Why we need a recession plan
The uncertain outlook for the world’s economy will have weighed on the mind of Finance Minister Grant Robertson over the holiday break. Will New Zealand be ready to cope with the buffeting it will get if the world’s big economies take a serious downturn? Dr Kirdan Lees suggests there are five reasons why Grant Robertson needs a plan in his back pocket.
Reason 1: The outlook now points to recession risk with little room for interest rates to do much
The global economy in 2019 is much weaker than 2018. Brexit, trade wars, a US government shutdown and declining China growth are all in the mix. Oil prices are lower. Stock prices are lower. Markets clearly expect a much weaker global economy ahead.
New Zealand activity is weaker than expected, but at least for now, our economy is not shrinking.
But interest rates have never been so low, leaving little headroom for monetary policy to kick in. Mortgage and lending rates can’t fall by much if the big banks are to retain margins.
Fortunately, unlike other countries, the New Zealand Government has room for fiscal stimulus and needs to take the lead and do much more than ever before when the economy turns.
Reason 2: By the time Treasury calls a recession it’s too late to trigger a fiscal stimulus plan
To be clear, current conditions do not warrant additional fiscal stimulus. The economy is growing with little slack in the labour market. Existing government initiatives are supporting the economy: Budget 2018 included KiwiBuild and the Families Package that lifts household incomes.
But these are policies for normal times; policies calibrated to a benign growth outlook. In a downturn, so called automatic stabilisers, such as the unemployment benefit, that mechanically increase government spending in tough times help. And government takes out less tax from the economy when activity is lower. But much more will need to be done in a recession when interest rates cannot support the economy.
Waiting until GDP data show a recession is too late to implement fiscal stimulus. That strategy puts too many jobs at risk.
Today, a myriad of timely data exists: across transport movements, customs data, privately held data on small businesses (such as Xero) and consumption (such as Paymark). A small panel of experts could use that data to gauge recession risk and tell us when to pull the trigger.
Reason 3: Economic theory can help: a fiscal plan needs to follow three principles
When it comes to fiscal stimulus principles, macroeconomists have their own triple-T: stimulus needs to be timely, targeted and temporary.
To avoid firms starting to lay-off staff, stimulus needs to come quickly. A timely response hits the period of greatest need, not when the economy is already recovering.
Stimulus also needs to be temporary. Any package needs an explicit exit strategy. This improves allocation of resources in the economy and reduces the risk of costly debt increases.
Tax cuts and government spending should be in the mix and their relative merits evaluated. Tax cuts for high income people are likely to be saved rather than spent but so Government spending measures should be targeted towards poorer families that are compelled to spend in bad times.
Reason 4: Trotting out the same tired approach will provide the same tired results
One of the enduring traits of fiscal policy is tacking on extra spending in good times and taking away spending just when it is needed.
Governments seeking a labour boost need a better targeted fiscal stimulus. That means targeting labour-intensive industries such as such as health and education, construction, horticulture, accommodation and retail industries.
Right now the construction sector is tight, but experience suggests developers and builders shed jobs rapidly in a downturn. Governments that can keep existing projects on the table will be more effective than governments that promote new projects that take too long to begin.
But identifying labour-intensive industries is not enough. Maximum effectiveness comes from targeting the labour-intensity of the entire supply chain: labour-intensive industries that in turn use labour intensive inputs from other industries are the best bets for fiscal stimulus.
Reason 5: Articulating a trigger for the fiscal plan shapes the expectations of Kiwi businesses
Pulling the trigger should set in train implementation of the package of fiscal spending, and any additional measures (such as increasing unemployment benefits).
In a recession debt-to-GDP should materially exceed the usual targets. And that’s a good thing. But the plan then needs to spell out what part of the increase in debt-to-GDP is due to the shrinking economy and what is due to additional debt-financed spending.
Robertson needs to make explicit that fiscal spending is conditional on the state of the economy. Such a move consolidates support for the conservative approach to debt management Robertson has adopted so far while making a clear case for doing much more when needed.
The alternative of slavishly sticking to a conservative debt-to-GDP target as the economy turns south opens the door to speculation on an untenable target. Agitation would come not just from the public but from his fellow ministers pushing their own spending plans.
Families and businesses would get behind that planned-out approach. So too would coalition partners and cabinet colleagues.
Dr Kirdan Lees has managed research and policy teams at the Reserve Bank and has consulted to the Treasury on macroeconomic issues. He is a partner at http://www.sense.partners/