Optimistic we can get through Covid-19

It is hard not to fret about the country’s economic stability when the Reserve Bank is spending tens of billions of dollars on quantitative easing and government debt is spiralling.

These are frightening and difficult times for the tens of thousands of people that are starting to be be laid off, and for business owners who are locked out of their premises and facing a collapse in sales.

But the economy can pull through the coronavirus pandemic without complete calamity, and so could many of the individuals most affected, if those who are less impacted are willing to share the financial burden.

As ANZ chief economist Sharon Zollner and many others have pointed out, New Zealand is in a better place that most countries to weather the storm.

It wouldn’t be surprising if New Zealand’s GDP fell an unprecedented 15 per cent, or more, in the three months to the end of June.

But, by the definition of the lockdown rules, the “essential” parts of the economy are continuing to operate.

The 10 to 20 per cent of economic activity that may not take place during the quarter will mostly relate to activities that have been deliberately turned off and could be “caught up on” as and when coronavirus restrictions are relaxed – such as most retail and entertainment spending.

More than ever, it makes sense to think of the economy from a “wellbeing” perspective.

Hopefully many of us will have had the chance to learn a new skill online, catch up with the DIY, get to grips with new technology, or just recharge our batteries and have a bit of a “reset” – activities that won’t contribute to GDP but which are still productive.   

Loss of international tourism will be very tough, but not horrific

Having fewer tourists and foreign students will be a large loss that will linger over the economy for years, until the pandemic is brought to some sort of conclusion and overseas economies recover.

That may be especially the case if – as now seems increasingly possible – New Zealand succeeds in eliminating the coronavirus within its borders.

It may then find itself in the position of having to seal itself off for a protracted period from visitors from countries where that won’t be a realistic goal.

Given what is happening in overseas economies, even if New Zealand opened its borders tomorrow, foreign visitors would not be arriving in large numbers.

But domestic tourism has been slightly more important to the economy.  

New Zealand stands to lose about $17 billion a year from the loss of foreign tourists’ dollars, while the border remains closed.

But that should be substantially offset by the $9.5b that Kiwis used to spend when overseas and on foreign travel, before the crisis.

They may not spend that money in the same places that relied on foreign tourists, but not much of it is going to be leaving the country.

The net impact? A drop in GDP of perhaps 3 per cent.

Quantitative easing really should help

Creating money through quantitative easing should prevent viable businesses from having to fold because of a credit crunch.

It involves a cental bank creating money to buy debt, generally government bonds, thereby freeing up money for banks and other investors to keep lending to businesses and consumers.

The Reserve Bank has committed $33 billion to its quantitative easing programme so far, with the suggestion of more to come, to stop credit in the economy from drying up.

Given the Reserve Bank’s balance sheet is in turn guaranteed by the Crown, quantitative easing may seem like a trick.

But creating more money through quantitative easing needn’t do harm, just so long as it doesn’t undermine confidence in “money” to a degree that would stop it being useful as a means of exchange or store of wealth.

Quantitative easing by the European central banks and the US in the wake of the GFC has largely been viewed by most academics as at least a qualified success.

Yes, ‘QE’ may have spilled out into asset-price inflation, in particular through rising house prices and soaring sharemarket valuations.

But its main goal of preventing a crippling liquidity crisis was, by and large, achieved and – critically – consumer price inflation did not get out of control as a result of the increase in the money supply.

And, no, there is no chance of the Reserve Bank going broke because of quantitative easing.

Because central banks can create their own money, they can in practice only be bankrupted by foreign-currency debts and index-linked liabilities.

NZ won’t run out of foreign currency

Preliminary data released by Statistics NZ strongly suggests “NZ Inc” will be able to continue to pay its way in the world, even during the level 4 lockdown.

New Zealand is believed to have run a $1.3b trade surplus in March as exports, including agricultural exports, held up impressively, and imports, probably mostly of non-essential items and oil, fell.

There is every reason to think that pattern should continue, just so long as New Zealand’s port and freight companies can keep the supply lines of essential goods out of the country open.

According to Statistics NZ, New Zealand only had about $8b of external, foreign currency-denominated debt that wasn’t hedged back into New Zealand dollars in September.

This really is a huge saving grace, providing as it does a sound platform for quantitative easing.

The Government can tax us more

No-one likes being taxed, but the Government has decent headroom to raise taxes over time to pay back the money it will borrow to fund the massive $50b fiscal stimulus it is now planning for.

New Zealand’s top marginal income tax rate of 33 per cent is the lowest of any country in the OECD, although it admittedly kicks in at a low threshold.

It is also rare in having neither a comprehensive tax on capital gains nor any kind of wealth tax, such as an inheritance tax.

Raising the tax rate on income above $70,000 a year from 33 per cent to 39 per cent would raise about an extra $2b a year.

It would still leave New Zealand sixth-equal from bottom in the OECD tax table, in terms of its top marginal rate.

Following the UK and imposing an inheritance tax of 40 per cent on the value of any estates over about $2m would probably raise something like an additional $1b a year based on Britain’s experience.

That would mean estates under that threshold paid nothing, and 40c in each dollar only on the dollars above that level.

It might be a fair “quid pro quo” for the sacrifices all younger New Zealanders – rich and poor – have been making through the lockdown to keep our older generations safe.

However it was done, tax changes on that sort of scale, $3b a year, could help put the country on an accelerated track to wind back government debt and quantitative easing.

Most analysts disagree that the time to start down that path is now, arguing for example that higher taxes would undermine the fiscal stimulus the Government is providing.

But I’m not so sure.

People on higher incomes will currently be spending a much lower proportion of their income than usual, and saving a higher proportion, due to the lockdown.

That means the dampening effect of a higher top marginal tax rate would be much less significant than might ordinarily be anticipated.

I think it will become ever harder to achieve public buy-in for tax changes to help share the pain of the coronavirus response, the longer the Government leaves it.

I’m also nervous about Finance Minister Grant Robertson’s assumption that New Zealand could take “generations” to pay for the economic recovery.

Regrettably, there is no rule that says ‘mother nature’ needs to let us recover from one calamity before handing us another.

The economy will I think weather the coronavirus crisis a bit better than anticipated.

But the Government should retain a large capacity to borrow in foreign currency, primarily because of the country’s natural disaster risk.

That requires not allowing debt to rise too high for too long.

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