4.1 Baseline model

Figure 3 shows the estimated responses of the six variables in the baseline model employing China as the large international economy influencing growth in New Zealand and Australia. More specifically, estimated mean responses are shown to a one unit (percentage point) shock to China's output growth, when estimation is over the entire sample period from 1982, with these shown as solid lines. The shaded bands around these impulse responses show 90 percent confidence bands estimated by 2000 Monte Carlo simulations.

This baseline model implies that New Zealand's output increases by 0.23 percent on impact (quarter 1 on the horizontal axis). The effect is largely completed within four quarters of the China growth shock, with subsequent domestic output responses being virtually zero. Although the confidence bands indicate that the point estimate of the impact is not very reliable after the first quarter, nevertheless it is both statistically significant and important economically, and contrasts with the lack of spillovers detected in the analysis of Sun (2011) over a shorter sample period. It is notable that the initial response of Australia's GDP to the growth shock from China is lower than that of New Zealand but is more persistent. The peak impact occurs in this case in the quarter after the shock and the effect is statistically significant for five quarters. The persistence and the pattern of effects can be partially explained by the possible lagged effect of the mining industry on growth in Australia. In other words, the nature of Australia's commodities means there needs to be investment to supply them and therefore longer lag times for production. This contrasts with New Zealand's 'soft' commodities where supply can be ramped up relatively quickly up to a point constrained by biological processes. The implication is that much of the growth spillovers from China to New Zealand are direct effects, rather than operating indirectly through Australia, as suggested by Sun (2011) for spillovers from 'Emerging Asia'. Such a direct role is also implied by the current importance of China as a destination for New Zealand exports.

Figure 3: SVAR Responses to a China GDP shock

With the increase in domestic output, Figure 3 shows mild but insignificant increases in domestic inflation, although with a stronger response in New Zealand interest rates and a highly significant appreciation in the exchange rate. The appreciation in the exchange rate is important, as it acts as a buffer against the inflationary impact that would otherwise apply due to the additional stimulus.

Notes: The figure depicts the impulse responses to a one-percentage point orthogonalised shock to China's GDP. The baseline SVAR model is estimated using data for 1982Q1-2011Q4. The solid line shows the estimated mean responses, with the shaded bands indicating the 90 percent confidence interval, obtained using 2000 Monte Carlo replications. Responses are shown for the quarter of the shock (quarter 1) and 9 subsequent quarters. Source: Authors' calculations.

Using the same SVAR specification, but replacing China with the US as the international driving force, Figure 4 shows the estimated responses to a one percentage point shock to US output, and these responses differ substantially from those seen in Figure 3. The impact of the US shock (Figure 4) on both domestic New Zealand variables and also Australian GDP is relatively longer-lived and statistically more significant; however, the impact on New Zealand within the quarter is lower. In particular, after an initial estimated increase of 0.13 percentage points that applies in the quarter of the shock, the peak output response is at a lag of one quarter (labelled 2 in the graph) and domestic New Zealand GDP continues to increase due to positive impulse responses for a total of around 5 quarters; the cumulative response of domestic output to the shock originating in the US is estimated to be approximately 0.66. This, combined with the positive and significant response of inflation to the output increase after three or four quarters, leads to an increase in interest rates of around one percentage point. The exchange rate appreciates on impact, helping to keep inflation low, with further responses not being significant.

Figure 4: Responses to a US GDP shock

Notes: The figure depicts the impulse responses to a one-percentage point orthogonalised shock to US GDP. The SVAR model is estimated using data for 1982Q1-2011Q4. The solid line shows the estimated mean responses, with the shaded bands indicating the 90 percent confidence interval, obtained using 2000 Monte Carlo replications. Responses are shown for the quarter of the shock (quarter 1) and 9 subsequent quarters. Source: Authors' calculations.

