some of the high rates are just a function of small market/correlated risk problems. But I’ve never seen a fully satisfactory account.

  • @Nick Rowe

    @Eric Crampton

    Our high cash rate in the past didn’t necessarily mean high interest rates – we are a tiny open economy, our interest rates were still very determined by the world interest rate. In the end though, our interest rates did get to high levels – albeit not as high as the cash rate differential would suggest

    The increase in our debt levels has seemed quite unsustainable. I don’t know of an economist who would expect us to go back to our pre-crisis trend, solely on the basis of this.

    This cycle, New Zealand’s neutral is expected to run in line with Australia’s – even though the implied TOT boost from spot prices for NZ is a lot higher (we are at pre-crisis spot levels, Aussies have only recovered about 30%). According to the RBNZ the change in the implied OCR stems solely from an unwillingness of foriegn lenders to give us money, not a change in consumer risk preference. As a result, NZ domestic interest rates should head to high “effective” levels.

    Ultimately, even with the OCR at 8.25% nominal consumption as a % of GDP remained about average levels. This implies to me that consumer spending was neutral with a very high cash rate, this could mean two things:

    1) In NZ the OCR is ineffective at setting interest rate,
    2) NZer’s willingness to borrow is high.

    It will be a while until we can properly judge which hypothesis is correct given the significant holes in NZ data.

  • Andrew Coleman

    I shan’t be so agreeable. In work that was presented in the 2007 RB Bulletin, I examined the change in prices in NZ and Australia, sector by sector, over horizons from 2 – 12 years. This clearly shows that in the medium term sectors which have higher than average rates of price change in NZ are the same sectors in Australia, suggesting that the much faster rate of increase of non-tradeables prices in NZ is not due to peculiarly local factors – it is due to more global, or at least Australasian factors. The correlation is considerably higher for tradeable goods and service than for non-tradeable goods and services, but it is high in both cases. (The graphs in the article clearly show this point.)

    According to Statistics New Zealand, average non-tradable prices increased by 63 per cent in the fifteen years to June 2006, or 3.3 per cent per year, while average tradable prices increased by only 16 per cent, or 1.0 per cent per year. This obviously reflects a large relative price movement – but one that is almost the same as in Australia. The key to getting inflation down is not to engineer a smaller rate of relative price shift, say by reducing non-tradeable price increases from 63% to 50% while keeping tradeable price movements at 16%. The key is getting both numbers smaller : say 53% and 6% respectively. Only in that way will the value of the dollar be preserved from the evils of “low” inflation.

    Incidentally, how long do you think it will take before someone tries to sue the government and the Reserve Bank because the policy target agreement is not consistent with section 8 of the Reserve Bank Act (1989)- that the primary goal of the bank is to achieve stability in the general level of prices? Over a typical 80 year lifetime, 2% inflation implied a 5-fold increase in prices, and it is stretching the language to think that this is consistent with “stability in the general level of prices”. Ever since returning to NZ I have been bemused that the Minister of Finance (s) have been able to sign off the PTA with neary a protest that it is probably not legal. But, not having any legal expertise, I wouldn’t even know how to begin a high court injunction (or whatever) to question whether it is actually legal to have a PTA of 1-3% in the medium term, without changing section 8 of the Act.

  • @Andrew Coleman

    “I shan’t be so agreeable”

    Excellent 😀

    “suggesting that the much faster rate of increase of non-tradeables prices in NZ is not due to peculiarly local factors – it is due to more global, or at least Australasian factors”

    Of course the labour markets and general political settings in both countries will share distinct similarities. I suspect that these two would be the major drivers of non-tradable price growth.

    “The key to getting inflation down is not to engineer a smaller rate of relative price shift”

    I completely agree – the relative price movement is structural and not of concern for monetary policy directly. I think the Bank believes that is what it is doing fundamentally – as the headline rate does track marginally within the band 😉

    My main concern is how this functions in the face of a “shock”. Non-tradable price growth is invariably “stickier” than tradable price growth, so if conditions change sufficiently overseas and we begin to import inflation it will be extremely costly to get the non-tradable rate down. Surely in this case it would be better to ere on the side of caution with the headline target in order to ensure that non-tradable growth is weaker.

    “Incidentally, how long do you think it will take before someone tries to sue the government and the Reserve Bank because the policy target agreement is not consistent with section 8 of the Reserve Bank Act”

    The same argument will appear that always appears – CPI growth overstates “inflation” due to measurement issues and improvements in quality that aren’t captured. As a result, a target of “2%” gives us “price stability for a given level of quality”.

    It would be interesting to see some actual work on this though. Is 2% the right number? Is it even the implicit inflation target anymore 😛

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