Quake's economic aftershocks, EU crisis ripples both here to stay - Bollard

New Zealand is still absorbing the impact of a year of twin shocks, says Reserve Bank governor Alan Bollard.

Although the Eurozone situation now looks less fragile than it did before Christmas, Dr Bollard told a business lunch in Christchurch today that the effects will take some time to work through the global economy.

"Experience shows that regions cannot ‘decouple’ themselves from global financial events, though the timing and transmission of shocks can be quite different," Dr Bollard said in his annual scene-setting speech to the Canterbury Employers‟ Chamber of Commerce. This year's title was "A Tale of Two Crises".

"For example, New Zealand’s increasing reliance on Asia as a trading partner reflects export market flexibility and has helped growth, but could not shield us from the slowdown in world demand, or the drying up of financing, even if it has meant a smaller drop in demand for our exports."

"New Zealand’s geographical isolation is no protection from economic events abroad. If major world economies have a significant economic problem, then that is going to affect us too, as New Zealand has seen in our export commodity prices, currency, and funding our foreign debt."

There is likely to be an increase in the funding costs for New Zealand banks during the year, and that will push up retail interest rates -something the Reserve Bank will take account of in any changes to the official cash rate (OCR), he said. 

"When large economies take remedial measures such as the bailouts in the euro zone and quantitative easing in the United States, and the consequent fiscal austerity, it can have major distortionary effects on the global economy and New Zealand. 

"Such measures affect financial market pricing, access to international credit and international capital flows. Funding may not be available to banks or to sovereigns…International markets are an important source of funding for our domestic banks. Although New Zealand banks are currently well funded, bank funding costs are likely to increase to some degree over the coming year."

While the Reserve Banks prudential liquidity policy, which started last year, will help to some degree, "the underlying vulnerability will remain until New Zealand achieves a sustained improvement in national savings."

The long slow crisis in Europe – as well as the different type of crisis in the US - is also a reminder that although a loose fiscal policy by governments can be a useful stimulus if a recession is deep and/or long, such a policy needs to be disciplined. 

Such a fiscal stimulus " needs to be swiftly identified and implemented, credibly sun-setted, and coordinated with monetary policy," he said. 

The sovereign debt crisis in Europe also underlines the need for governments to maintain a strong fiscal position – i.e. surpluses – when there is not a recession. 

A major crisis along the lines of the EU "can deliver a severe combination of reduced revenue, higher transfers, and ballooning government debt (potentially exacerbated by bailed-out bank debts being transferred on to a government’s balance sheet)."

Add to that longer term structural issues such as the ageing population and long-term savings and investment imbalances and governments who run a loose fiscal policy can find themselves in difficulty. 

That is the more so as the world financial markets are much more wary about risk than they have been for the past 15 years or so. 

"As this crisis persists, it is evident that public borrowing capacity is being much more tightly constrained by credit ratings, fiscal projections and market discipline. This limits what governments can do to stimulate economies in the future, or bolster bank balance sheets, if there were to be a double dip."

In New Zealand's case, there has been a looser fiscal approach run since 2008, although this has mostly been in the form of a huge surge in infrastructure investment and tax cuts rather than in the kind of large increases in operating spending seen in Australia and in numerous North Atlantic economies. 

But the New Zealand government has a second shock of its own to deal with – the cost of the Canterbury earthquakes. 

These costs are likely to be higher than the $20 billion the Reserve Bank estimated before the Christmas Eve aftershocks, he said, although he did not provide a new estimate. 

"In addition, the longer the delays to rebuilding, the greater the human cost and the risk of leakage of businesses and residents from Christchurch to other centres. Delays could also mean the rebuild is done more quickly, albeit starting later, so exacerbating inflationary pressures."

Earthquake related government spending is already estimated at $13.6 billion for last financial year, and that is only the start, he said. 

"Overall, there still remains a great deal of uncertainty in quantifying the effects of the earthquakes."