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Economic Situation Report

Treasury Scenarios

Last week – the third full week of Alert Level 4 – saw the release of a set of scenarios from the New Zealand Treasury. While we can quibble with some of the details, one thing it does illustrate is the historic magnitude of this shock to the economy. The gross domestic product statistics we use now only began in 1987. A look at the history of that data shows that quarterly changes average around 1 percent in magnitude, with the largest change in a single quarter being the -4.2 percent fall in 1989. Since 1987 falls of 3 percent or more have only been recorded 4 times. Treasury’s ‘scenario 1’ (the least severe) suggests a single-quarter fall of 24 percent in the current quarter.

Source: Statistics New Zealand, Treasury

Longer term time series are of varying quality and comparability. Statistics New Zealand provides several series that estimate gross domestic product, which have been combined in the chart below (along with a rough adjustment to remove the effect of population growth). The red X in the chart marks the estimate for annual real growth in gross domestic product by the first quarter of 2021 in the Treasury’s scenario 1. (The scenarios in which level 4 lockdowns have to apply for longer estimate a fall in gross domestic product of more than 30 percent). Regardless of the duration of the current shock, it certainly looks to be the sharpest ever experienced in Aotearoa-New Zealand.

Sources: Statistics New Zealand System of National Accounts and population estimates; Rankin, K. (1991) "New Zealand's Gross National Product: 1859-1939"; Easton, B. (1997) "In Stormy Seas - The Post-War New Zealand Economy"; Greasley, D. & Oxley, L. (2008) "Re-inventing New Zealand: Institutions Output and Patents 1870-1939"

That the recession that is upon us is both sudden and severe is not in doubt. There are questions, however, about the speed at which we will be able to recover. In all of the Treasury scenarios, activity bounces back relatively quickly, and by the end of 2024, has not just recovered to pre-lockdown levels, but close to the previous forecasts for 2024 from their Half-Year Economic and Fiscal Update (HYEFU).

Source: https://treasury.govt.nz/publications/tr/treasury-report-t2020-973-economic-scenarios-13-april-2020

A relatively quick recovery in incomes is certainly to be hoped for. And as scenarios 1a and 2a (which assume additional fiscal stimulus over and above that already committed) suggest, a strong policy response from the government will be necessary to achieve that. Fortunately, the strength of the government’s balance sheet means it is well placed for this. The Reserve Bank of New Zealand is also likely to have an important role in recovery, although some commentators consider it has so far appeared rather complacent about this. Also in our favour, the capital base of the economy, while idle, is largely undamaged (unlike shocks that may occur in war or natural disaster, where large scale destruction of capital may occur), so there is at least the possibility of a quick return.

There is a risk, though, that such a large shock may trigger a self-reinforcing series of events in which the initial disruption of supply and lockdown leads to business failures and rising unemployment, which in turn leads to belt-tightening and falling demand, to further business failures, and so on. Such a contractionary cycle leads to the possibility of a much more protracted depression-style event. Again this underscores the importance of a strong fiscal response with the government stepping in to fill the gap in aggregate demand.

Unemployment Rate

The Treasury’s scenarios indicate a sharp rise in unemployment is underway. Scenario 1 has the unemployment rate peaking in the current quarter at 13.4 percent – higher than the peak of 11.4 percent reached in the early 1990s, following a period of significant reform and fiscal contraction. The worst-case scenario presented by the Treasury, which assumes 6 months at Alert Level 4, would see unemployment rising to more than 25 percent.  

Source: Statistics New Zealand, Treasury

How this national picture may translate to the Waikato region remains to be seen. However, it is likely that those groups typically characterised by higher unemployment such as Maaori and younger workers, may be particularly hard hit here as well as nationally.

The tourism sector – which is estimated to contribute around 10 percent of jobs in the Waikato region – has been a significant early casualty of the lockdown, and the closure of the borders means jobs related to international tourism were amongst the first to go. But tourism in the Waikato was, before the lockdown, weighted towards domestic markets, and there is potential to grow that part of the business again as the alert level is moved to less restrictive levels. Finally, the speed at which unemployment comes down again may depend on how much of the government’s fiscal stimulus is pointed in this direction.

There are good arguments to say that the economy that existed prior to the Covid-19 pandemic was all very well, but it was failing to deliver in many ways. Productivity in the economy overall was poor and has been underperforming for years. Many persistent social and environmental problems appeared intractable. It is worth considering that the economy that we had may not be the same as the one we want to get back to.

Blair Keenan
Principal Economist
Waikato Regional Council

 

About out guest contributor

Blair has an undergraduate degree from the University of Otago. Keenan worked at ANZ as a macro-economist and industry analyst for five years before heading overseas as a researcher for Japan’s External Trade Organisation in the UK. While in the UK, he also received his Master’s degree in applied environmental economics from the University of London and was an economist at the National Farmers Union of England and Wales. Back in New Zealand, he held several policy roles at Landcare Research, Department of Internal Affairs and Housing New Zealand before his current role as principal economist at Waikato Regional Council. He also continues to collaborate on projects with the University of Waikato, CRIs, central and local government, and a variety of industry groups.