I have written multiple financial crises articles in the past but have yet to touch on my home turf, New Zealand. These tumultuous times make for quite the backdrop to finally highlight this nation. New Zealand found itself in quite an enviable position following the GFC due to a number of policy decisions that put it in a position to succeed and it was also fortunate to have surrounded itself with powerful trading partners. This article will discuss some of the points of resilience from the last GFC and whether those points will persist in today’s rocky economic climate.
So how did New Zealand manage to escape the GFC relatively unscathed?
Whilst being one of the most significant worldwide financial crises in history and largest since the Great Depression, the GFC was followed by a recession in New Zealand that involved a relatively minimal output loss in comparison to other countries and in comparison to previous global crises (pdf). It had been a while since the world had seen a widespread recession, and many countries found themselves in a difficult economic position. From 2007 to 2012, many developed countries experienced significant GDP per capita losses, such as Norway (3.3 percent), the UK (5.6 percent), and Denmark (6.7 percent). During the same period, New Zealand’s GDP per capita only dropped 1.5% (pdf). Six years after the start of the GFC, New Zealand had fully recovered in attaining its pre-crisis level of GPD per capita, outpacing the USA, the UK, France and Ireland.
Gabriel Makhlouf, former Reserve Bank Secretary, gave five major reasons (pdf) why New Zealand had managed to avoid the fate suffered by other advanced economies. These were:
- Domestic banks had limited exposure to global assets
- Household wealth fell only slightly due to a limited decline in house prices
- China & other Asian countries continued to demand exports
- High nominal interest rates and low public debt meant that there was plenty of room for monetary and fiscal stimulus
- Flexible exchange rate, product and labour markets
Going through these points with reference to the historical context will help to clarify why these characteristics of New Zealand’s economy were key.
Point one refers to CDOs, which I discussed in my previous GFC article, so I won’t reiterate the details but it’s well worth a read if you’re interested.
On the second point, the stability of house prices in New Zealand prevented panic selling of assets that could have led the financial system into turmoil. Residential building investment in New Zealand makes up a large proportion of investment as a proportion of GDP, around 25% at the time of the GFC. Additionally, there is a large amount of foreign investment in the nation’s housing industry. A major decline in property prices would have had a major impact on New Zealander wealth, and could have resulted in a reversal of foreign investment, capital flows and a sudden stop crisis for New Zealand. Thankfully, median prices in the housing market remained reasonably high, with the growth of house prices stagnating only temporarily rather than falling. Unfortunately, the New Zealand of today may not be so lucky. The Reserve Bank predicts that housing prices will drop by 9-10 percent. The HPI (Housing Price Index) is already 2.4% lower than in March. However, the HPI may not be the most accurate measure of house prices. In 2008, the HPI contradicted Makhlouf and other median house price studies by showing a large decline in the value of housing. Regardless, the trend of house prices will be a key indicator for understanding the strength of the New Zealand economy in coming months.
The third point, regarding sustained demand for New Zealand’s exports, is a rather interesting one. A workingpaper from the National Bureau of Economic Research (pdf) examining 120 years of historical data shows that New Zealand is highly vulnerable to external shocks, as you would expect for a small open economy. The paper indicates that external shocks have a more pronounced impact at times when New Zealand exhibits weak fundamentals (such as during the oil price shocks of the 1970’s), but shocks to US GDP were shown to hurt New Zealand’s growth in the medium term regardless of the underlying strength of New Zealand’s economy. This means that it is difficult for New Zealand to insulate itself from external shocks. Therefore, it is fortunate that New Zealand’s main trading partners, Australia and China, navigated the GFC well and continued to demand exports. New Zealand has previously seen crises due to falling export prices (pdf, see end of page ten), which led to declining land prices, leading to recession. If Australia and China had suffered a recession in 2008, New Zealand may have been in a lot more trouble. New Zealand’s exports have remained surprisingly stable in recent months, declining only 4% compared to the previous year. While Australia’s prospects are currently in doubt, China’s economy is predicted to grow up to 3% in 2020, and this growth should keep milk and other commodity prices high.
Now, we shall move on to the fourth point surrounding government stimulus. New Zealand’s monetary policy targets the official cash rate (OCR), a rate charged on overnight loans to commercial banks and which impacts all aspects of the economy. The aim is to set the OCR at a level which achieves a low and stable rate of inflation of within 1-3%. Fortunately, the Reserve Bank had set the OCR at 8.25% in the years prior to the GFC in an effort to offset the inflation caused by the housing boom. This gave New Zealand room to manoeuvre by reducing the OCR in order to stimulate the economy. By April 2009, the OCR had been heavily reduced to 2.5%. This gave New Zealand further room to adjust rates as it saw fit as opposed to other nations that reduced their rates to near 0% levels. New Zealand today does not have such luxuries. Over the last decade, the OCR peaked at 3.5%, leaving much less wiggle room. The current rate is a low 0.25%, which could prove problematic if further monetary policy action is required.
Finally, New Zealand’s adoption of a flexible exchange rate in the mid 1980’s gave it the ability to implement a loose monetary policy to help it through the crisis. A fixed exchange rate hamstrings the central bank as policy must be focussed on keeping the exchange rate stable. A fixed exchange rate is destined to fail, due to the potential of speculative attacks, when large inconsistencies develop between central bank policy and prevailing market conditions (pdf). Thus, in a crisis environment, when a country would be better served by focusing on monetary policy that stimulates growth, fixed exchange rate countries are forced to pursue a stable exchange rate instead of economic recovery. To see this you just need to consider the performance of Denmark and Sweden following the GFC, two countries with similar characteristics but different exchange rate regimes. Their differing recoveries suggest that Denmark’s fixed exchange rate and corresponding lack of monetary policy autonomy hurt its economic recovery. The only difficulty for floating exchange rate countries is that expansionary fiscal policy could result in an appreciating exchange rate, which would hurt export quantities. As discussed previously, the New Zealand economy is heavily reliant on exports, so this may provide some clarity as to why New Zealand’s fiscal policy approach was limited.
The COVID-19 world is a strange place. Rising unemployment and falling consumer spending coupled with a stock market collapse and subsequent rebound mean that it is unlike anything experienced since the 1930’s, and guidance from the recent past may be of limited use. However, if we use the GFC as a gauge for New Zealand’s resilience in the current climate, it appears that it is in a relatively strong position. While the low OCR and potentially dropping house prices are a cause for concern, continued export demand is arguably the most important factor to New Zealand’s economic performance. Financial instruments used in the world have become more complex over time and the interconnectedness of the global economy make the transmission effects more palpable – the small fish like New Zealand have to hope that other major economies stay strong in an uncertain world.
Dean Franklet is a recently graduated economics and finance master’s student from the University of Canterbury where he was President of the largest commerce society on campus. Spending his life in Texas and then New Zealand with a few other stops along the way, he gives a unique global viewpoint to portray in his writing.
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