Peter Lyons: Fairy tale economy not a pathway to sustainable growth

The Christchurch rebuild has been touted as a bonanza for our economy. Photo / Geoff Slaon

New Zealand is a Goldilocks economy. We avoided the worst carnage of the financial meltdown. Growth is forecast at around 2 per cent in the coming year, driven by the Christchurch rebuild and record low interest rates.

House prices are taking off in certain areas and the share market has had a stellar year. The unemployment rate is 6 per cent but most are either shirkers or lack the skills required for the contemporary workforce. Inflation has flatlined at 0.9 per cent. Best of all, the Government is on track to balance its budget by 2015.

That is the official "feel good" portrait of our economy. It is worth taking a closer look under the bonnet. The Christchurch rebuild has been touted as a bonanza for our economy. The reality is that the rebuild may allow us to regain the huge loss of wealth that occurred as a result of the quakes. While the incomes and output generated by the rebuild will add to our GDP, the rebuild is allowing us to regain only some of the wealth that was lost. It is not a pathway to sustainable economic growth.

Politicians have referred to our record low interest rates as a sign of strength. The reality is that our economy has been on life support since the global financial crisis. Things could turn ugly when this is turned off. The surging stock exchange and housing market has largely been driven by those artificially low rates. In Auckland and Christchurch, unleashed demand for housing is meeting constrained supply.

The Reserve Bank slashed interest rates during the financial meltdown. The aim was to encourage people to borrow and spend or invest to pump up economic activity. For the first few years this had little impact as confidence had collapsed and people sought to reduce debt. But memories fade.

The policy now appears to be unleashing asset inflation rather than stimulating productive investment and job creation. This flaw in the monetarist approach to economic management has become apparent since the GFC. Using interest rates to stimulate the economy during downturns often creates asset bubbles as excess credit floods the economy. It is a recipe for greater disaster in the future.

Unemployment of around 6 per cent is an ugly blot. This rate likely understates the problem because of the Australian safety valve and the high level of under-employment due to casualisation. Some commentators attribute unemployment to shirkers and skill mismatches between job seekers and employers. They conveniently overlook that in the boom years before the GFC our unemployment rate fell to around 3 per cent.

The Government has made much of its target to balance its budget. On the surface this sounds like sensible housekeeping. It has raised taxes in certain areas and cut spending in others. The brunt of this policy has been borne by low-income earners. The taxes raised include GST, tobacco and petrol which are regressive taxes impacting heavily on lower income earners as a proportion of income.

They also cut the top income tax rate. Government spending cuts generally hit lower income earners harder because they are the main users of government services. But the aim of balancing the books to reduce government debt ignores a fundamental lesson from the GFC. Both public and private debt can wreak havoc in an economy. Private debt can be more damaging and quickly morph into government debt.

In the past year mortgage debt rose by 5 per cent. The banks are getting back to their old lending habits. People are feeling wealthier and this usually encourages them to borrow and spend more.

This Government has been prudent in its management of public finances during a very turbulent period. Much of the cost of this caution has been borne by the less affluent. But this prudence will mean little if private debt levels mushroom to fund another round of asset inflation.

Peter Lyons teaches economics at St Peter's College in Epsom and has authored several economics texts.