Notwithstanding the importance of China in relation to New Zealand trade over the recent past, a comparison of Figure 3 with Figure 4 emphasises the key role played by the US economy for GDP growth in both New Zealand and Australia over the three decades of the sample period. Indeed, while the growth spillovers from China to New Zealand are found to have an important role for domestic variables beyond output, those from the US are more pervasive, with both inflation and monetary policy responding due to the strength of the growth spillovers. Interestingly, New Zealand's exchange rate responds in a similar way, irrespective of whether the growth shock originates in China or the US, hinting at the role of a common channel.

Finally, Figure 5 shows the responses to a one percentage point shock to Australian GDP, estimated from the model including the US as the major international economy. These responses follow broadly similar patterns to those seen in Figure 3 and Figure 4, with positive growth spillovers. Although the response of New Zealand to an Australian output shock (Figure 5) is stronger than to one from China (Figure 3), the patterns of a relatively quick response of domestic output alongside insignificant effects on inflation are shared by both these figures. However, domestic interest rates respond more strongly and the exchange rate appreciation is substantially more marked and significant when the output shock originates from Australia compared with China.

Figure 5: Responses to Australia GDP shock

Notes: The figure depicts the impulse responses to a one-percentage point orthogonalised shock to Australia's GDP. The SVAR model is estimated using data for 1982Q1-2011Q4. The solid line shows the estimated mean responses, with the shaded bands indicating the 90 percent confidence interval, obtained using 2000 Monte Carlo replications. Responses are shown for the quarter of the shock (quarter 1) and 9 subsequent quarters. Source: Authors' calculations.

Across the three sets of impulse responses, the important role of the US in the world economy over this period is reflected in the stronger overall domestic output response to this shock than others, and also in the greater responses of domestic New Zealand inflation seen in Figure 4 compared with Figures 3 and 5. In other words, the source of the foreign growth shock matters. Also, and perhaps surprisingly, shocks originating in Australia have less impact overall on the New Zealand economy (except for the exchange rate) than those originating in the US.

A further comparison of the growth spillovers from the two major foreign sources of shocks are shown in Figure 6, where the corresponding impulse responses seen in Figures 3 and 4 are aggregated over lags. In addition to those for New Zealand, the figure includes the own China or US responses and also the responses of Australia obtained from each model. While the own responses of the US or China, respectively, are greater than the spillovers, the effects on Australia are (except for the initial effect of a China shock) larger than on New Zealand. Further, according to these models, the response of output in both New Zealand and Australia to a China output shock is about half that of a US output shock. This may reflect the role of the US in the world economy over this period, with effects originating there having spillovers to many countries, which in turn influence growth in New Zealand and Australia. Furthermore, the more persistent nature of US shocks relative to China shocks may also be a contributing factor to the greater New Zealand response. The faster pattern of response of domestic New Zealand output when the shock originates in China may reflect increased demand from China for New Zealand products (such as dairy products), whereas that from the US may operate more indirectly through other countries.

Figure 6: Accumulated GDP responses to growth shocks in the US and China

Notes: Impulse responses are accumulated from those shown in Figure 4 and Figure 3 for US and China shocks, respectively. Source: Authors' calculations.

The overall conclusion from the baseline SVAR model, using data over the three decades from 1982 to 2011, is that growth spillovers from China to New Zealand are non-trivial, with a one percentage point shock to China's growth estimated to increase New Zealand's GDP by around 0.3 percentage points within a one year period. Further, this effect on New Zealand applies relatively quickly, and with little significant impact on other domestic variables beyond an immediate appreciation of the real exchange rate. On the other hand, shocks originating in the US or Australia have greater spillovers to New Zealand's growth, with consequent effects also on domestic interest rates in addition to the exchange rate. The implication of Figure 6 is also that growth in New Zealand has an overall slightly lower response to shocks from the major economies of the US and China than does Australia particularly in the medium term. It is important to note that the analysis so far has concentrated on the spillover impacts on the volume of domestic output. This, on the other hand, is only part of the story as the transmission channel via commodity prices has an important impact on domestic nominal GDP as well as second-round impacts on volumes via an income effect. The next subsection extends the investigation to include a commodity price channel, in order to further explain these response patterns.