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Special Topic: Recessions and recoveries

This Special Topic illustrates some of the similarities and differences between the current and past recessions.

The current recession in historical context

The global economy is experiencing what looks likely to be the deepest downturn in the post‑World War II period.  While many aspects of the current crisis are new and unanticipated, particularly the financial aspects of the crisis, neither global downturns nor financial crises are new.

In addition to the current cycle, a significant number of advanced economies were in recession in 1975, 1980, 1982 and 1992. New Zealand has also experienced financial crises - the collapse in asset prices in 1987 severely impaired the health of the banking system and increased the economy’s vulnerability to the negative shocks that precipitated the 1991 recession. Therefore history can be a useful guide to understanding the present.

To put the current episode into historical perspective we look at the nature of recessions in the post-1955 period. Figure 5 shows that only the recession that began in 1976 is likely to have lasted longer and to have had a more drawn out recovery than the current recession.[1]

Figure 5 – GDP during recession and recovery
Figure 5 - GDP during recession and recovery.
Sources: Hall and McDermott, Statistics NZ, Treasury

Despite its length, the current recession is not expected to be significantly deeper than those beginning in 1967, 1982 or 1991.  However, when measured on a per person basis, the current downturn would be deeper than on any previous occasion, including 1976. This reflects the impact of net migration flows, which tend to be pro‑cyclical – net inflows occur when the economy is doing well and net outflows occur when it is doing poorly. Annual net migration turned negative in 1976 and outflows reached over 43,000 in 1979, causing the country’s total population to decline slightly. In contrast, while net migration inflows slowed over 2008 they remained positive and have picked up over 2009, rising to 9,200 in the year to April.

Another feature of the current cycle is the substantial fall in real house prices (Figure 6). Real house prices peaked in the June quarter 2007, but by the end of 2008 had fallen around 12%. The Treasury's 2009 Budget Economic and Fiscal Update forecasts real house prices to fall 28% over a total of 18 quarters – i.e. until late 2011.  Even if house prices do not fall as much as expected, the decline to date is still larger than in all recessions except 1976 when real house prices fell 38% over 26 quarters.

Figure 6 – Real house prices
Figure 6 - Real house prices.
Source: Treasury

International events are a common trigger for NZ recessions and commodity price movements are one of the ways these events impact. Figure 7 shows that the 2008 recession is associated with an expected 20% decline in the terms of trade. This occurs towards the end of the downturn so its main effect is to moderate the pace of recovery. The 1976 recession was initiated by a 45% fall in the terms of trade between 1973 and 1975, which followed a similar sized rise in the preceding two years, and while they subsequently regained some of their lost ground, the economic impacts continued to be felt for some time.

Figure 7 – Terms of trade
Figure 7 – Terms of trade.
Sources: Statistics NZ, Treasury

The 1967 recession was also associated with a large fall in the terms of trade.  But the world was not in a recession at this time and, assisted by a 20% devaluation of the exchange rate, output returned rapidly to its pre-recession level. 

Declines in housing wealth and the terms of trade have rarely been sufficient to cause consumption to fall.  Figure 8 shows that only the 1991 recession was associated with falling consumption.  This reflects the financial aspects of the recession.

Figure 8 – Real private consumption
Figure 8 - Real private consumption.
Sources: Statistics NZ, Treasury

As noted earlier, the 1991 recession was preceded by a collapse in asset prices that wiped out huge amounts of wealth, weakened bank balance sheets and constrained access to credit. The current financial crisis has not affected the quality of Australasian banking sector assets to the same extent, but its exposure to household and corporate sector debt is now much greater. Aggregate household debt rose to around 160% of disposable income in 2008 from 60% in 1991, and with falling house prices and stricter borrowing criteria, the scope to finance consumption with additional debt has been markedly reduced.

IMF research (WEO April ’09) finds that fiscal expansions can be successful in reducing the severity of recessions associated with financial crises and in promoting recovery, particularly where debt levels are low. That is, concerns about debt sustainability may detract from the effectiveness of fiscal policy during recoveries.

At the start of the 2008 recession gross public debt stood at around 17% of GDP, about a third of what it was in 1976.  In the other recessions, 1997 excepted, debt was typically around 60% of GDP – at this level the IMF finds fiscal stimulus can have negative impacts on growth.

Finally, the economy has undergone significant structural changes - labour markets and product markets are considerably more flexible - that will help promote a more durable recovery than in the past.  An independent monetary policy and a floating exchange rate also help to limit some of the negative effects on the economy, and promote a sustainable recovery. Nonetheless, history shows that the road to recovery is unlikely to be as smooth as portrayed in our forecasts. Economic conditions remain volatile and uncertain, debt remains high in many advanced economies and households are vulnerable to further unexpected falls in wealth and income.

  • [1]Quarterly data from Hall, Viv and John McDermott, "A Quarterly Post-World War II Real GDP Series for New Zealand," Motu Working Paper 07-13.
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