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Bernard Hickey: Take forecasts with grain of salt

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Finance Minister Bill English. Photo / Mark Mitchell
Finance Minister Bill English. Photo / Mark Mitchell

It's amazing what you can promise when you forecast strong growth. If you went to your bank and promised your salary would increase 10 per cent next year, there would be a good chance they would lend you more money.

They would probably ask for proof but a letter from your employer would do the trick.

This is exactly what John Key and Bill English will do on Thursday when they release the 2011 Budget.

They will forecast strong economic (gross domestic product) growth and explain to our ratings agencies that this growth means our debt-to-GDP ratio over the next couple of years will stay relatively low at below 30 per cent, even though debt is growing at a record rate.

As long as the denominator (GDP) is growing almost as fast as the numerator (debt) then that ratio will stay under control. These growth forecasts will, in effect, be the letter from the employer to show the bank manager's representative, which in our case is Standard and Poor's.

New Zealand will probably avoid a downgrade in our credit rating because the Budget's economic growth figures for the next three to four years will look extraordinarily strong.

They will argue the Christchurch earthquake rebuild and a historic boom in commodity prices will power GDP growth to more than 4 per cent over the next two years.

This seems sensible until you look at the track record of these forecasts in the past three years since the global financial crisis.

Every economic forecast by the Treasury underestimated the impact of an epic change in the way New Zealanders think about debt and spending.

In May 2008, Treasury forecast growth rates for the next three years of 1.5 per cent, 2.3 per cent and 3.2 per cent. Instead, we got -1.1 per cent, -0.4 per cent and -0.1 per cent.

The inaccuracy of these forecasts isn't just Treasury's doing. All the economic forecasters have missed out on a structural shift. New Zealanders have stopped borrowing overseas to pump money through the housing market into consumer spending, which makes up almost 70 per cent of the economy.

It has been stalled for three years and there is no indication it is picking up quickly. New Zealand households have got the message that they can't live beyond their means. Lending growth has stalled and the banks are increasingly desperate in their efforts to encourage households to borrow.

An influential book, This Time is Different: Eight Centuries of Financial Folly, written by United States economists Kenneth Rogoff and Carmen Reinhart, demonstrates that heavily indebted economies almost always grow much more slowly after a financial crisis and that this slowdown can last seven to 10 years.

A process of de-leveraging after a credit-fuelled boom in asset prices drags down on economic growth, particularly when financial crises continue to reverberate through the system.

New Zealand is not unique in this, which helps to explain why every economic forecast by Treasury since May 2008 has overestimated actual growth by between 2-3 per cent.

Key and English will argue that somehow growth in the next three years will be different.

Rogoff and Reinhart's work indicates growth will continue to be at least 1-2 per cent below "normal" for another three to five years as we de-leverage.

We have a long way to go.

Household debt to disposable income is still above 150 per cent and will have to drop down to something closer to 100 per cent before we return to "normal".

Meanwhile, our Government keeps borrowing as if growth is continuing normally.

Luckily for us our bank manager's representative, S & P, will simply rely on these forecasts and not ask for a letter from our employer.

The banks themselves, and global credit markets, may not be so relaxed in years to come as growth continues to disappoint.

That's why we should all take Thursday's growth forecasts - and Key's smiling confidence - with a grain of salt.

This time it is different.

bernard.hickey@interest.co.nz

- NZ Herald

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