Given the growing importance of tourism to the NZ economy, there is a risk that the latest earthquake could adversely impact visitor arrivals. However, looking at the 2010/11 earthquakes, the long-term impact appears to be limited (see graph from ASB Bank). It is estimated that the impact on visitor arrivals is likely to be small in comparison to the previous quakes, though Wellington through to North Canterbury are likely to see a reduction in visitors. Spare a thought for Kaikoura, the whale-watching capital, which has experienced a lot of damage and currently has no access routes.
Unlike other sectors which produce material goods, tourism encompasses a range of industries and is based on characteristics of the consumer, rather than what is being produced by the producer. Feeder industries into the tourism sector include:
Accommodation – Transport – Retail Trade – Food and Beverages – Car Hire – Tourist Sites
Tourism spending – year ended March 2016
- Domestic = $20,213m ($15,361m spent by households $4,852m spent by business and government)
- International = $14,486m ($2,747m from international students)
Total = $34,699m
One significant point from the data was that tourism revenue surpassed export revenue from dairy products.
Contribution of Tourism to Gross Domestic Product (GDP)
- Direct contribution – $12,873m = 5.6 % of GDP.
- Indirect Contribution (supplying of goods and services to tourism sector) – $9,815m = 4.3% of GDP
- Total contribution = $12,873m + $9,815m = $22,688m = 10% of GDP
Employment – the tourism sector is quite labour intensive, with:
- People employed 188,136 = 7.5 % of total employment.
- People indirectly employed = 144,186 = 5.7% of total employment.
- Total 332,322 = 13.2 % of total employment
Source: Parliamentary Library – Monthly Economic Review November 2016
Although the attention this morning was on the election of Donald Trump as US President the RBNZ cut the OCR to 1.75% with a mild easing bias of “numerous uncertainties remain, particularly in respect of the international outlook, and policy may need to adjust accordingly”.
It is expected that the OCR will remain at this level in the near future with inflation expected to be back within the 1-3% Policy Target Agreement (PTA) by the end of January next year – see graph from ASB Bank. The reason for this is that:
- Dairy prices have recovered considerably.
- The labour market is tightening.
- Growth is running at an above-trend pace.
- The OCR is already at an expansionary rate and the economy.
Could there be another cut in the OCR? There would be pressure if the following eventuated:
- there is a strengthening of the NZ dollar,
- increasing bank funding costs,
- any further weakness in inflation expectations,
- any deterioration in the global growth outlook.
The change of US Presidency will also be a wildcard over the longer term, with its mix of potential fiscal stimulus and trade protectionism. Trump has already signaled that he is not keen to sign TPP and he wants to reopen the NAFTA – North America Free Trade Agreement. Furthermore, he might take umbrage on the Chinese with their manipulation of the Yuan to advantage its exports and put a large tariff on its goods coming into the US. For New Zealand it may mean that they have to go down the bi-lateral agreement option in order to increase trade.
Other than the US election, Graeme Wheeler needs to be aware of the following:
- Theresa May has indicated she wants to trigger Article 50 by May 2017 – it is very unclear what the process will be and the negotiating strategy of both the UK and the EU. This could have implications for NZ trade.
- In China the increasing of centalised power of the President.
- China has a huge amount of corporate debt relative to GDP – see graph below.
- Brazil is still in recession
- Russia still has issues in the Middle East
Brian Fallow of the New Zealand Herald wrote a very informative article on the inflationary target that the Reserve Bank of New Zealand keeps missing – the CPI has been below the bottom of the bank’s 1 to 3% target band. Some will say that the RBNZ has been too tight with its monetary policy stance – maintaining high interest rates for too long. Assistant Governor John McDermott has defended the bank’s position for the following reasons:
- Nearly half the CPI consists of tradables where the price of goods is impacted by competition from outside New Zealand. For the last four years the global economy has been in a disinflationary environment caused by excess supply and in particular low commodity prices especially oil. Year ending September 2016 Tradables = -2.1%. This offset almost all of the +2.1% rise in non-tradables prices. See graph below.
