Listener 13 March, 1999

Keywords: Macroeconomics & Money;

Sometimes public comment on forecasts focuses on the statistics, and ignores that there ought to be an underlying account of the state of the economy. With the March quarter round of forecasts underway, it may be useful to set down the some of the questions that top forecasters are pondering.

We know the economy is an expansionary phase of the business cycle, but what sort of expansion? The main options are the expansion is driven by exports or it may be a domestic one. If the latter, with a big increase imports and insufficient exports, the current account deficit will look even worse.

What are components of the expansion? It might occur by the stock cycle (retailers and manufacturers replenishing their stocks); by an increase in public spending (a big one seems to be on at the moment; but it partly reflects oddities of statistical definitions); from an expansion in private consumption (perhaps induced by the July tax cuts); by an increase investment (additional productive capacity and/or extra housing); by additional exports (a lot of the value data we are seeing reflects higher prices from a fall in the exchange rate, rather than additional production). Forecasts with similar overall expansions may have different patterns for the components. So despite the apparent unanimity, they have quite different accounts of what is happening in the economy.

Why have we low inflation, despite a fall in the exchange rate? A lower exchange rate (around ten percent in the last year on some measures) means higher prices for imports (and for domestic products which are also being exported). That should appear in higher consumer prices. But consumer inflation remains low. Part of the explanation seems to be that the world price of exports and imports are falling too. Export prices have fallen further than import prices, which is bad news for exporters, for some of their exchange rate gains are only compensating for the parlous state of their world prices. But is the external price path all of the explanation? Are New Zealand firms squeezing their margins? Is it because of productivity gains, or are they cutting into profits? What would be the implications of lower profitability.

What are the sustainable growth prospects? Forecasting is about considering the fluctuations about a long term trend growth rate. Without one you cannot tell whether the upswing is rapid or slow, and whether the economy is overheating into a burst of inflation, or will struggle weakly along. The general view seems to be the growth rate of volume (or real) New Zealand GDP in the long run is about 3 percent p.a., much the same as the rest of the OECD. How did the forecasters come to this conclusion? Is there enough capacity and ongoing investment to enable the economy to grow at this rate? Will it be able to earn enough foreign exchange from exporting to fund the imports a sustainable expansion requires?

How are we paying for the expansion? While there is much comment on the low household savings levels, the big New Zealand savers are the corporations and unincorporated businesses. While a lot of big corporations are part or fully owned by foreigners, the rest of the businesses are mainly owned by the households, so their savings are a part of the nation’s private savings. But they are insufficient, given the large current account of the balance of payments deficit the economy faces.

Can we rely upon foreign investors to cover the gap between our foreign earnings and foreign spending? New Zealand is seen to be a safe haven for investors, so they put here some of the funds they withdrew from more risky East Asia, South America, and Eastern Europe. We have been lucky in the world financial crisis. Will that continue? If it does not, we could be a basket case to join the other areas.

How are we to interpret the latest pronouncements of the Reserve Bank?