Today, our special series on the recession looks at how our home-grown recession is being infected by the global financial crisis and how, according to an independent think tank, it may be able to survive its effects
While tax cuts, interest rate cuts and easing inflation will help, households are being hit by two serious negatives: falling wealth and rising unemployment.
As the recession moves into its second year its nature is changing - from one largely of our own making to one driven by a global credit crunch, and from wealth destruction to job destruction.
"We are really talking about two recessions back to back," AXA Global Investors chief economist Bevan Graham said.
"Last year it was a domestic one, that we needed to have. There were excesses in the housing market and consumption that needed to be worked out. But then we get hit by this global storm."
For much of last year it was hoped that by now the economy would be in an export-led recovery.
Instead world trade is shrinking. Consensus Economics' latest monthly survey of economists around the world found that New Zealand's 14 largest trading partners are expected to shrink by 0.8 per cent this year, a stark contrast to the 3 per cent growth they have averaged over the past 10 years.
This is hitting exporters and the tourism sector, even as the inward-facing sectors of the economy struggle with the hangover from a binge of borrowing and spending.
The middle years of the decade were good times for consumers and for businesses catering to them.
For four straight years (until last September) the unemployment rate was below 4 per cent. Wages rose accordingly.
And consumption was turbocharged by a housing boom. House prices doubled between 2002 and 2007. Tough as this may have been for first-home buyers, for those who already owned a house every year brought a letter from Quotable Value explaining that they were tens of thousands of dollars richer than the year before.
By one means or another people tend to spend a few cents in the dollar of that extra wealth - adding billions of dollars to consumer spending.
But when demand in the economy outstrips its capacity to supply goods and services, all it buys you is inflation and blowout in the trade accounts (which you have to borrow to fund).
By 2007 households were collectively spending $1.13 for every $1 of income and the country's overseas debt, relative to the size of the economy, was second only to Iceland's among developed countries.
The housing market was seriously overvalued by any measure: house prices relative to incomes, household debt relative to incomes, debt servicing costs as a share of income.
To rein it in Reserve Bank governor Alan Bollard by the middle of 2007 had pushed the official cash rate to 8.25 per cent, driving the dollar to export-withering heights in the process. The combination of gravity catching up with the housing market, extremely tight monetary conditions and a drought was enough to tip the economy into recession early last year.
Households have cut back their borrowing and spending.
In real terms retail sales have fallen in each of the past four quarters and the growth in household debt has almost dried up. This is challenging for businesses trying to sell them goods and services, but it is an adjustment economists say had to happen.
Markets have adjusted too. House prices have dropped 8 per cent over the past year on average and are, the Reserve Bank reckons, only about halfway through their eventual peak-to-trough fall.
The New Zealand dollar has fallen 37 per cent against the US dollar over the past year, softening the blow of falling world prices for export commodities.
The inflation cycle has turned. The annual inflation rate peaked at 5.1 per cent last September, an 18-year high, before falling to 3.4 per cent in December. Some forecasters expect to see it below 1 per cent this year.
Policymakers have not been standing idly by. Dr Bollard has slashed the official cash rate from 8.25 to 3.5 per cent and financial markets expect further cuts to 2 or 2.5 per cent before he is done. The result is mortgage rates in the 5.8 to 7 per cent range depending on term, compared with average rates in the 8 to 9.5 per cent range over the past five years.
"When you go round talking to clients and start talking interest rates with a 5 or 6 in front of them, you can see people's eyes light up," said Westpac economist Doug Steel. "It's as if you can see monetary policy working."
But the price of credit is not the only factor. It has to be available in the first place. New Zealand banks import more than a third of the money they lend.
Overall, our international liabilities, net of New Zealand assets abroad, are $166 billion or $38,000 a head. That is a vulnerable position to be in when globally credit has gone from being abundant to scarce.
Meanwhile fiscal policy - the net effect of taxation and Government spending - has moved from contractionary to significantly stimulatory, to the tune of 4 to 5 per cent of GDP over the next two years, Finance Minister Bill English says.
The larger part of that "fiscal impulse" is due to Michael Cullen's last Budget, with its hefty increase in Government spending and last October's tax cuts. Government operating spending in the current June year is expected to be 9.4 per cent or $5.3 billion higher than in the previous year.
And the new Government has its own tax cuts scheduled for April and the following two years, and has raised the budget for capital spending by hundreds of millions of dollars a year.
But the flipside of this spend-up, when combined with tax cuts and falling company tax receipts as profits crumple, will be a steep rise in the projected track for Government debt, to an extent that Mr English has labelled unacceptable and which has prompted credit rating agency Standard and Poor's to warn of a possible downgrade.
While tax cuts, interest rate cuts and easing inflation will help, households are being hit by two serious negatives: falling wealth and rising unemployment. If the Reserve Bank is right and house prices fall, peak to trough, by 16 per cent, that represents at least $100 billion wiped off the net worth of households.
On top of that is New Zealand investors' share of the tens of trillions of dollars wiped off the value of global sharemarkets in an avalanche of selling over the past six months.
Wealth destruction on this scale is bound to have an effect on consumer confidence and spending. So too will the spectre of unemployment.
The year started with 105,000 people or 4.6 per cent of the workforce unemployed. Forecasters expect it to be closer to 7 per cent by the end of the year.
Every percentage point increase represents around 23,000 people.
The effects spread beyond those who lose a job or cannot find one, and their families. The fear of losing their jobs encourages people to spend less and reduce debt or build up precautionary savings.
The risk is a vicious circle where cautious consumers spend less, leading businesses to invest less and employ fewer people, leading to a further contraction in spending.
* Around the world in $4.5 trillion
So far governments around the world have announced stimulus measures worth US$2.25 trillion ($4.5 trillion) as they combat a deepening recession, according to the giant Swiss bank UBS.
Just under two-thirds of that is expected to have an impact on the world economy this year and would be the equivalent of 1.9 per cent of global gross domestic product (GDP).
It does not include the vast sums Governments and central banks have expended propping up tottering banks and injecting liquidity into the financial system.
- United States President Barack Obama last week signed into law a US$787 billion package of spending and tax cut measures. It represents some 2.7 per cent of GDP a year over the next two years.
- The Chinese Government has announced a 4 trillion yuan ($1.1 trillion) investment package over the next two years, equivalent to 6 per cent of GDP a year, mainly in infrastructure. Various tax cuts and subsidies for farmers and the poor would add another 0.8 per cent of GDP each year, UBS estimates.
- Australia's A$42 billion ($52 billion) package announced this month, on top of measures announced in the latter part of 2008, represents a 5.2 per cent of GDP boost, UBS said, but spread over three and a half years.
- Britain in November announced a range of tax cuts and government spending projects totalling 20 billion euros ($56.53 billion) to stimulate the economy. The Treasury announced it was prepared to inject up to 50 billion into British banks to support their businesses in return for preference shares.
- The European Commission estimates that fiscal policy among EU member states will be worth 3.3 per cent of GDP a year over the next two years - some 600 billion euros ($1.5 trillion).