4 Problem definition
To be able to identify possible policy responses to a problem, an understanding of the causes is necessary. The following section considers possible policy-related reasons why debt imbalances may have arisen, and discusses mitigating and aggravating factors associated with private debt in New Zealand.
4.1 Is persistently high and growing private debt a problem?
4.1.1 Opposing the proposition
The previous section has identified offshore and related household/farm debts to be key imbalances facing New Zealand. However, to a large extent there are good arguments why private debts should not necessarily be a concern or require a policy response. New Zealand is a relatively young economy with good income prospects to pay back its offshore debts. Indeed, some go further and consider current account deficits are generally not a problem because of New Zealand's floating exchange rate and open markets (Pitchford, 1989 and Corden, 1991). This idea became an important part of the New Zealand macroeconomic thinking (Collins et al, 1998)
The Pitchford view is that, unless individual entities are ill-informed, short-sighted, or unduly influenced by government policies, or that lenders are not providing enough scrutiny on borrowers, there is little reason for concern about current account deficits. This is because, as long as these conditions hold, economic agents have the incentives and information to make the correct decisions, so the current account is just an aggregation of a number of rational private lending and borrowing decisions. The corollary is that, if individual decisions are justifiable, so then is the aggregation of these decisions. This view is often referred to as the “consenting adults” model.
Consistent with “consenting adults”, the response of debtors to the GFC has been rational, given the uncertainty around incomes, the property market and funding. Private saving has risen, the use of debt has been tempered, and existing mortgages are being repaid in preference to withdrawals of equity. This is helping to reduce financial risk and is reflected in a declining current account deficit and household debt ratios, but it is also contributing to a significant slowing of the economy (Section 4.3).
4.1.2 In favour of the proposition
Private saving decisions are not made in a contextual void. Decisions are influenced by circumstances, and in particular the policy environment set by government. Accordingly, New Zealand's private saving decisions can be influenced by tax and transfer policies, or regulatory settings. As noted earlier in 3.3.2, government actions can also have current account impacts through engaging in pro-cyclical fiscal policy.
The overall impact of government on the economy therefore raises questions about the quality of private saving decisions, and therefore consistency with the Pitchford “consenting adults” model. It can be argued that government policy over a long time has unduly influenced household decision-making, which may have led to ill-informed and short-sighted private sector decisions that are later regretted. For example, this may explain the general willingness of households to continue to support a rapidly rising property market and to draw down on housing equity, leading to higher aggregate consumption between 2002 and 2007.[17]
Moreover, there are further possible dynamic effects, in that the sum of many household consumption decisions that may be biased has created its own larger distortions. This is because higher aggregate consumption required even tighter monetary conditions than otherwise to restrain demand, which led to the currency appreciating to the detriment of tradables production.
High private debt co-incident with a shock could lead to sharp adjustments in private consumption and investment to the detriment of economic activity, as households and creditors try and rectify balance sheet stresses. Iceland, Ireland and Spain are examples of countries where a financial crisis arose from the co-incidence of the GFC and private debt growing too quickly because of poorly co-ordinated economic policy frameworks.[18] Government responses may have exacerbated the crisis in these countries, as they too now face balance-sheet stresses from responding to the financial crisis and associated private debt problems.