- The recovery form the GFC has been quite weak and with the NZ$ strengthening (imports cheaper) accompanied by lower world prices has meant that import prices have been very low.
- The growth of the supply-side of the economy has been particularly prevalent which again has led to less scarcity and lower prices.
- Recent years has seen immigration boost the demand side of the economy but because the age composition is between 15-29 rather than 30-40 in previous years, the former has a much less impact on demand as they don’t tend to have the accumulated cash for spending.
- The RBNZ reckon that the output gap is now in positive territory (actual growth being higher than potential growth) which will start to put pressure on prices as capacity constraints become more prominent.
- Statistically with a weak inflation rate in the December 2015 quarter the December 2016 quarter is most likely to be higher as the percentage change is taken on the CPI of the previous year.
The spectre of deflation hitting the New Zealand economy does not seem to be a concern at this stage especially with the longer-term inflationary expectations being in the mid range of the target bank i.e. 2%.
In 1894 New Zealand made history by being the first developed nation to introduce a minimum wage. The Economist had an article on minimum wages and the fact that they might in fact be good for an economy. Most economists believe that a higher minimum wages = the artificial increase in labour costs and therefore lower demand for labour.
Some economists have suggested that minimum wages can increase employment and obviously pay. However if employees have monopsony power as buyers of labour and are able to influence wages they can keep the wages lower below its competitive rate – see graph below.
Two economists (David Carr & Kruegger) found out in New Jersey that when the minimum wage was raised employment in fast-food restaurants actually increased. The Economist suggests that if firms are not reducing the number of their employees with higher minimum wages they must be employing a number of strategies such as raising prices of their goods/services or saving money from reduced revenue. The IMF state that a moderate minimum wage (30-40% of the median wage – see graph) doesn’t have a significant negative effect on employment numbers and may do some good.
Monopsony in the Labour Market
A monopsony occurs in the labour market when there is a single or dominant buyer of labour. The buyer therefore is able to determine the price at which is paid for services. Unlike other examples we have looked at, in this situation we are now dealing with an imperfect rather than a perfectly competitive market. The monopsonist will hire workers where:
Marginal Cost of labour (MCL) = Marginal Revenue product of labour (MRPL)
From the perspective of the monopsonist firm facing the supply curve directly, if at any point it wants to hire more labour, it has to offer a higher wage to encourage more workers to join the market – after all, this is what the ACL curve tells it. However, the firm would then have to pay that higher wage to all its workers so the marginal cost of hiring the extra worker is not just the wage paid to that worker, but the increased wage paid to all workers as well. So the marginal cost of labour curve (MCL) can be added to the diagram.
If the monopsonist firm wants to maximise profit, it will hire labour up to the point where the marginal cost of labour is equal to the marginal revenue product of labour. Therefore it will use labour up to level of Eq which is where MCL=MRPL. In order to entice workers to supply this amount of labour, the firm need pay only the wage Wq. (Remember that ACL is the supply of labour). You can see, therefore, that a profit-maximising monopsonist will use less labour, and pay a lower wage, than a firm operating under perfect competition.
In this situation the power of the employer in the labour market is of overriding importance and the employer can set a low wage because of this buying power.
Household debt in New Zealand is now equivalent to 163% of annual household disposable income – see graph below. Record low interest rates has seen credit growth rising at a pace not seen since 2008. How do low interest rates contribute to this?
Household debt as a share of disposable income (including investment housing)
Low borrowing rates have made it easier to purchase property with bank funds especially as the supply of housing hasn’t matched the increase in demand. The strong growth in property prices has meant that those who already own a house are using that security to purchase additional property. According to the IMF New Zealand has the highest ‘House Price-to-Income Ratio’ – see graph below.
Other parts of the world are experiencing high household-debt to income levels (see graph below) but does high debt levels mean that the economy is going to hit a major recession? Since the credit crisis of 2008 the global financial system has seen tighter regulations put in place to improve stability with banks limiting access to credit so there is less exposure to the risks associated with highly leverage lending.
