Downturns are common but this one is different
Downturns are baked into our economic system. Even during the golden post-war years, developed economies slid into recession every decade or so. With international stock markets suffering their worst days since the 2008 crash, it looks like the inevitable downturn might finally have arrived.
This time, however, it’s different. We haven’t seen a potential global pandemic like this since the Spanish Flu ravaged developed economies in 1919. Most recent public health emergencies have been localised, leaving the rest of the world to go about its business. Sars, swine flu, and bird flu each gave Asia a decent lashing, but their effect on other economies was isolated to certain sectors.
The last time there was a global economic shock, the Government largely relied on the Reserve Bank to do the heavy lifting. The bank slashed interest rates by 5.75 percentage points over the course of a year to keep people borrowing and spending.
The Government hastily announced a guarantee of bank deposits to maintain people’s confidence in the financial system and the incoming National Government spent up on the first generation Roads of National Significance and (though they couldn’t foresee it at the time) the Christchurch rebuild.
This time, the financial system is intact and firms aren’t having difficulty accessing credit. However, Chinese factories have been unable to supply New Zealand businesses with inventory, which hurts firms on the supply side, while exporters are being slaughtered by a downturn in demand thanks to our largest trading partner going into effective lockdown.
None of those things are likely to be helped by a conventional fiscal or monetary policy response. People can’t go to work or head to the shops if they’re not allowed out of their homes.
Governments around the world are putting together packages to protect their economies. Finance Minister Grant Robertson has said this Government would roll out targeted wage subsidies to help struggling firms retain staff.
He is largely on his own. In a briefing he received from Treasury in January last year, he was warned the Reserve Bank could only cut rates to roughly -0.35 before people started to hoard cash. Treasury told him he’d need to get ready to spend money to stimulate the economy, saying such spending should be ‘‘timely, targeted, and temporary’’.
He’s got other options, but these should be weighed up carefully to make sure they fit the crisis.
Economist Brad Olsen says short-term targeted wage subsidies and tax deferrals are the best immediate option as, at the moment, the key issue is ensuring businesses retain staff.
Sweeping measures such as tax cuts might be able to stimulate demand by putting money in people’s pockets, but they’re difficult to roll back after the threat recedes. People get used to a tax cut.
The Government also has to make sure any changes it makes reach the people they’re supposed to. Sometimes stimulatory tax cuts have the effect of discouraging business to put up wages, as staff feel like they’ve been given a pay rise already.
A stimulatory tax cut is also extremely expensive. National’s 2017 tax cuts of about $11 a week for workers on more than $22,000, and $20 for those on more than $52,000 a year, cost $2 billion in forgone revenue.
That’s a lot. It would give a tax cut to the 110,500 taxpayers who earn more than $150,000. Those people might not need a cut and, were they to get one, they’re more likely than low-income workers to save rather than spend it.
Economist Michael Reddell has recommended a temporary cut to the GST rate, which would have a similar effect. The Government would lose revenue, but people might be encouraged to buy more. There’s also no guarantee firms would pass on the entire tax cut.
Another popular move is ‘‘helicopter money’’, currently being tried in Hong Kong. The Government hands out money to people to spend (as if it were thrown from a helicopter).
But there are problems with this too. There’s no guarantee they’re likely to spend it – or spend it in the right places. Treasury was concerned some might splash stimulus on goods from offshore. Great news for Amazon owner Jeff Bezos, not so good for the New Zealand economy.
There is a silver lining. The Government has extraordinarily low debt, which currently sits at roughly net 20 per cent of GDP. Treasury thinks it could rise to 30 per cent of GDP in normal times, allowing a rise to 50 per cent during a crisis. Allowing debt to rise to 40 per cent would mean borrowing roughly $60 billion – an extraordinary sum, which no-one is anticipating.
Unfortunately for Robertson, the problem isn’t having money to spend, it’s how to spend it. In that sense, he’s in very uncharted territory.
Tax cuts might be able to stimulate demand by putting money in people’s pockets, but they’re difficult to roll back after the threat recedes. People get used to a tax cut.