Brian Fallow: Checking on the anti-virals

Treasury Secretary Dr Caralee McLiesh and Finance Minister Grant Robertson at Parliament's finance and expenditure committee this week. Photo / File

COMMENT:

Both the Reserve Bank and the Government are keeping their powder dry as they wait to see how bad the impact of the coronavirus epidemic gets. That raises the question: how much policy powder do they have?

Finance Minister Grant Robertson and governor Adrian Orr were both gingerly threading their way along the narrow path between reassurance and complacency on Wednesday.

Robertson told MPs on the finance and expenditure select committee that it was early days to decide what the economic impact would be. The public health dimensions of the epidemic were still uncertain.

March quarter gross domestic product would undoubtedly take a hit. Sectors like tourism, international education, fisheries and forestry were already feeling the impact. The timing and extent of a subsequent rebound were not so clear.

"We are taking this very seriously," Robertson said, but New Zealand was coming from a sound economic base and was in a position to withstand headwinds like this in a way many countries could not.

"We are in a very strong [fiscal] position to respond. To take net debt as an example, it is considerably lower than we inherited even with the infrastructure package we announced," said Robertson.

Orr said the bank assumed the overall economic impact of the coronavirus outbreak on New Zealand would be of a short duration, with most of the impacts in the first half of this year.

"Nevertheless, some sectors are being significantly affected. There is a risk that the impact will be larger and more persistent. Monetary policy has time to adjust if needed as more information becomes available."

Monetary policy would only be part of any policy response, he said, and not the most effectively targeted part.

And other factors like the exchange rate (lower) and the shape of the yield curve (flatter) were also moving in real time.

The Reserve Bank's problem is that the scope for conventional interest rate cuts is severely limited by historical standards, while the scope for the kind of quantitative easing practised by other central banks in recent years is limited too.

Reserve Bank Governor Adrian Orr. Photo / File

The official cash rate, left unchanged this week at 1 per cent, compares with 8.25 per cent when the global financial crisis hit, allowing then-governor Alan Bollard to cut by 5.75 percentage points. The average monetary easing in recent recessions has been between 3.5 and 6 percentage points.

As for unconventional monetary stimulus, the scope for the Reserve Bank to buy up government or corporate bonds, pushing up the price and thereby lowering the yield, is constrained by the fact that there is comparatively little government and corporate debt on the secondary market that the bank could bid for before liquidity became an issue.

One of the key ways quantitative easing works is to lower longer-term interest rates, but the yield curve is already fairly flat when the Government can borrow 5-year money, for example, at 1.1 per cent.

Another objective of quantitative easing is to encourage investors to replace low-yielding government debt with riskier but more stimulatory private sector investment. But as a majority of New Zealand government debt is held offshore, it is not clear that would have the desired effect on our economy.

So with so few bullets in the central bank's bandolier, it is fortunate, should things get ugly, that the Government is well armed.

At December 30, half-way through the current fiscal year, core Crown net debt stood at $64 billion or 21 per cent of gross domestic product, compared with around 76 per cent for advanced economies as a whole.

That does not mean the Government could pile on scores of billions of dollars of additional debt with impunity.

Its debt levels may be low by international standards, but the same cannot be said of the household sector at 95 per cent of GDP or the country's external debt, at 51 per cent of GDP in net terms or 96 per cent gross. These are factors the credit ratings agencies regularly cite as risks.

Then there are the longer-term fiscal implications of an ageing population. The International Monetary Fund reckons superannuation and public health care costs will each rise by around 1.5 per cent of GDP by 2030, a material increase when core Crown expenditure is running around 30 per cent of GDP.

Even so, there is clearly plenty of headroom for fiscal policy to respond in the event the economy gets sideswiped by a negative shock from the other 99.8 per cent of the world.

Workers disinfect a closed shop following the coronavirus outbreak, in Jiang'an District of Wuhan. Photo / AP

That shock might arise from the coronavirus, especially as it is way too soon to assume — as economic forecasters seem to be doing — that it will be confined to China and therefore only affect New Zealand indirectly via trade, tourism, international students, financial markets and business confidence.

Then again, the shock might yet arise elsewhere. Only last month, the focus of concern was a possible war in the Gulf and attendant oil shock.

So it is instructive to consider Treasury thinking about what a fiscal stimulus might look like. Glimpses of that, at a high level, can been seen in a report officials wrote in the middle of last year, a heavily redacted version of which has been elicited under the Official Information Act.

The policy response to an economic downturn, we are told, should aim to minimise the reduction in incomes, investment and aggregate economic activity, preventing job losses where possible and providing other opportunities where not, while not allowing inequality between households or regions to worsen because of a downturn.

A fiscal stimulus response should be timely and it should be targeted in the sense of minimising the amount of stimulus spending that flows overseas through imports or into other non-stimulatory forms of spending.

Officials also argue that a stimulus should satisfy their third "T" of being temporary — that is, not commit the Government to permanently higher spending and higher debt.
That is more debatable. What would be wrong with a policy which provided both a timely stimulus and addressed an ongoing need?

Ten years after income tax thresholds and rates were last adjusted, there is a case for addressing the stealth tax increase of bracket creep.

And the Welfare Expert Advisory Group has made a strong case for lifting the level of the main benefits.