Growth in house prices and household credit 2011 – 2015.
However debt servicing remains tolerable with low interest rates and much of the debt secured against investment housing. Also debt-to-asset ratios have fallen to levels that were experienced in 2007 but this has eventuated from low interest rates which have boosted house prices. Ultimately with a fall in house prices, and depending on its severity, those who recently entered the property market would suffer some degree of hardship whilst those already well established in the market might have a financial buffer.
Debt and future growth in New Zealand
Household debt still has implications for the long-term growth of the economy.
- With larger proportions of their income being allocated to debt consumers have less disposable income for other goods and services which creates less aggregate demand.
- High debt levels mean households have more exposure to unfavorable economic conditions that could lead to rising unemployment. In this case they have less money to fall back on.
Source: Westpac Economics Overview – August 2016
With the RBNZ to announce the Official Cash Rate next Thursday there is common agreement that there will be a 0.25% cut to leave the OCR at 2.00%. However with 2.8% growth and a favourable PMI do the RBNZ need to cut rates? With inflation at 0.4% it is still not between the 1-3% target range (as outlined by the Policy Target Agreement in the Reserve Bank Act 1989), and there is pressure for the central bank to hit a target of 2% inflation. With the global economy in an era of very low inflation (even a threat of deflation) one wonders the logic of keeping the PTA at 1-3%. In fact it is being reviewed by the RBNZ in the next month. The logic behind the lower OCR will be to stimulate more spending but also trying to make the NZ$ less attractive for foreign investors.
With NZ rates being significantly higher than other developed countries the NZ$ is seen as a good investment and ultimately attracts a lot of ‘Hot Money’ into the economy. The NZ$ is the 10th most traded currency in the world and this is also due to the stable environment in the NZ economy as well as relatively high interest rates. But have the lower rates had the effect of reducing the value if the NZ$? A lower dollar makes exports prices more competitive and increases the price of imports.
If you contrast the OCR with the TWI over the last year you will see that a lower OCR doesn’t necessarily mean a lower NZ$. Furthermore the lower rates do nothing to halt the rise in the property market especially in Auckland.
The RBNZ faces potentially conflicting outcomes as it tries maintain financial stability and price stability. The Policy Targets Agreement demands lower interest rates in a bid to raise CPI inflation while financial stability concerns, especially with the housing market, probably demands higher rates.
Images from ANZ Bank
The aim in many developed countries is to stimulate economic growth and to raise inflation within the target bands as stipulated by many government’s central banks. For some countries the immediate objective has been to prevent their currency from rising making their exports more expensive and imports cheaper. Therefore the thought of negative interest rates discourages investors from buying your currency which would push up its value. The EU, Denmark, Sweden, Switzerland and Japan, central banks have decided to have a negative rate on commercial banks’ excess funds held on deposit at the central bank. In effect, private sector banks have to pay to park their money – see graph below.
New Zealand is currently in a bit of a predicament in that the OCR (central bank rate) is at 2.25% which is relatively high compared to other central banks and therefore does attract ‘hot money’ into the economy – money that ‘parks’ to earn interest. However if they drop interest rates to ease the pressure on the NZ$ they run the risk of further inflating the housing market by making borrowing cheaper.
For the consumer as soon as the rate banks offer fall below 0%, savers have an incentive to withdraw their money and put it under the mattress. By charging negative rates the central banks are hoping that the trading banks will keep more of their money and therefore lend it out to investors. However the desire to reduce a banks reserves is futile as if someone borrows money from a bank and buy a new car the money is paid to the car company who will then deposit the money in their account which increases the reserves of the bank.
Overall negative rate reflect the constant state of weak aggregate demand in many developed economies since the 2008 financial crisis. Central banks have kept their policy interest rates very low to stimulate economic growth and more recently to get higher inflation. However, how low can they go?
Below is a very good cartoon from the FT looking at negative interest rates.