History and its recessionary lessons

If New Zealand economic history is any guide, then pencil in the next recession for 2015. But the good news is we should hit our growth peak by the September quarter of 2011  just in time for a glorious Rugby World Cup.

Those are just a couple of interesting snippets from Westpac research economist Dominick Stephens' analysis of 80 years of New Zealand recessions.

New Zealand averages a recession every 5 1/2 years and growth rates tend to peak, he says, about nine quarters after economic expansion recommences.

The exercise by Stephens' firm is undoubtedly motivated by its belief that the Reserve Bank is applying the wrong monetary policy setting in waiting until June 2010 to raise the official cash rate.

It shows the economy typically responds much more strongly after downturns than consensus forecasts suggest.

Stephens and Westpac chief economist Brendan O'Donovan are way out on their own with their pick of 3.5 per cent growth in gross domestic product in 2010. The Reserve Bank has opted for 2.5 per cent. The mean out of 16 predictions is 10 basis points below that. The lowest forecast is for expansion of 1.3 per cent for the year. Are they all taking happy pills at Westpac then?

"The thing is the New Zealand economy is volatile and people appear to have forgotten that, as day follows night, recovery follows recession," Stephens says.

"That's the way it's been over history and there's no reason to believe it will be any different. In fact, there's very little that's special about this recession in New Zealand.

"Growth is the natural state of a modern economy."

And rapid growth, he adds, is the norm once a recession ends in the Shaky Isles. Since 1890, according to a database developed by British academic Angus Maddison, there have been 23 recessions and the average size of the rebound in the following year has been a whopping 6.4 per cent. Since World War II, the average is 4.8 per cent.

There have been occasions when the recovery has been truly anaemic, but the 1970s and late 1980s and early 1990s were periods when the economy suffered terms-of-trade shocks (oil crises and Britain joining the then European Economic Community) and, in the latter instance, a domestic banking crisis.

Neither is a feature of the present recession and recovery. In fact, terms of trade are above historical averages. This suggests New Zealand is well placed to post impressive growth figures, Stephens argues, certainly better than what the Reserve Bank and Treasury expect.

Of course, 25 years of a market economy has knocked some of the volatility out of previous cycles  a point Stephens acknowledges. It is why, he says, Westpac's prediction is more than a percentage point below the post-World War II average.

Stephens freely concedes his analysis is a bid to justify his outsize growth forecast and back up his criticism of Reserve Bank Governor Alan Bollard's insistence that emergency cash-rate levels will be maintained.

We are now at the point where hindsight can be applied to central bank and government decisions to meet the challenge of the global financial crisis.

As Stephens notes: "It was an unprecedented monetary and fiscal stimulus, and for each individual country, nobody could put their hand on their heart and say they knew what the outcome was going to be."

Bollard and the Government earn full points, to Stephens' mind, for doing just enough but not too much. Although critics aimed slings and arrows at the Government's response, particularly in comparison to Australia, "I think they clearly did enough".

The United States economy is still fragile, although defying doomsayer predictions, and the jury is out on events in Japan and Europe. Australia, however, clearly overcooked its monetary and fiscal pudding. "You can judge how well they did after the fact by the inflation outcomes," Stephens says.

Underlying inflation in the Lucky Country is 3.5 per cent, well outside the band of 2 per cent to 3 per cent. Australia had far fewer problems than New Zealand, yet Kevin Rudd's government threw everything at it, including the kitchen sink.

"I think by this time next year, they'll have more problems."

By contrast, the Reserve Bank is well within its inflation mandate. Whether we share Australia's pain down the track depends on Bollard's response: "We're just worried that if they don't start hiking soon, it will be too late," Stephens admits.

People rightly fear volatility but Stephens worries the Reserve Bank will play an instrumental role in building the economic vulnerabilities that Bollard talks about in his monetary policy statement.

If housing gets away on the governor, he'll have to raise quickly, perhaps as high as last time before the bubble bursts, resulting in exchange-rate pain for exporters and the domestic sector when house prices fall. Some history you don't want to repeat.

Nick Smith is a senior financial journalist.