Timing of floods terrible for economy

The floods of the past week are bad news for the economy. That should be obvious, but it isn’t always the case. Natural disasters are never really good for an economy but occasionally, they can seem like they are. Economists call this the broken window fallacy. It’s a fallacy because fixing broken things is no way to create wealth. Of course, it actually makes you worse off in the long run.

With hundreds of houses either written off or requiring major repairs, it’s easy to see how the total bill for flood damage is already being estimated at more than $1 billion.

There is also substantial infrastructure work to be funded. Then there are the lost earnings that many businesses will simply have to wear.

But the insurance money and government support that pours into an economy after a disaster, and the extra activity that repairs and reconstruction generate, do have a stimulatory effect.

So, weirdly, economies can experience a bump in GDP growth in the wake of disaster. That happened after the Christchurch earthquakes.

Unfortunately, the timing of the floods in the past week is entirely unhelpful given where we are in the economic cycle. The last thing we need is more stimulus.

The Reserve Bank is already hiking interest rates to slow economic activity and, hopefully, get inflation back under control. Economists say it is still too early to be sure of the overall economic impact of the flooding. But, on balance, they see it as being inflationary.

The economy is running at capacity and the construction industry and food producers are struggling to keep up with demand, prices keep rising. Damage to crops in the fertile belt around Pukekohe will mean more upward pressure on food prices.

The timing for construction costs is also terrible. The first signs of inflation easing in the building sector were just starting to show in the latest Consumers Price Index data. The sudden increase in demand for construction products and workers is likely to blow that out of the water for the next few months.

If there is any consolation, it is that economists expect the Reserve Bank to look through the short-term price shock the flooding will cause and will remain focused on core inflation over the next year to 18 months. There are signs that it has peaked.

In the US and Europe, they are already celebrating (perhaps too early) with stockmarkets booming back to life. In New Zealand, the evidence has been more subtle — buried in recent CPI and labour market data.

The impact of flooding may make the evidence even harder to discern in the next round of data.