In the recovery ward, but GFC after-effects linger

By Brian Fallow

Crash cost two years' growth, writes economics editor Brian Fallow

When Lehman Brothers collapsed and the United States' financial system went from unstable to critical, New Zealand was already in recession.

Reserve Bank Governor Alan Bollard had pushed the official cash rate (OCR) to an eye-watering 8.25 per cent in response to the spillover effects of one of the biggest housing market booms going. That was enough to get through to the mortgage belt and ankle-tap the economy.

But it also meant that when the global financial crisis hit, the bank had plenty of room to cut interest rates to bolster demand in the economy. By April 2009 the OCR had been slashed by 5.75 percentage points to 2.5 per cent, where it still sits, leaving room for manoeuvre, unlike central banks elsewhere which have reduced rates to zero, or close to it.

Read the stories of NZ business leaders and their experience of the crash here.

At the same time, 14 straight years of Budget surpluses had left the Government's books in good shape and able to take the strain as the automatic stabilisers kicked in - falling revenue and increased welfare payments, which pushed the fiscal bottom line back into deficit.

In addition to conventional monetary and fiscal stimulus, New Zealand also benefited from the nature of its external trade. Even in a global slump people need to eat, whereas they might not need to replace cars or television sets, and our largest trading partners, Australia and China, navigated the GFC fairly well.

Even so, between the start of 2008 and the middle of 2009, the New Zealand economy shrank by 3.6 per cent. And the recession had a pup, in the form of another two quarters of contraction in the second half of 2010.

Unemployment climbed. The unemployment rate, which averaged 3.9 per cent over the four years before the 2008-09 recession, has averaged 6.6 per cent over the four years since it ended. In the June 2013 quarter it was still 6.4 per cent.

The number of people unemployed - 153,000 at the last count - is only 3000 fewer than the average over the past four years. Job growth in the recovery, in short, has barely kept pace with growth in the labour force.

For the past five years the output gap has been negative; in other words, the economy has been producing less than it could have.

The equivalent of two years' normal growth has been lost.

A comparison of household finances today with the outset of the recession five years ago also makes for cheerless reading.

Average household disposable, or after-tax, income in the year to March 2013 was just 1 per cent higher than it was five years earlier, after adjusting for inflation.

And in terms of wealth, the average household has lost ground. Average household net wealth (assets minus liabilities) is $425,000 - $10,000 lower in today's dollars than it was in 2008.

Debt servicing takes a smaller share of household incomes than it did five years ago, as would be expected when mortgage rates are at multi-decade lows, but as the Reserve Bank made clear yesterday, the clock is ticking on that one.

Five years on, what are the lessons of the GFC for New Zealand and have they been learned?

One is never to underestimate the capacity of events in the other 99.7 per cent of the world economy to sideswipe ours.

Another is the importance of shock-proofing the banking system. Although several finance companies failed, and the taxpayer was left carrying the can for South Canterbury Finance, costly bank bailouts, such as occurred in several northern hemisphere countries, were avoided.

But though New Zealand dodged the bullet then, the system has not been disarmed.

The fact that house prices suffered only a comparatively mild and short-lived correction means that they remain very high, by historical and international standards, relative to incomes and rents. And now they're rising again - by 8.5 per cent nationwide over the past year, according to Quotable Value, and 8.3 per cent above their pre-recession peak.

The risk to financial stability that poses is the main reason the Reserve Bank has given for the recently introduced restrictions on low-deposit mortgage lending, to bolster the banks' resilience to some future shock which would undermine the ability of heavily indebted households to service their loans.

Governor Graeme Wheeler was living in the United States in the wake of its property market crash and has seen what it does to an economy when one mortgage in four is under water - that is, when the debt exceeds the value of the property it is secured on.

Meanwhile, the main lesson the Government has drawn is the need to return to surplus and rebuild the balance sheet strength that would enable a future Government to deliver deficit financing on the scale it has been able to under the twin shocks of the GFC and the Canterbury earthquakes.

To avoid, in other words, the kind of austerity which most of Europe has laboured under since the GFC, or the fiscal brinkmanship Washington has displayed.

"One thing that we are still learning, not just here but around the world, is that monetary policy can't fix everything," says AMP Capital chief economist Bevan Graham.

"Has quantitative easing in America fixed anything? I would say no. What it has done is give the economy some time to repair itself, particularly the housing market, and the politicians an opportunity to do some of the structural things, like tax reform, they needed to do. I think that is the element that got wasted."

- NZ Herald

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