Full recovery will take years, says Bollard

Reserve Bank Governor Alan Bollard paints a grim short-term picture. Photo / Mark Mitchell

The economy's recovery could be a long, slow affair, in a world still suffering the aftershocks of the global financial crisis, Reserve Bank Governor Alan Bollard warns.

In a downbeat speech to a Deloitte tax conference yesterday, Bollard said the rebalancing of the economy was progressing - aided by strong growth in Asian and Australian export markets - but very slowly.

"Substantial fiscal stimulus helped cushion the economy over the past few years. The fiscal deficit will need to be closed and private demand take over [from] public sector support," he said.

"Moreover, it appears that some of the fiscal deficit is structural and unwinding this support will subtract from growth for a number of years, with our housing market remaining weak, consumption impaired, balance sheets fragile and businesses remaining cautious. Private demand is still impaired."

On Thursday, Treasury secretary John Whitehead called for a return to fiscal surplus within three or four years.

He said a faster return to surplus would mean interest rates would not have to rise as fast as they otherwise might, taking pressure of the exchange rate.

"For those of you with any doubt what facilitating an easier monetary stance can do for the exchange rate rate, may I point you to the recent US experience," Whitehead said.

Bollard pointed to big swings in exchange rates as an "aftershock" of the global financial crisis.

The weak state of the United States economy required very easy monetary policy, he said, but quantitative easing had depressed the US dollar and resulted in new capital inflows into emerging markets.

Japan had intervened "massively" in the foreign exchange market in September in a bid to push down the yen, and other east Asian countries could be encouraged to follow suit.

A record build-up of external imbalances had created the preconditons of the global financial crisis, he said. "In short-hand, the East was building trade surpluses, savings and high reserves, while in the West the opposite was happening."

Last year had seen some rebalancing as Western consumers cut spending and imports, and repaid debt.

"However the forecasts suggest this rebalancing may not continue, and we have not yet reduced these international imbalances to sustainable levels."

The second aftershock was the sovereign debt crisis, Bollard said.

The resulting crisis first burst out in Ireland and the Southern European cluster of countries, but "financial markets have now also focused on some more major G-7 sovereign risks, in particular in the UK, US and Japan, where demographic ageing adds pressure to major government funding burdens," he said.

"With the recession delivering lower tax revenue, higher social spending, and banking sector liabilities, projected government funding requirements in these countries now look very tight, severely limiting the room for future support to increasingly unorthodox monetary policy," he said.

"Thus private demand in Western countries remains too weak to provide real impetus to the recovery."

The NZ Government has adopted a cap of $1.1 billion a year for increases in its discretionary spending.

However, Whitehead said a lot of government spending fell outside that constraint. Some spending is automatically increased in line with inflation or the average wage. Some depends on uptake, such as KiwiSaver subsidies, or is driven by formulas such as funding for educational institutions.

In some areas it might be appropriate to weigh up those automatic increases against choices being made in within the operating allowance, he said.