Brian Fallow: Wild swings in the year of Covid

If the Reserve Bank is too aggressive in fighting inflation, it could trigger a property market crash, and reduce consumer spending. Photo / NZME

OPINION:

What's wrong with this picture? New Zealand households ended a year marked by lockdowns and recession more than 20 per cent richer than they started.

It is a picture of socialised losses, as the Crown's balance sheet took the strain, and privatised (capital) gains as a side-effect of ultra-low interest rates.

Statistics New Zealand has started to produce quarterly numbers on a broad sectoral basis tracking incomes and the uses to which they are put, and changes to balance sheets. Previously, those parts of the national accounts were only available on an annual basis.

But the past March year was marked by wild swings as economic activity first plummeted during the lockdown of the June quarter, followed by a swift rebound in September, some slippage in the December quarter and unexpectedly brisk growth in the March 2021 quarter.

The net effect, taking the year as a whole, was that the production measure of gross domestic product fell 2.3 per cent from its average over the year before.

The new income GDP numbers, however, suggest that it could have been a lot worse if fiscal measures like the wage subsidy, and other Covid-related programmes, had not propped up household and business incomes to the extent they did.

Households' disposable (after-tax) incomes rose 5.4 per cent in the latest March year.

That is altogether, not per household, and is nominal, not inflation-adjusted.

The flipside of the fiscal support was a jump in central government debt, which started climbing in the March 2020 quarter as Covid reached our shores. Between December 2019 and the March quarter this year, government debt rose by $64 billion or 72 per cent. The biggest chunk of that, $25b, was in the locked-down June quarter.

It is a legacy of debt for future taxpayers to service in an environment of rising interest rates.

Interestingly, the Government has been borrowing faster than it has been spending. As at March 2021, it had $25b more sitting in its account at the Reserve Bank than it did a year earlier. We are assured it will eventually make its way into the pay packets and business revenues of the nation.

Meanwhile, exceptionally easy monetary policy has been inflating asset prices.

Over the four quarters since March 2020, households' collective net worth rose just over $400b to $2.3 trillion. That is an increase of 21.6 per cent in nominal terms or 18.2 per cent adjusted for consumer price inflation. It was nearly as much as net worth had risen over the previous four years.

For that to happen in a year in which the economy's output fell rather challenges the belief that in New Zealand wealth is just the accumulated fruits of hard work and enterprise, which has been taxed as it was earned but has not yet been consumed — and the Government can keep its thieving hands off!

That proposition has been debunked by research within Inland Revenue with respect to the very richest New Zealanders at least, and in any case it is implausible in a country which generally does not tax capital gains.

In the year ended March, household assets rose by $417b, while debt rose by $16b.

Just over half (54 per cent) of the increase was in property assets, both owner-occupied and investment properties, to the not inconspicuous sum of $1.1 trillion.

Reserve Bank of New Zealand Governor Adrian Orr. Photo / Mark Mitchell

Financial assets rose by almost as much, reflecting the fact that global sharemarkets have been bullish, driven by the same ultra-low interest rates.

It leaves the Reserve Bank with a tricky problem. Inflation risks are mounting but if the bank is too heavy-footed when it comes to switching from the accelerator to the brake pedal, it could trigger a property market crash and send the wealth effect which has supported consumer spending into reverse.

The other side of the bank's dilemma is the fact that its monetary policy remit has been amended to include "assess(ing) the effect of its monetary policy decisions on the Government's policy ... to support more sustainable house prices, including by dampening investor demand for existing housing stock, which would improve affordability for first home buyers."

An injunction that micro-economic does not really belong in the monetary policy committee's riding instructions; its proper place is in guiding the bank's macro-prudential role.

But it is there, all the same.

In any case, the financial markets have convinced themselves the Reserve Bank will start to raise the official cash rate next month. That would be a year earlier than it indicated as recently as its May monetary policy statement, when its watchwords were "time and patience".

Part of the case argued for this hawkish view is the March 2021 GDP out-turn, which was a rise of 1.6 per cent, quarter on quarter, when the Reserve Bank had expected a further fall of 0.6 per cent.

But the latest income GDP numbers take some of the gloss, or inflationary menace, off that upside surprise.

The major driver of the jump in GDP was household consumption, but only half of the increase in consumer spending was explained by higher household incomes. The rest reflected a shift in how much of that income was consumed and how much saved.

For four quarters household saving — whether involuntary because of lockdown or precautionary in these times of peril and pestilence — had run high by historical standards, but in the March quarter it fell back to more normal levels. In our case that means very low levels.

In seasonally adjusted terms, all but $200 million of households' $50b of income in the quarter was consumed.

That was a one-off, though, or at least if household consumption was turbocharged in the same way in any future quarter, that would require the saving ratio to go negative, with spending exceeding income.

That is possible and not unprecedented. But it is rare and not a sustainable source of demand growth.