Adrian Orr needs a monetary policy mate and fast

Awful business confidence figures suggest GDP growth is slowing to 1 percent. The Reserve Bank is running out of ammunition in its fight to boost the economy as the OCR approaches zero and banks tighten lending. It needs the Government to step up with fiscal stimulus, rather than its current contraction, Bernard Hickey argues.

The current slump in business confidence to the lowest point since the Global Financial Crisis is reinforcing the case for the Government to use the 'out clause' in its Budget Responsibility Rules to allow it to use growing surpluses and/or extra borrowing to help the Reserve Bank strengthen the economy.

The reading of confidence is not just a "snapshot of opinion" as Prime Minister Jacinda Ardern said on Wednesday in playing down the prospects of a downturn.

"We've got solid projected growth relative to other countries. Our unemployment levels are near-record low. And when you look at the share markets and exporters and how they are tracking and also profitability of our business, all of those are tracking well," Ardern told Country Radio host Jamie Mackay on NewstalkZB.

The problem for Ardern is all those factors she cited are lagging indicators and official forecasts from before the New Zealand Institute of Economic Research's June Quarter survey of business opinion (QSBO) showed confidence about both the wider economy and actual experienced activity at 10 year lows. This is not just a political bias story. Businesses' experience of their own activity and outlooks is the worst since the depths of the Global Financial Crisis.

This is despite Ardern's announcement on April 17 of the abandonment of the Capital Gains Tax under her leadership and a Reserve Bank rate cut on May 8.

Economists firmed up their predictions for two more Official Cash Rate cuts this year to 1.0 percent this year, probably with the full Monetary Policy Statements on August 7 and November 13. This came as the Reserve Bank of Australia cut its cash rate by a further 25 basis points to 1.0 percent on Tuesday afternoon.

RBNZ almost out of ammo

The potential for the Reserve Bank to exhaust all its ammunition is growing as the OCR gets closer to zero and it needs 'monetary policy mates'. The issue becomes more acute when it is combined with planned capital increases for banks that may mean much of the remaining cut in the OCR is not passed on and as banks restrict lending.

Currently, the Government is actually subtracting from economic activity over the forecast horizon. The Budget in late May showed the 'fiscal impulse' was actually a combined subtraction of 1.3 percentage points of GDP over the next four years (see the chart below).

Meanwhile, Treasury reported last week a surplus of $7.0 billion for the 11 months of the fiscal year, which was $2.5 billion above the May forecast. And it's not a temporary thing. Tax collections under the new IRD system have been higher than expected and Treasury said it expected most of the extra money to persist to the end of the year.

Beehive has plenty of ammo 

Net debt has already fallen to 19.3 percent of GDP, which is three years earlier than planned in the Budget Rules.

Moody's points out New Zealand's net debt is a full 10 percentage points below the median for AAA rated countries such as ours. Even the Treasury has said the Government could go up to 30 percent without too much trouble.

Yet we have a Reserve Bank that desperately needs mates and a Government running a surplus and detracting from GDP. This is all due to the Government's adherence to its Budget rules set before the election.

Here's how much room New Zealand has. Most other countries with the same credit rating have higher net debt levels. New Zealand's 10-year Government bond yield fell to a record low of 1.5 percent. Central banks are about to embark on fresh rounds of 'quantitative easing' or money printing to buy their own Government's bonds. The German 10-year Government bond yield fell to negative 0.36 percent this week. That means fund managers in Europe to happy to pay their Government money to look after their money for 10 years. 

Those same fund managers are desperate to invest in growth economy with an astonishingly high (to them) yield of 1.5 percent.

Time to use the 'out clause'?

 But there is an 'out clause' and Finance Minister Grant Robertson set the groundwork for the Government to use its balance sheet in its last Budget before the next election by widening the net debt target to 15-25 percent of GDP from 2022. The midpoint is still 20 percent, but there's flexibility to grow debt by as much as $20 billion or six percentage points of GDP without breaching the range.

Most had expected Robertson would wait until well into next year, using the cover of the wider range and the further downturn in the global economy. But the case is growing for the Government to act earlier. The current out clause says: "We expect to be in surplus every year unless there is a significant natural event or a major economic shock or crisis." (The bolding is mine.)

Now. Not later 

No one would call the current economic situation a new global financial crisis, but global trade flows are dropping quickly. Also keep an eye on the Baoshang Bank crisis in China, which is causing ructions in the wider banking and shadow banking markets there. Check Monday's email for more background on that.

Robertson may be able to wait until next May and deliver an election year whump of spending, but things are deteriorating fast enough that the December Half Year Update may see him signal extra spending early.

By then the OCR is expected to be 1.0 percent and RBNZ Governor Adrian Orr may be asking for the Government to be much more of a monetary policy mate.

This week the Reserve Bank of Australia's Governor Philip Lowe took the unusual step of asking Prime Minister Scott Morrison to add stimulus as he cut his cash rate to 1.0 percent.

"We will achieve better outcomes for society as a whole if the various arms of public policy are all pointing in the same direction," Lowe said.

He warned of a deteriorating global environment with slowing growth in America and China and Europe, on top of headwinds from the China vs America trade war. Politicians and Governments were not helping with policies focused on austerity and skimping on infrastructure spending.

"Many are preferring to sit on their hands, rather than commit to capital spending," he said. "If this continues for too much longer, the effects on economic growth are likely to be significant."

Government running tight budget

He was speaking after New Zealand's Budget included $3.3 billion less borrowing over the next 18 months than was expected in December and a reduction in forecast capital expenditure over the next four years of $3.3 billion. 

Ardern and Robertson are jumping at the shadows of bond vigilantes who were euthanised a decade ago ...

It seems incredible. Just as the Reserve Bank was having to loosen monetary policy to help the economy, the Government was reducing capital expenditure forecasts and planning to subtract from economic growth because it did not want to break a promise that few New Zealanders knew about, let alone cared about. It's also a promise that the people who should care, ratings agencies and bond investors, don't think is a problem at all.

Ardern and Robertson are jumping at the shadows of bond vigilantes who were euthanised a decade ago and are worried about what the Opposition might say about the Government's fiscal responsibility. The same Opposition complained this week about delayed infrastructure spending and weak business confidence. 

There are plenty of options for boosting the economy, starting with infrastructure. But the much faster and more effective option would be to heed the advice of its own Welfare Experts Advisory Group, which called for income increases for beneficiaries that would cost $5.2 billion, but would reduce healthcare, education and justice system costs, along with boosting productivity. 

'When the facts change, I change my mind. What do you do, sir?'

Ardern said this week the Government could not spend that money because it had to adhere to its Budget rules. 

They are rules that no one in financial markets or the electorate cares about. They are a construct of a conservative Labour and Green leadership in 2017 who did not know the scale of the infrastructure deficit and the need to be a monetary policy mate as interest rates approached zero.

The famous economist John Maynard Keynes was often quoted as saying: "When the facts change, I change my mind. What do you do, sir?"

It's time for Ardern and Robertson to change their minds along with the facts.

Newsroom is powered by the generosity of readers like you, who support our mission to produce fearless, independent and provocative journalism.

Become a Supporter


Newsroom does not allow comments directly on this website. We invite all readers who wish to discuss a story or leave a comment to visit us on Twitter or Facebook. We also welcome your news tips and feedback via email: contact@newsroom.co.nz. Thank you.