Don't panic - a recession may not be what you think

2:16 pm on 11 March 2020

Opinion -The virus is spreading, financial markets are in freefall and we are probably already in a recession. Such a three-punch crisis combo of health, financial and economic is new.

New Zealand's sharemarket has immediately fallen two percent after opening after the Waitangi Day closure. Global markets have been left reeling in the biggest one-day fall on Wall Street since 2011.

File photo. Photo: RNZ / Rebekah Parsons-King

Unlike the last financial meltdown, monetary policy is a spent force. Success will be about containing the virus, avoiding lasting job losses and business failures and being ready to unleash stimulus once we are past peak infection. Government holds the big keys and should deploy them smartly now and then boldly once the worst of infection is over.

But don't panic. Even in a recession, the vast majority of Kiwi businesses and jobs will be fine. They should not panic and look to gain market share and snap up good talent in this period of uncertainty. Recessions happen at the margin. But it will be a world of pain for the unfortunate few.

Economist Shamubeel Eaqub

Shamubeel Eaqub. Photo: RNZ / Cole Eastham-Farrelly

It is meaningless to predict the depth and duration of the crisis. We simply do not know if the virus can be contained with relative success (for example in Singapore) or require massive social distancing (for example the whole of Italy, a population of 40 million, under quarantine conditions). The more of the latter, the bigger the economic and financial impact.

Financial markets have slumped in recent days. Markets are pricing in significant disruption to businesses and economies from the spread of the virus and measures to contain it.

Figure 1: Crude oil price

Figure 1: Crude oil price Photo: Source: Sense Partners calculations from US EIA and Bloomberg data.

Markets fear loss of demand from people doing less and spending less (affecting tourism and exports, and domestic spending at home); and supply disruptions (of imports) meaning many businesses cannot make or do their business. This is likely to lead to a crash crunch for affected businesses and a wider confidence loss for households, businesses and investors.

Lower share prices affect savers. For young savers, who will be in the market for many decades, it is important to keep saving through such a slump. For older folk in or near retirement, it can be very difficult to recover from a big loss. If you are in this position, seek professional advice urgently - the money you want to spend in the next decade should be locked away in very safe assets.

Commodity prices have also fallen in tandem. This will reduce the price of our exports, but also the cost of inputs like oil. The benefits will tend to be more towards urban NZ, while rural NZ will be harder hit.

A fall in share markets has been accompanied by increased fear. This can lead to parts of the market not working well. This happened during the GFC, when banks were unable to roll-over their borrowings as they matured. This is the final channel, where falling asset values and a rising tide of fear reduces how much banks lend and pivot to less risky customers.

The virus is transmuting from a biological event, to financial and economic events too.

A recession may not be what you think

Financial markets suggest we will be in a global recession this year. In a recession the period of decline tends to be brief, but the recovery may be rapid or long and slow. If there is a global recession, NZ will also be in recession.

A recession is also not what many people fear.

The number of business failures may rise a touch. But the real impact is from fewer new businesses starting up. New jobs in new businesses don't materialise.

During a recession people become more careful, take fewer risks and delay making decisions.

This paralysis is a better description of a recession, rather than a mental image of a bonfire of businesses and jobs.

In the last recession, 2.2 million people were still employed at the worst point of the cycle. The unemployment rate rose from around 3.5 percent to a peak of around 6.5 percent, around 80,000 people lost jobs.

Jobs losses were widespread, but most painful in manufacturing, construction, retail, hospitality and logistics. Professional services were largely unscathed, and public services grew. It will tend to be worse for young people and those in the gig economy.

Figure 2: NZ unemployment rate

Figure 2: NZ unemployment rate Photo: Source: Statistics NZ, RBNZ

Recessions tend to be deflationary. Prices of inputs like commodities fall. Businesses reduce prices to stir up demand. And wage demands are subdued, because it may be hard to find a new job. This means prices for many good and services fall or do not rise very much. This gives the central bank a good reason to cut interest rates.

Orthodox policy is spent

During a recession the central bank cuts interest rates. This reduces the cost of borrowing, helping existing borrowers through lower repayments and encourage new investments. But when interest rates are already very low, it is hard to do that.

We are in that position, with borrowing cost at historic lows. Its not the cost of borrowing that's holding the economy back.

Central banks also deployed unconventional tools, known as quantitative easing, to essentially reduce the cost of borrowing for businesses. It helped, but there is considerable debate about whether it helped financial markets more than the real economy.

Regardless of the debate, unlike the GFC or even after the Canterbury earthquakes, lower interest rates wont help much. We are down to the government to blunt the recession and spur the later recovery.

The central bank can and should facilitate lines of credit for banks so that they have a war-chest to lend for businesses affected by Covid19.

It's fiscal policy time

Right now, the focus needs to be on preserving jobs and avoiding business failures. Rather than handing out cash to all businesses, it would be much better to provide target assistance to alleviate the cash crunch, do what it takes to preserve jobs (eg subsidising holiday pay or offering no-stand-down-welfare payments for those temporarily unemployed) and avoid business failures by providing as much cashflow support as possible through delayed tax payments or tide over through credit facilities.

A few will rort the system, but it will be better to provide all the assistance to those who need it, rather than a little assistance to everyone. The latter would spend a lot of cash, but not preserve jobs nor avoid business failures.

Once the panic has peaked, government policy needs to think about spurring long term recovery. Without support from monetary policy, the government will need to implement a wider range of programmes over a longer period.

There is time to consider the exact shape of it, but a bold 'covid19 response' allowance should be announced.

It could include rearranging the tax regime to provide more income to lower income households, and add long term low cost debt to finance significant expansion of infrastructure, including housing and crumbling water infrastructure around many parts of New Zealand, and a sizeable investment in green economic initiatives to deliver on the zero carbon vision.

There is significant capacity to borrow, especially since the cost of government borrowing is now less than 1 percent per annum. This is what the fiscal war-chest is for - if not now, then when?

Figure 3: Net core crown debt

Figure 3: Net core crown debt Photo: Source: The NZ Treasury

Don't panic

Covid19 has spread from biological to financial and economic parts of our lives. As individuals, we need to prioritise health. For most of us, even a recession will be a relatively short-lived affair. There is no need to panic. For those at the teeth of the downturn, government has the capacity to respond smartly to start with and then boldly to guide us back to normalcy.

* Shamubeel Eaqub is an economist at Sense Partners.

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