COVID-19 economic analysis – 22.04.2020
Analysis of Treasury’s scenario forecasts (released 13 April) and weekly economic commentary (released 17 April), by Senior Researcher Julian Wood as at 22.04.2020
The following is an overview and commentary on economic information available from the New Zealand Treasury on the impacts of COVID-19. As such it widely reformats or directly quotes the available documents and adds commentary from a wide range of sources.
COVID CONTEXT AND ALERT LEVEL DECISIONS
Treasury argues that the peak of active COVID-19 cases is behind us and that the growth in global infections continues to slow. (Many commentators are highlighting that as economies open there are now higher risks of a secondary round of infections occurring and people are watching Singapore closely in this regard). The Treasury also outlines that the Government has started planning for alert Level 3 and further support for small businesses. The decision has now been announced and the country will move to level 3 on April 29 for two weeks. In this two week window further alert level decisions will be made.
DOMESTIC ECONOMIC FORECASTS ARE BECOMING MORE NEGATIVE
Treasury highlights that bank forecasters over the last week have grown more pessimistic with the general view from banks now being that GDP will contract by around 15% in the June quarter and unemployment will rise to around 9% in September (this would equate to total unemployment of around 230,000 people). In contrast the Treasury’s own forecasts on 13 April, put the GDP contraction in the 5-8% in the June quarter, with unemployment rising to 7% (180,000 unemployed) in their most optimistic forecast (Scenario 1) and 23% in their most pessimistic (598,000 unemployed).
In response to questions from the Epidemic Response Select Committee Reserve Bank officials offered the following rule of thumb in regards to government economic models. They seem to predict that existing at Level 4 restricts the economy by around 40% (i.e. running at 60% capacity), Level 3 by 30% (70% capacity), Level 2 by 20% (80% capacity) and Level 1 by 10% (90% capacity).
It is my opinion that Treasury models seem to have a strong “reversion to the mean” built into their design which means they mathematically pull growth rates back to their long term averages rather than allowing their modelling to include the possibility that the shock may have long term negative effects (hence they do not explicitly model hysteresis effects whereby an economy locks in a lower growth path over time). In this regard I argue that Scenarios 1-4 all appear to underestimate the shock to world demand that we are likely to experience and hence overestimate the economic bounce back. Scenario 5 tries to estimate a shock to world demand on their most optimistic forecast and this slows the economic rebound considerably
If one were to re-run the scenarios with the negative worldwide outlook included it is likely that this would slow the rebound recovery. In this regard it is useful to take note of the generalised rebound pattern in Figure 1 below. This illustrates how the Treasury model estimates the impact on Scenario 1 (the most optimistic scenario) of a 3% decline in world annual average real GDP growth in 2020 and 4% in 2021.
GLOBAL ECONOMIC FORECASTS ARE BECOMING MORE NEGATIVE
Treasury do note that the International Monetary Fund has cut global growth forecasts. Looking at the IMF data we can see that world output is forecast to contract -3% in 2020, with advanced economies contracting -6.1%, and emerging and developing economies contracting -1.0%. Australia, our largest trading partner and second largest destination for our exports (at 15% of NZ exports), is forecast to contract by -6.7%.
In regard to China (the largest destination for our exports) Treasury notes that the trade data is better than expected and that this is supporting global markets, although overall activity in China remains weak. A sharp decline in China’s GDP data was expected at around -6% by Treasury but we now know that China’s economy has contracted by -6.8% in the first three months of 2020. Having said this the IMF is still forecasting a small growth in GDP over the entire year. See the table below for more global growth forecasts by country and grouping. The important detail to note is that all our major trading partners are significantly negatively affected.
IMF FORECASTS FOR WORLD GROWTH
Source: Author using https://www.imf.org/external/pubs/ft/weo/2020/01/weodata/download.aspx and https://oec.world/en/visualize/tree_map/hs92/export/nzl/show/all/2017/
OIL IS MASSIVELY OVERSUPPLIED AS DEMAND DROPS OFF A CLIFF
In regards to oil, Treasury comments that OPEC has agreed to cut oil production. I would add that the massive fall in demand, combined with Saudi Arabia and Russia undertaking a price war, means there is still a massive oversupply of oil and crude oil is trading at unprecedented lows. I would expect this to translate into a continuation of the current low pump prices until the oversupply is absorbed).
HOUSE PRICES ARE EXPECTED TO DECLINE
Treasury note that the numbers of house sales have fallen but prices hold up. However, Treasury also notes that commentators expect house prices to fall by between 5% and 15% over the coming year, as heightened uncertainty and lower household incomes negatively impact demand.
INFLATION IS RISING BUT SOME FORMS WILL BE CONSTRAINED IN THE SHORT-TERM
Treasury notes that food and rental prices have risen. CPI inflation is now known to have risen 2.5% over the year to March 2020 even accounting for the massive adjustment in petrol prices. Treasury do note the rent freeze will hold rents at their current level for now.
MAXIM COMMENTARY ON THE RESCUE PACKAGE
On the rescue package it is worthwhile to note that Treasury outlines three scenarios, a NZ$20 billion dollar rescue package as the baseline, a NZ$40 billion rescue package and a NZ$60 billion dollar rescue package. This highlights the uncertainty around the total costs of the rescue package but also the extent to which the government sector is preparing to intervene with assistance. While these higher rescue package amounts were able to improve output and employment outcomes under their forecast scenarios it’s important to note that these were still only an improvement . The overall impact even with massive injections of assistance is still expected to be negative over the next year.
Finally, the amount of debt the government is running up is significant and this will have a number of distributional and equity outcomes over generations (see separate note for more detail). It would also appear that when it comes to paying off this debt, all the cards are on the table. Yesterday the Governor of the Reserve Bank in his comments to the Epidemic Response Select Committee appeared to leave the door open (maybe slightly ajar) to monetising the debt we incur during this crisis recovery. This amounts to printing money.
This analysis should not be taken as personal financial or economic advice, as it is subjective opinion based on Julian’s reading of the economic situation as at 22.04.2020 and it does not take into consideration your particular objectives or circumstances. While care has been taken in the preparation of this analysis, this is a fast-moving situation with many unknown elements and unpredictable decisions that must be taken by individuals, organisations, and institutions both local and international.
Julian Wood is a Senior Researcher with Maxim Institute, an economic specialist with published policy papers on regional development and immigration in New Zealand. Previously he worked as a senior policy analyst for the Department of Labour, where he provided the government with advice and research into labour market dynamics, minimum wage and employment legislation, regional development, business dynamics, immigration, and the future of work. Julian holds a First Class Master’s in Social Science from Waikato University with an economics major examining gross labour market flows and testing matching functions in the New Zealand economy.