6 Conclusions
The structural VAR model of the New Zealand economy developed in this paper significantly expands on previous VAR models for New Zealand. This new model extends the range of international macroeconomic linkages, captures the impact of climatic conditions, and extends the range of domestic financial variables. The model seems to behave broadly as expected in response to various shocks.
Historical decompositions are used to evaluate the structure of the New Zealand business cycle during the last two decades, and to identify the predominant shocks and their contribution to deviations in New Zealand GDP about its trend. Individually, international variables, notably world output, world equities, world interest rates, import prices and export prices have been dominant influences on the New Zealand business cycle. These results underscore the importance of earlier attempts to evaluate the impact of international price effects on New Zealand real GDP by Wells and Evans (1985) and Conway’s (1998) attempt to explore whether international influences had changed since market deregulation in the mid 1980s. The results also provide strong justification for our attempt to expand the international linkages to include, in addition to world prices, world output and several more direct financial linkages.
A novel feature of this structural VAR model is the attempt to capture the effect of changes in domestic climatic conditions. These have been found to be important, particularly in explaining the 1998 recession. The decomposition of contributions to the 1998 recession illustrates the utility of the structural VAR modelling procedure. Contrary to popular belief, the results presented here show that summation of international influences during the 1998 recession would have resulted in New Zealand real GDP being maintained around trend during the so called “Asian crisis”. Foreign output movements appear to have contributed to the 1998 recession but that contribution was largely offset by positive foreign equity shocks. A detrimental climate shock was a principal reason for the 1998 recession.
The effects of climate change on the New Zealand economy warrant more attention in public debate and New Zealand macroeconomic modelling. In contrast to the attention received in public debate, shocks to the exchange rate have been a relatively unimportant contributor to New Zealand recessions and expansions during the last two decades. Changes in domestic interest rates also receive considerable attention; yet their contributions to business cycles in New Zealand have been less important than shocks to export prices, import prices and climatic conditions.
There are several directions in which to build on the model developed in this paper. One direction is to use the model to evaluate the impact of monetary policy on the New Zealand business cycle. This is undertaken in a forthcoming paper (Buckle, Kim, and McLellan, 2003). Another direction is to modify the model to evaluate fiscal policy. The analysis of the impact of fiscal policy will require the inclusion of suitable fiscal variables. The identification of the direct and indirect effects of fiscal policy on domestic economic activity represents a difficult challenge but one that would be worthwhile in order to interpret the impact of fiscal policy. A third direction for future development is to evaluate the sectoral implications of international and domestic shocks. There is also the potential to specify the model to include the stochastic trend component of growth and to evaluate the impact of international and domestic shocks on New Zealand’s long run growth rate.
