Macroeconomic adjustments in the current crisis

Even though New Zealand’s banks are sound, global interdependencies and accumulated domestic imbalances mean that the economy is being affected by the worldwide financial and economic crisis. New Zealand has one of the OECD’s highest levels of foreign debt, the result of sustained and sometimes large current account deficits that reflect a long period of unbalanced growth and structural deficiencies, notably a small pool of household savings and a low rate of productivity growth. These imbalances, along with the present reversals in global risk appetite and credit availability, present a risk of sudden and costly macroeconomic adjustments. As a small nation on the world’s periphery, New Zealand is affected by the sharp decline in world trade, which began in late 2008 and is unlikely to be reversed during 2009. At the start of the crisis, both fiscal and monetary policies had substantial room for counter-cyclical action, and much has been done on both fronts. There remains more room for monetary policy easing than in most OECD countries, while fiscal policy is now constrained by the projected growth in debt and associated credit-rating concerns. Even so, a deep and protracted recession, involving a housing-market correction and deleveraging of household and business balance sheets, is unlikely to be avoided. As principal intermediaries between foreign savers and domestic borrowers, banks depend to a large extent on overseas funding, most of which is short term. A number of smaller finance companies, less regulated than banks, have gone bust. To maintain confidence in the banking and financial sector, new guarantee schemes for retail deposits and wholesale bank funding have been introduced, along with temporary liquidity facilities, and non-bank deposit-taking institutions have been brought under the central bank’s regulatory umbrella. The main challenges for policy makers are to manage the downside economic risks posed by the current crisis, while preserving the longer-run credibility of the macroeconomic policy framework.