When the Reserve Bank (RBNZ) delivered the first rate cut of a new monetary easing cycle last month, it represented the end of an era for Covid economics.
With a massive injection of fiscal and monetary policy stimulus, New Zealand saw off the worst
What we learned: 10 of NZ’s top economists share their biggest lessons from the Covid years
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NZH Graphic/Richard Dale
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Kelly Eckhold, Westpac chief economist
“Monetary policy eventually works,” says Eckhold. “We certainly saw periods at both ends of the cycle where there were concerns about whether the transmission mechanism was working and whether more tools were necessary. In the end, the boom-bust cycle is evidence there is plenty of powder in the cannon – we just have to wait for the cannonball to reach its range.”
Another big lesson from the pandemic era was that people hate inflation, he says.
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“Despite people not having to deal with it for a long while, when inflation appeared and stuck around, we saw a strong constituency for inflation control when it was apparent that incomes weren’t going to be able to keep pace.”
The cycle has been a reminder that policymakers need to use “the right tool for the right problem”, he says.
“The authorities pulled all the levers – both fiscal and monetary – to stimulate demand in the face of the Covid shock. However monetary policy with its long and variable lags was poorly suited to the uncertain situation - and quantitative easing and long-term committed lending operations were especially bad.”
“These tools have impacts long after the need for impact was gone and can’t be easily fine-tuned. Temporary fiscal expansion was always going to be the most appropriate tool, and we would hope this lesson was well (albeit painfully) learned”.
But the long-term fiscal expansion done during and after Covid “suffers the same drawbacks we found with monetary policy”, he says.
“We have a long potentially painful road back to fiscal consolidation on that score.”
Sharon Zollner, ANZ chief economist
“The passionate hatred of inflation is what’s struck me too,” says Zollner. “People despise inflation even if median incomes are keeping pace.”
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That explains why inflation was so political (and why we have inflation targeting in the first place), she adds.
The pandemic years also highlighted the difference between GDP and real incomes, she says.
“It might be all obvious in hindsight, but economists had assumed a massive, persistent negative confidence shock to spending that just wasn’t there once people realised their incomes were secure.”
Finally, she says, the pandemic has really shown up New Zealand’s “reliance on importing labour, skilled and unskilled, to paper over all the cracks in our education system, apprenticeship system, health system, mental health support system... you name it.”
“Our vulnerability was horribly exposed,” she says.
Stephen Toplis, BNZ head of research
“One big question is why New Zealand has underperformed its trading partners by so much this cycle?” says Toplis.
“It is difficult to reach any conclusion other than New Zealand policymakers got it wrong with both the Government and RBNZ sharing in some of the blame – the extent of the lockdowns, the fiscal response, the monetary response and the coordination between fiscal and monetary policy.”
Overall, Covid reinforced many of the views that we already had about the world, Toplis says.
“You get the biggest immediate bang for your buck from fiscal policy and “the quality of fiscal decisions is more important than the quantity. It’s also a lot harder to remove assistance packages than it is to initiate them.”
“Monetary authorities are not well placed to cope with supply shocks and economists don’t spend enough time thinking about them,” he says.
Ultimately, excessive provision of free money ends up causing inflation problems, particularly in asset prices. And the impact of changing asset prices is often underestimated.
But Toplis notes that economic models do not work well when hit by “new” shocks.
He also adds that New Zealand has a much higher dependence on foreign labour than we had understood.
And finally: “People have amazing resilience in the face of adversity.”
Nick Tuffley, ASB chief economist
Tuffley picks up on the resilience of people through the pandemic.
“Never underestimate the ingenuity of people to rise to challenges in a way we don’t during ‘peacetime’. The ingenuity and resources put into developing vaccines were huge, saving lives and giving politicians and individuals the courage sooner to reopen to the world.”
“People are inherently very adaptable: give people the right incentives and signals and you can get powerful outcomes. And people weren’t as cautious (e.g. job security concerns) after lockdown as feared – so a lot of activity recovered quite quickly.”
He notes that the impact of policy responses “cushioned the worst periods” and were a lot more effective in holding economies up than many expected.
“We took the kitchen-sink approach to prop the economy up. In hindsight, the support (particularly monetary policy) was too much but we didn’t know that at the time.”
“Being cautious and doing too little would have been a worse place to be in. NZ got through 2020 and over half of 2021 remarkably well. But stimulus just brings forward activity from the future, and we are now in the payback time. The policies also caused distributional distortions, for example, the wealth boost to (mainly older) property owners relative to younger generations.”
We generally underappreciated the long tails across many facets that will have lasting impacts, Tuffley says
“The pandemic period itself dragged on, it wasn’t one wave and done, it was several significant ones.”
The quality of education suffered through the lockdown period and after, he says. There were deep-seated behavioural changes as a consequence of the pandemic, such as working from home, and the growing distrust of governments and policy institutions. Misinformation and conspiracy theories have become a more significant issue.
The pandemic also exposed underlying problems in the economy, that have been “deep-seated” for some time, including our: productivity, reliance on foreign labour and infrastructure deficit.
“We need to look beyond the short term and make long-term strategic decisions.”
Jarrod Kerr, Kiwibank chief economist
“The biggest lesson learnt has to be the power of monetary and fiscal policies when working together,” says Kerr. “Monetary policy was left to its own devices following the 2008 crisis and fiscal austerity hit, particularly in Europe. Covid was a different shock. It was a health shock and governments were eager to help.”
