Brian Fallow: How's the economy? Depends who you ask

A global recovery and resurgent confidence are providing ammunition for the optimists, but others have a more cautious view. Photo / Martin Sykes

Whether it is Alan Bollard setting the official cash rate rate or businesspeople contemplating investment, decision-makers face the problem that two plausible, but very different, stories can be told about the economic outlook.

The bullish view is exemplified by Westpac's economists. Previous recoveries have been strong, they say, and why should this one be different?

The average New Zealand recovery after a significant slowdown - not just outright recession - has seen annual growth peak at 5 per cent.

And if you exclude the mid-1970s oil crisis (a supply shock) and the early-1990s recession (a local banking crisis atop radical structural change), both quite different from the latest slump, annual growth peaked on average at close to 6 per cent, nine quarters after the recession.

This time round Westpac points to a global recovery under way, resurgent business and consumer confidence, a surge in net immigration, a recovery in house prices to within 4 per cent of their 2007 peak, and anecdotal evidence that the labour market has turned.

They expect recovery to be led by construction, consumer spending and the dairy sector.

New home construction has fallen by more than a third from its 2007 peak, even as the annual net migration tally climbed from a low of just 3500 in November 2008 to 20,000 a year later.

Meanwhile surveys of consumer sentiment have rebounded and the Westpac economists see a boost in spending power from the drop in the share of household disposable income pre-empted by debt servicing costs.

They estimate debt servicing costs fell from 17 per cent of income in October 2008 to to just over 13 per cent a year later, and will still be around 13 per cent in October this year.

Rural incomes are underpinned by a 50 per cent rise in world dairy prices last year, or 14 per cent in New Zealand dollar terms.

It is not just a dairy story. For ANZ's commodity index overall the rise in world prices for export commodities entirely offset the impact of the strong kiwi dollar.

Around the world authorities' immediate response to the financial crisis was dispense an extraordinary amount of fiscal and monetary stimulus. Policy remains very stimulatory. It would be remarkable if all that did not rev up the world economy, and it has.

And while the New Zealand Government talks of the need for fiscal "consolidation" after the very stimulatory policy of the last two years, the question is how.

It is not going to reverse last year's tax cuts, much of the planned infrastructure spending has been already set in motion, and it has already announced in last year's Budget a $1.1 billion limit on new spending initiatives.

The more cautious, and widespread, view of the outlook is exemplified by ANZ National Bank's economists. They argue that this time round the economy has less spare capacity.

Without minimising the human cost involved, an unemployment rate of 6.5 per cent is not too bad by international (the US rate is 10 per cent) or historical standards (11 per cent here in the early 1990s).

The Reserve Bank is surprised the recession has not had more of an impact on domestic inflation. As the ANZ economists put it, inflation has not been crushed, though it is contained.

While house prices fell less than expected and have retraced most of the fall, turnover is low - only about three-quarters of the average of the four years preceding the slump.

Credit growth remains subdued and is not going to go back to the boom-time conditions when credit was expanding three times faster than the economy, ANZ chief economist Cameron Bagrie believes.

The the new environment will be less about capital gains and more about yield and cashflow, he says, if only because it will be harder for the next buyer to borrow the money to pay more.

Spending will be more subdued and driven by income growth rather than the wealth effect, in contrast to the mid-2000s boom when consumption was turbocharged by people borrowing or withdrawing equity on the strength of swiftly rising house prices.

To Westpac's question "Why would it be different this time?" Bagrie's answer is that unlike previous credit crunches arising from businesses overextending themselves, this time it is households that have done so.

Households have a lot fewer options than businesses when it comes to retrenching and reducing debt, making the necessary adjustment a long-drawn-out affair.

A V-shaped recovery implies policymakers would be willing to see things go back to the "old normal" of borrow and spend. They are not.

"We need to ensure there is no return to a debt-fuelled housing cycle which would likely bring with it further exchange rate pressure and erosion of competitiveness," said Reserve Bank Governor Alan Bollard when releasing the bank's financial stability report last November.

To that end he can use not only monetary policy but regulation, and has already made changes to the liquidity policy banks must adhere to.

On the international front China and therefore Australia are going strong - to the point that both have already begun to tighten monetary policy.

That is helpful when nearly half of New Zealand's trade is with non-Japan Asia and Australia.

But the rest of the world is not looking as flash, and real doubt remains about the robustness of growth when the plaster cast of unprecedented monetary and fiscal support comes off.

Another key uncertainty, so to speak, is how ambitious the Government will prove to be in pursuit of structural economic reform.

Will we see a blockbuster Budget, consistent with the "step change" rhetoric?

On tax policy, for instance, an ambitious plan would cut everybody's income tax and fund it by a combination of higher GST and a low-level land tax.

Preliminary modelling for the tax working group included a scenario where the top personal rate and trust rate were cut to 30 per cent and the two lower rates cut to 10.5 and 19 per cent respectively, from 12 and 21 per cent now.

That would cost about $3.5 billion which could be found by raising GST to 15 per cent, introducing a land tax at 0.25 per cent and getting rid of accelerated depreciation on new plant and machinery.

By contrast at the timid, minimalist end of the spectrum, no doubt accompanied by a lot of rhetoric about downpayments or first steps, would be to scrap the 38c rate so that the top rate at least aligned with the trust rate of 33 per cent

That could be funded by scrapping the depreciation deduction on buildings, which is in effect just an interest-free loan to landlords but one with a mounting cost to the Crown in the context of rising property values.