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New Zealand has for a long-time lived with a large and negative international investment position, mainly in the form of private debt intermediated through the banking system. These debts create economic risks. Fortunately New Zealand's good institutional and policy arrangements provide economic resilience to avoid and respond to economic shocks. These include: relatively transparent and prudent fiscal policy; independent monetary policy; and a floating exchange rate. This resilience has also been strengthened by relatively prudent private sector lending and borrowing.
However, this does not mean New Zealanders can be complacent. History shows that high levels of debt secured against elevated asset prices tend to magnify the negative impacts of economic shocks, or can cause persistent slow growth. This paper departs from typical discussions of debt imbalances by suggesting New Zealand's private debts could reflect decisions that may have been poorly made for some time. This results from long-term structural and fiscal policy settings that may have discouraged saving. In turn, this may have contributed to tighter monetary conditions than otherwise needed for price stability. This contributed to the stifling of tradables production to the detriment of economic growth.
Like the recent Canterbury earthquakes, the nature of potential macroeconomic shocks and the likelihood of them eventuating are difficult to identify with precision or confidence. The sharp adjustment that should be avoided is where creditors suffer a loss of confidence in New Zealand's debtors. This would force a substantial cut to standards of living, which a policy response designed to pro-actively reduce debt may be able to avoid. Accordingly, New Zealand's government should be vigilant in pursuing fiscal and regulatory policies that continue to build resilience through encouraging individuals to strengthen their financial position.
The author would like to thank Michael Reddell at the Reserve Bank of New Zealand and formerly at the Treasury for providing insights into this topic, and Bruce White for many helpful comments and suggestions on the draft the paper. Thanks also to Tim Hampton for his comments on various drafts and general support for the project.
The views, opinions, findings, and conclusions or recommendations expressed in this Working Paper are strictly those of the author(s). They do not necessarily reflect the views of the New Zealand Treasury. The Treasury takes no responsibility for any errors or omissions in, or for the correctness of, the information contained in these Working Papers. The paper is presented not as policy, but to inform and stimulate wider debate.
Table of Contents
- Executive Summary
- 1 Introduction
- 2 Imbalances: a threat to growth
- 3 Imbalances described
- 3.2 New Zealand's imbalances
- 3.2.2 High offshore debt
- 3.3 The connection between household/farm and offshore debts
- 3.3.2 International competitiveness
- 4 Problem definition
- 4.2 Crisis
- 4.2.2 Factors detracting from resilience
- 4.2.2 Factors detracting from resilience (continued)
- 4.3 Slow growth
- 5 Assessing New Zealand's resilience
- 6 Scenarios
- 6 Scenarios (continued)
- 7 Policy response
- 8 Conclusion
- Appendix: Financial market impacts of a “sudden stop”