“So super-loose, highly extraordinary monetary policy, with well-oiled printing presses was combined with large, well-timed, and well-targeted fiscal policies. They worked better than expected and helped generate a strong rebound, and then inflation.”
Tony Alexander, independent economist
“Extraordinary measures require an extraordinary assessment of their effectiveness and their ongoing need,” says Alexander.
“Actions by both the Reserve Bank and Finance Minister over the pandemic were ultimately failures. They started with successes in 2020 by containing the drop in the economy and sentiment. But this was wiped out by their failure to recognise the impact of their measures and the quick erasure of their need to be continued in 2021. Ultimately many of the thousands of businesses closing currently and people losing employment are in this position because of the 2021-22 policy failures. Act and assess.”
Cameron Bagrie
Bagrie highlights the use of Covid response money for obviously non-Covid purposes as a lesson we should learn.
“Covid became an excuse to do anything as opposed to targeted Covid relief, AKA a slush fund,” he says.
He also argues that the interaction between monetary and fiscal policy wasn’t well understood.
“I don’t think the RBNZ fully appreciated the scale of fiscal stimulus that was being pumped into the economy, which meant they went too far loosening monetary conditions.”
“The post-Covid bounce in activity courtesy of extraordinary stimulus lulled us into a false sense of security over what was normal. This has made the reset harder,” he says.
Christina Leung, Deputy Chief Executive, Auckland & Principal Economist, NZIER
“With 20/20 hindsight I would say it is the impact of the response in economic activity to policy decisions i.e. the feedback loop,” says Leung of her pick for the most important lesson.
“For example, at the beginning of the pandemic, most analysts were forecasting a tanking of the economy. Alongside that pessimism were forecasts among many of the unemployment rate reaching double digits (in fact our NZIER forecasts of the unemployment rate reaching around 8% were called by some in the media as optimistic!).”
In response to these forecasts, central banks and governments around the world injected an unprecedented amount of stimulus into the economy, thus driving an acceleration in inflation.
The “forecast errors” reflected forecasts for an economy in a “do nothing” scenario, she says.
But in reality, policymakers went on to put in place rather extreme stimulus measures to ward off exactly such outcomes.
“Related to that is the importance of understanding the drivers of the inflation outlook when forming policy responses. An unprecedented amount of stimulus was injected into an economy which was suffering from supply shocks in the form of lockdown restrictions and illness, rather than weak demand.”
Dr Oliver Hartwich, New Zealand Initiative chief executive
Hartwich also highlights a misreading of the extent of the demand shock.
“When Covid struck in early 2020, we were all at sea because none of us had ever dealt with this kind of situation before. We did not know what it would be like having your borders closed and the country in lockdown. My gut feeling (and that of most economists) was that it could push the economy off a cliff – a bit like the GFC, perhaps like the Great Depression.”
“However, it became clear by around May 2020 that our situation was nothing like these other events. This was not a Keynesian demand slump. No, with all the supply-chain disruptions and people still working from home, this looked much more like an exogenous supply shock.”
“Now, whether it was a Keynesian demand slump or an exogenous supply shock really mattered. Because if it was the former, then stimulus might have been justified. If it was the latter, stimulus would have made a bad situation worse because the extra stimulus would have encountered a reduced supply and just resulted in higher prices. Well, it turned out that’s exactly what’s happened.
“So while many central banks kept treating it like a normal recession, the administered medicine turned out to be the wrong one.”
“And to me, that demonstrates why it is absolutely crucial to get your underlying analysis right.”
“By the way,” adds Hartwich. “As I said, I was in the stimulus camp, too – but only until about May when it turned out that it was something else. I changed my mind then. Others took longer, and it cost us dearly.”
“The single biggest takeaway for me was the realisation that getting your fundamental economic analysis right really matters,” he says.
Brad Olsen, Infometrics chief executive
“Inflation is hard to control once it starts running away – I was on Team Persistent, but it took longer for Team Transitory to see that inflation was higher and stickier than hoped – by the time that evidence was in, it seemed too late to keep inflation more contained, and that saw monetary policy exacerbate the economic cycle!”
“We’re often fast to respond to downside risk, but we’re more reluctant to react as fast on the upside!”
So while the pandemic era affirmed that monetary policy works, Olsen notes that fiscal policy also works, “all too well”.
“We saw that fiscal policy worked well too during the pandemic, getting money out quickly and stimulating activity. But is also raises the question of if automatic stabilisers remain the best fiscal option for economic downturns (or all downturns), given that New Zealand was more proactive, providing a wage subsidy instead of just allowing unemployment to rise … What should our policy stance be in the future?”
Another lesson we learned was that the world is really interconnected, he says.
“Yes, that was clear before the pandemic, but the disruption in production and shipping globally had a large and continued effect. Probably the biggest lesson was that supply shocks are still a thing, and they’re hard(er) to work against than demand shocks.”
Finally, Olsen says, the pandemic provided a reminder that forecasting is an art rather than a science.
“[It] becomes far more challenging when you have to make assumptions about not only the usual economic trends, but also the structure and composition of the economy and about non-economic factors.”
Liam Dann is business editor-at-large for the New Zealand Herald. He is a senior writer and columnist, and also presents and produces videos and podcasts. He joined the Herald in 2003. To sign up to his weekly newsletter, click on your user profile at nzherald.co.nz and select “My newsletters”. For a step-by-step guide, click here. If you have a burning question about the quirks or intricacies of economics send it to liam.dann@nzherald.co.nz or leave a message in the comments section.
