KEY POINTS:
Even as the economic outlook worsens, the seeds of recovery are being sown.
It will be a while before the harvest, economists warn, and as with any crop all sorts of things might go wrong.
But the things which need to happen are under way: Households are reining in their spending and borrowing, the housing market is falling, the currency likewise, and both monetary and fiscal policy are being eased dramatically.
On the dimensions of the hole we are in - how deep and long the local recession will be - views vary, the key uncertainty being how unpleasant and protracted the global downturn will be.
The OECD said yesterday that the United States and the euro area are already in recession and will continue to be until the second half of next year.
With the two great locomotives of consumer demand going backwards the export-focused economies of Asia are inevitably hit too, as is the big mine across the Tasman.
The Treasury, in an updated outlook written for the incoming Government this week, has slashed its expectations of growth among New Zealand's trading partners by a third from what it expected in the pre-election "opening of the books" only last month. Hopes for an export-led recovery starting about now are therefore on hold.
For households the news has not been all bad, however.
Petrol prices have fallen by 25 per cent from their mid-year peak.
The Reserve Bank has cut the official cash rate by 1.75 percentage points. The market is expecting another full percentage point cut next month, and further easing beyond that.
Banks have passed on most of the easing to mortgage rates, but the popularity of fixed-rate loans means it takes time for the mass of borrowers to feel the benefit, just as it shielded them when rates were rising.
And the change of Government means last month's tax cuts will be followed by another round in April.
Some relief for consumers is timely. They have been tightening their belts all year. Retail spending shrank in real terms in each of the first three quarters of 2008, and growth in borrowing by the household sector is the weakest it has been for seven years.
But this new restraint follows a borrow-and-spend binge which saw household debt levels, relative to income, increase by more than 50 per cent over the past five years.
That trend, which also saw debt-servicing costs as a share of income rise by around 50 per cent over five years, was unsustainable and in the process of correcting.
Westpac chief economist Brendan O'Donovan said it was inevitable that at some point households would begin to cut back on the excesses of recent years and start spending more in line with what they earned.
Just as banks' access to international funds had become more difficult, demand for credit had reduced dramatically as well.
"In the middle of the housing boom - the system was having to come up with $1.6 billion or $1.8 billion a month to fund additional mortgages. Now it is down to about $200 million a month," O'Donovan said.
The Reserve Bank in the financial stability report it released on Wednesday said the rate at which households were accumulating liabilities had fallen sharply over the past year and the ratio of household debt to disposable income appeared to have peaked.
"Sharply lower turnover in the housing market means fewer people are taking out mortgages to trade up or buy their first home," it said.
House prices are down nearly 7 per cent on a year ago, according to Quotable Value.
The Reserve Bank estimates the market is about half-way through its correction. Westpac also expects a peak-to-trough fall of 15 per cent and does not expect house prices to return to 2007 levels until 2012.
Deustche Bank chief economist Darren Gibbs takes a dimmer view. He believes the housing market will fall 20 per cent from its peak late last year and that the resulting drop in homeowners' wealth will reinforce weakness in consumer spending - the reverse of the "wealth effect" which turbocharged spending during the housing boom.
But BNZ chief economist Tony Alexander is more sanguine.
"The reason I don't buy the idea of a 20 to 30 per cent decline is that we don't have the physical oversupply of housing that has built up in the United States for example," he said. "And new construction has been dropping like a stone."
In addition Alexander expects a pick-up in net inward migration, though not on the scale of the big surge of returning expatriates which followed the tech wreck and September 11 attacks seven years ago.
The big cloud over households, however, is the labour market.
Confronted with recession on both the home front and offshore, and a credit squeeze, businesses are cutting back on investment and employment.
The unemployment rate is 4.2 per cent. Forecasts for the peak are clustered closer to 6 per cent - not too far above the average over the past 10 years which is 5.3 per cent.
But what matters for consumer confidence, retail spending and the housing market is not how many people lose their jobs but how many feel insecure and pull in their horns accordingly.
Housing is not the only market well on the way through a correction from over-valued levels.
The Kiwi dollar has depreciated 25 per cent from its peak in the middle of last year, on a trade-weighted basis, and economists see it falling further yet.
"The currency has got a lot further to fall. The world is shunning debt and New Zealand is one of the most indebted countries around," O'Donovan said. He sees it dropping below US50c and by a further 13 per cent on a trade-weighted basis by the middle of next year.
It marks a shift from several years at levels tough on exporters but good for the consumers of imported goods.
It will help to narrow deficits in overseas trade and the current account of the balance of payments, which have become unsustainably wide at $5 billion and $15 billion respectively.
The size of the gap between what New Zealand spends and what it earns, in its dealings with the rest of the world, is the economy's Achilles heel.
In recent years the deficit has largely been funded by inflows of foreign credit into the banking system. The international credit crisis means that funding is no longer readily available. That has triggered moves by the Reserve Bank to provide alternative sources of funds to the banks, and by the Government to provide a guarantee for banks' wholesale funding.
The cumulative effect of decades of deficits is that the country's net overseas liabilities stand at $159 billion or 88 per cent of gross domestic product. We are, in short, up to our chins in debt to the rest of the world at a time when credit is tight and investors are risk-averse.
The process of reining in a current account deficit involves a contraction in domestic demand (less call for imports and less profit for foreign-owned firms) and lifting exports.
The Treasury points out that export performance will benefit both from a lower dollar and higher volumes of agricultural products next year as the effects of last summer's drought wear off. But in the meantime, reflecting evaporating demand, export commodities prices are dropping fast. Last month they posted their steepest decline for at least 22 years in world price terms, to be 11 per cent lower than a year ago.
Policymakers went into this downturn with plenty of ammunition.
Having started with just about the highest official interest rates in the developed world, the Reserve Bank still has plenty of room to cut them.
And with no net debt - the legacy of 14 years of fiscal surpluses - the Crown's accounts balance sheet is enviably strong by global standards.
The status quo before the election already implied a large fiscal stimulus in the year to June next year - equivalent to 2.8 per cent of GDP, the Treasury estimates.
The April tax cuts, the planned boost to the accommodation supplement for people made redundant and accelerated infrastructure spending will extend that stimulus into the following year.
But while fiscal stimulus is timely, New Zealand Institute of Economic research chief executive Jean Pierre de Raad warns of a couple of risks in the current environment.
One is that a sense of emergency makes for hasty decisions that look good in the short term but are poor investments or policy choices in the longer term.
The other is a ratchet effect. While it is easy for the Reserve Bank to reverse interest rate cuts, it is harder for a Government to scrap spending programmes once they are in place.
