In March of 2020 a decision was made to cease production of all non-essential goods and services unless the workers could produce these remotely. This was done in response to a new coronavirus pandemic. With much of the workforce forced into quarantine – unemployment spiked and GDP crashed in the expected ways. The question remains, what does the rebuild look like?
Subsequent to the lifting of most restrictions Treasury, the Reserve Bank of New Zealand (RBNZ) and BERL have produced a number of forecasts for the economic rebuild. We focus on unemployment for this article.
We first look at the Treasury’s September Pre-Election Fiscal Update (PREFU) and latest Half Year Economic Fiscal update (HYEFU). In the PREFU Treasury was forecasting a more intense depression and increase in unemployment spiking at 7.7 percent in 2021, followed by a very swift recovery to 5.3 percent by 2024. This forecast has been moderated substantially in the December HYEFU and now Treasury expects a spike to 6.8 percent unemployment later at the year 2022 and a distinctly slower recovery down to a much lower four percent unemployment by 2025.
Next we add to the chart the RBNZ and BERL forecasts for the economic rebuild. The RBNZ forecast is from the August Monetary Policy Statement. The RBNZ at this time forecasts a sharp increase to 7.7 percent unemployment in the June 2021 year followed by a very rapid rebuild and more modest unemployment rate of 5.9 percent in 2023.
BERL maintains our view that this economic shock will cause unemployment to spike at 8.5 percent in 2021 and follow a gradual but sustainable rebuild path down to around 4.8 percent by the year 2030. This view is based on our understanding of the structure of the New Zealand economy and historical examples of economic shocks and recoveries.
We note there is substantial uncertainty in all of these forecasts. It’s worthwhile looking at the upside and downside risks.
On the upside:
Treasury notes that the data support the view that the effect of the health response to COVID-19 was more subdued than originally expected. BERL’s view is that this is because of assumptions on the structure of the economy (who works where, on what, and with what) that were made a priori were incorrect and might be updated.
The current softness of the depression and expected swifter rebuild by the Treasury is built on the acknowledgement of the significant effect of fiscal support such as the wage subsidy scheme. This scheme is credited with keeping people in work and allowing businesses some “breathing room” to restructure or pivot instead of shutting down.
Lending support is on the upside as the RBNZ continues accommodative monetary policy including the Large Scale Asset Purchases (LSAP) programme and government bond programme. These policies have pushed the costs of borrowing down for both the private sector and government. For government this means an increased “war chest” for continued fiscal support.
For the private sector things are not so clear. BERL notes here that there are significant structural barriers to business borrowing in New Zealand and the effect of the LSAP programme is unlikely to be seen in private business investment but more likely to be seen in private residential investment.
Treasury cites that an expected continued increase in house prices will support the rebuild from the demand side.
Globally, our key trading partners are faring ok. The Australian economy is expected to post a shrinking of four percent while the US economy will shrink by 3.6 percent in the 2020 year. The Chinese economy is expected to grow by 1.8 percent though this should be taken with an appropriately large grain of salt given the high level of uncertainty around China's GDP figures.
On the downside:
There remains continued uncertainty on border restrictions in response to the COVID-19 pandemic. The working assumption of Treasury is easing restrictions in July 2021 with potentially no restrictions by 2022. This is assumption only and there have been no official announcements.
There is also some uncertainty around possible vaccines for COVID-19. While a number of vaccines for COVID-19 have been developed, there remains uncertainty as to their efficacy and their ability to be quickly distributed.
The risk remains that we could experience a resurgence of community transmission of COVID-19 which would necessitate a return to higher alert levels and more restrictions.
We also need to consider the risk to the speed of the rebuild and recovery to lower levels of unemployment. The Finance Minister in the Question and Answer portion of the HYEFU briefing alluded to the fact that 2021 brings big changes for New Zealand on climate policy. We can interpret this as a green recovery. A green recovery necessarily means new taxes on production and new spending in areas to combat climate change. This may come with higher unemployment for longer. We’ve made the choice for a green recovery but we need to be realistic about the implications and trade-offs.
Globally there remains geopolitical tensions, particularly between the US and China, though these should ease given the election of a Democrat president. We expect GDP growth in the US to increase in the near term as that economy recovers.
The lockdowns in response to COVID-19 caused a severe supply shock across the global economy. Supply chains in all different products have been disrupted, upheaved, shifted, and mangled. This supply shock, as yet, has not culminated in a financial crisis. This non-emergence largely due to the monetary response from central banks around the world (and independent of any decision the RBNZ makes). Simply put, central banks have managed to delay the crisis for now, but the risk has not been eliminated.
BERL emphasises that we are far from being out of the proverbial woods yet and it would not be a surprise to see a financial crisis emerge in the medium term.