7  Policy response

Reducing the size of New Zealand's macroeconomic imbalances is likely to increase New Zealand's resilience and economic growth prospects. Therefore, it is worthy of consideration whether there are policy changes that could support this. Accordingly, this section looks at the scale of adjustment, and the possible policy levers to this end.

In order to make policy recommendations about how to mitigate imbalances, knowledge about causality is important to be able to properly identify possible rectifying policy interventions. In Section 3.3, alternative hypotheses were put forward to explain what has been causing high debts, either:

• persistent wealth effects from property that encourage private consumption, which leads to tighter monetary conditions and banks intermediating capital inflows that passively respond to finance the current account deficit; or
• more active capital inflows that drive the exchange rate, current account, and bank intermediation that together lead to higher consumption and tighter monetary conditions.

While it is possible for both explanations to hold to some extent, the passive capital inflow hypothesis in response to New Zealand households' relatively low saving rate appears to be the most likely. This is because capital will only be attracted to New Zealand if risk-adjusted interest rates are relatively attractive compared with global alternatives. Because of New Zealand households' propensity to over-consume at any given interest rate, the RBNZ needs to set interest rates relatively high to achieve price stability.

As a crosscheck on this logic, the following alternative perspective yields the same result. If households did not have this high propensity to consume at any given interest rate, then banks would respond to strong capital inflows beyond what is needed to satisfy household demand for funds by lowering deposit interest rates to the point that discouraged capital inflows. Assuming fixed intermediation margins, so the benefit of lower deposit rates are passed through to borrowers, the fact that this does not happen suggests that household demand for funds is highly elastic to interest rates. This is precisely because of households' high propensity to consume. Either way, the result is policy needs to address why national saving is so low, and thus interest rates so high.

7.1 Scale and direction of adjustment

A rebalancing economy would see a reversal of long-term trends involving: debt repayment to improve New Zealand's net international investment position, or at least an improvement in debt ratios with a closing of the gap between national saving relative to investment; and property-related ratios returning to long-term averages. This is likely to involve policies that promote a relative shift away from domestic consumption to export-led growth. This would provide room for the economy to reduce debt without putting growth at risk through a rebalancing of the economy from domestic activity to tradables. This could even provide an opportunity for higher sustainable growth. This is because a shift towards tradables could improve economic performance more generally, if exports are associated with greater productivity due to exposure to international competition (Fabling and Sanderson, 2010).

In particular, raising national saving would reduce demand in the economy and this would have the outcome of creating an environment conducive to a durable and deep depreciation in the exchange rate, which would enhance competitiveness and growth in tradables. While there is no explicit exchange-rate target (rather it is an outcome of a range of factors) IMF analysis estimates that in order to stabilise the net international investment position at its pre-housing boom level (i.e. around -75% of GDP, which is still high by international standards), the real exchange rate would need to depreciate by around 25% (IMF, 2010). The New Zealand: 2011 Article IV Consultation – Staff Report updated this estimate, the real exchange rate would now need to depreciate by around 15%.

Research by the New Zealand Institute of Economic Research (2010) found that an effective increase in national saving (a decrease in the average propensity to consume from 84% to 80%) would reduce the negative net international investment position from to -60% of GDP by 2025. This would lower offshore interest payments by $10 billion and the cost of capital by 10%. All else equal, this would have overall economy-wide beneficial impacts by 2025 of raising investment by 13%. This positively impacts on GDP by 4% by 2025, national disposable income by 9%, and would raise real wages and consumption by 7%. The Treasury (2010) Saving in New Zealand - Issues and Options shows that a 4% of GDP increase in national saving would improve the net international investment position to -70% by 2020, while a 2% improvement would be necessary to hold the level at that time constant.

7.2  Levers

This section briefly canvasses possible policy mechanisms or levers to reduce economic imbalances. For a more detailed discussion, refer to Saving in New Zealand - Issues and Options (Treasury, 2010). The Treasury Paper took the approach that reducing imbalances will require a consistent policy framework that first encourages economic growth (and so has merit in its own right), while also addressing national saving. The main lever was through raising government savings more quickly, but doing this in a way that also encourages private saving by removing the disincentives to higher national saving.[38] In particular, this involves looking at transfers and tax policies to encourage saving over consumption.[39]

Given the role of property in excessive domestic consumption, it would be desirable to reassess the pros and cons of regulatory settings in the housing market that artificially raise property prices. Possible structural changes to the property market to lessen deviations away from trend include: increasing the availability of land for development; reducing the preferential tax treatment of property, and reducing the costs and constraints associated with the regulations governing property development (Department of Prime Minister and Cabinet, 2008). However, this would need to be staged carefully to avoid crystallising a crash in property values from a sudden supply increase, and conflicting too greatly with environmental objectives.

Moreover, it is important to have the ability to generally mitigate debt-driven asset booms, without resorting to higher interest rates as the only tool. This helps to avoid damaging tradables through an overvalued exchange rate. There are two main policy levers to this end. First, employing instruments designed to encourage prudent lending over the economic cycle, so called “macroprudential policy”. Macroprudential policy goes beyond traditional prudential policies employed by authorities to regulate financial intermediaries through its dependency on macroeconomic conditions. For example, in a situation of rapid credit growth, coincident with quickly rising property markets, macroprudential policy would involve more stringent prudential requirements once pre-determined economy-wide thresholds had been breached. This would help temper asset cycles over the long term, which may also have ancillary benefits for monetary and economic development (RBNZ, 2006). However, how this could be achieved is still a matter of some ongoing debate (Bollard, 2011). Second, better fiscal management and institutions may prevent pro-cyclical increases in government spending during economic upturns. This would also reduce the work monetary policy needs to do to dampen activity (Brook, 2011).

The government has already in place a policy agenda to raise New Zealand's sustainable growth rate. This includes what it has articulated as the six key drivers of stronger economic performance - removing red tape and unnecessary regulation; lifting education and skills; investing in productive infrastructure; improving performance across science, innovation and trade; providing better, smarter public services; and strengthening the tax system. These jointly form a programme to lift growth through higher productivity in a more balanced way (Budget, 2011).