Unusual times call for some desperate measures

FIRST READING - VERNON SMALL

It is not business as usual, and it is just a matter of time before our leading politicians – supported by officials' advice – acknowledge that.

Though the effective nationalisation of insurer AIG by the United States Government will stabilise markets for now, there is no doubt that the problems on Wall Street – the nation is in total crisis, according to Republican presidential candidate John McCain – will reach across the Pacific.

So far Wall Street stocks have lost trillions; market value is down from US$19 trillion to US$15 trillion in a year. The worth of AIG has fallen from US$180 billion to US$32 billion in the same time, and Freddie Mac and Fannie Mae have accounted for another US$100 billion in lost value.

Add the latest moves – and the weird sight of the land of the capitalist free nationalising insurance firms – and it is whistling in the dark to hope the acknowledged "financial crisis" can be separated from an economic one.

Finance Minister Michael Cullen has made the requisite soothing noises about the fundamentals of our economy, in particular the banking sector, being sound – and they are. But it is in his job description not to spook the economic horses, just as it was when he downplayed the first signs of the credit crunch over a year ago.

Similarly John Key and Bill English have stayed true to their promise to offer another $50 a week of tax cuts, should they convert poll lead into electoral gold. Politically, it is difficult to see them backing off that flagship policy. And a pump-priming tax cut might, in the end, be the best policy response. But there is a debate to be had first.

For instance, just how bad will the pre-election economic and fiscal update (prefu) be when it is delivered a month or so out from the November 8 election?

Dr Cullen has acknowledged that slower world growth from the nightmare on Wall Street will curb growth here, or at least will make it harder for the economy to pull itself out of recession. He has also warned that the already large forecast cash deficits can only get worse.

It is likely that, ugly as it is, the prefu will harbour an even uglier sister – the December half-yearly update – who will crash the ball after the election.

And just how will lower growth, soft tax revenues, higher transfer payments and tax cuts affect the debt track? There is plenty of room to lift borrowing without scaring the international credit ratings, but the cushion the crown accounts can sit on for the next decade could quickly be whipped away if the economy stays low for longer.

Then Mr English's sanguine attitude to a "bit of red ink" could turn bloody.

The Treasury, in its 2006 statement of the long-term fiscal position, has already flagged the ticking demographic (and therefore debt) timebomb primed for two decades hence when health and pension costs will explode. A looser fiscal stance now might bring those difficult times closer much sooner than we, as a nation, would like.

The virtuous solution (easier said than done) is to reignite growth as soon as possible. In theory that could be achieved through an easier monetary policy and a looser fiscal stance – presuming we have all learned from the 1929 Depression, the Mother of all Budgets in 1991 and the Asian crisis that cutting government spending in the face of economic contraction is like falling to avoid tripping.

By far the most effective short- term tool is further "front-loading" of official cash rate cuts by the Reserve Bank, which can safely assume that inflation is due for another bucket of cold water from the world economy. (Already oil prices are heading helpfully under US$100 a barrel.)

Despite claims by high street bank commentators that a tightening credit market will keep interest rates high, it is a fair bet that governor Alan Bollard wants to see further quick reductions to help underpin domestic demand and the housing market.

One bank economist speculated this week that the bank was aiming for a fixed mortgage rate of about 8.2 per cent to insulate the incomes of those rolling off fixed rates at similar levels.

With that in mind, it now seems likely there will be a full percentage point drop in the OCR to 6.5 per cent late this year or early next.

Meanwhile, the latest events in the US have made it certain that the economy will be the central election issue here. Labour, as the incumbent, cannot avoid the worst of the fallout.

All it can do is make the best of a bad economy; to present Dr Cullen and the prime minister as safe custodians ranged against inexperienced risk-takers; to ask whether a "short-term gamble" is the right man to lead the country through perilous economic seas.

Hence Dr Cullen's repeated reminders that Mr Key was once a money-market man from the now- crippled Merrill Lynch. His opponents and some media labelled it desperate. It was just politics – and it is unlikely to work.

But in that sense, at least, some things are still business as usual.

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