KEY POINTS:
Financial trouble in the US could make tax cuts in New Zealand this year more than just an election-year bribe - they might be needed to spice up the economy, say economists.
Reserve Bank Governor Alan Bollard, who last week left official interest rates on hold, is preparing for at least $1.5 billion in tax cuts this year.
That is likely to provide some unwelcome inflationary pressure, but in the context of a slowing world economy, it might just turn out to be just what New Zealanders need.
Finance Minister Michael Cullen joined forces with Bollard last week, stressing that it's too early to know how any downturn in the US will affect New Zealand.
In a speech to the Canterbury Employers Chamber of Commerce last week, Bollard said recent turmoil on financial markets had not made him change his outlook and the financial turmoil had yet to translate into signs of recession.
In any case, New Zealand was "well-positioned" as a neighbour of Australia and Southeast Asia.
Director of Business and Economic Researchers (Berl), Kel Sanderson, says Cullen has been talking about how good the communication is between himself and Bollard.
"If we become even more concerned about international problems, [tax cuts] may have the opposite effect, that from a fiscal point of view you become somewhat more relaxed about even getting into a fiscal deficit," says Sanderson.
"It's also pragmatic from the inflation point of view, because if there's international recession, it's much less likely you're going to import inflation so you can get away with using a bit of your buffer to keep activity up in New Zealand.
"You're replacing some of the income that you were getting normally from international [sources] - you'd be replacing it by not taking so much tax. It's still responsible from a monetary or inflation point of view."
The large surplus that the Government had been running has been acting as a brake on the economy, reducing economic activity, he says.
Tony Alexander, chief economist at the BNZ, says he sees little need for any kind of "mini-budget" of New Zealand tax cuts or spending increases to influence short-term growth, as is happening in the US.
"Especially not given the Reserve Bank's fight against inflation - now the Reserve Bank has already taken into account $1.5b of tax cuts or increased spending," says Alexander.
"There's definitely scope there [for tax cuts]. It's up to the Government how they're going to do it, you'd suspect it'd be aimed at the lower end of the income spectrum.
"The significant issue will be whether it ends up being more than $1.5b - what else happens with increased spending and will there be extra upward pressure on interest rates?
"This might be an area where the global downturn might actually help the Government, to the extent the global downturn decreases New Zealand's inflationary pressures."
A downturn would provide extra scope for the Government to give tax cuts or increase spending ahead of an election without forcing a response from the Reserve Bank.
If tax cuts created too much of an inflationary response, then the Reserve Bank would increase interest rates.
But Alexander is still wary of getting too alarmed about the recession in the US spreading globally.
"If we really are looking at a much weaker global environment, then for New Zealand about 22 per cent of our exports go to Australia and 40 per cent of our tourists come from Australia - and Australia is looking strong.
"The impact on the New Zealand economy will be present, but we're not looking at an Asian crisis situation and there are gathering doubts whether Europe is slowing all that much."
Alexander says it is increasingly looking like this is a recession that the US "has to have" because it has been irresponsible with its monetary policy, as well as its banking and securities supervision.
Cullen has also been talking down any risk to New Zealand, saying talk of global recession has been "over-hyped" and it is still too early to see what kind of impact the US crisis might have for New Zealand.
Cullen has promised this year's Budget will not include anything that might exacerbate domestic inflationary pressures.
Deutsche Bank chief economist Darren Gibbs says the Reserve Bank will need to see signs of the US problems spreading to Asia and Australia before it considers cutting official interest rates.
"If you react to downside risks to growth at this point, and those risks don't eventuate, then you are going to have a horrible inflation picture facing you over the next couple of years. It's pretty horrible already," says Gibbs.
"If things do turn out to be weaker over the next six months, [Cullen] can come to the rescue and deliver $2b or $2.5b worth of tax cuts."
Alexander says the US volatility is not driven by any particularly nasty data releases but a global bout of the "heeby jeebies" about corporate earnings and economic growth.
"The Reserve Bank is likely to be in the same frame of mind as the Bank of England and the European Central Bank, not wanting to get dragged into the panic-driven interest rate cuts now happening in the United States.
"The US has definitely made the call that it would rather avoid a recession than miss its inflation target, although it has been assisted by more downside news and inflation pressures that are easing.
"But it has made it clear that inflation is more acceptable than an economic downturn.
"In our own minds, we would suggest that the costs of a major downturn in our economy would have a significantly greater effect on our economic growth than a period of high inflation."
The BNZ thinks that the Reserve Bank is likely to hold the official cash rate at 8.25 per cent next time Bollard makes an announcement "and then keep it there longer than it should".
