Treasury Estimates

The NZ Treasury released its estimates today for the effects on the economy of the Covid19 virus and associated shutdown.

The scenarios considered vary depending on how long the country is kept in each level of the shutdown. I thought scenario 1 looked most realistic; it assumes that Level 4 will last a month, then Level 3 for a month followed by Level 1 or 2 for ten months. The worst case is scenario 4, which assumes Level 4 for three months and Level 3 for 3 months. That does not seem plausible, but I presume it was put in there to make the others seem more acceptable.

Two figures stood out to me. First, if the best scenario applies, quarterly real GDP drops from 64 billion dollars in the March 2020 quarter to 54 billion dollars in the September quarter, when the economy has had quite a few months to recover. That is a drop of 14 percent, which is a huge hit on the economy. It takes out quite a few years’ worth of economic growth at a time when the population has grown rapidly, so the effect on real GDP per capita will be even worse.

The Treasury notes that this number is just an estimate, but I would have preferred that they gave more information about the assumptions on it was based, and an indication of the plausible range for their estimates. It makes a big difference, whether the estimated decline between March and September is between 12 and 16 percent, or whether it is between 9 and 20 percent.

But you cannot eat GDP, so these figures probably do not mean much to many people. However, the other figure that I noted really brings it home.

Under their best-case scenario, the Treasury estimates that unemployment will be 13 percent of the workforce in the September quarter 2020, well after the finish of the lockdown. The New Zealand workforce consists of about 1.5 million people, so 13 percent unemployment means 195,000 people without work. That is a huge amount of pain. Many of those who lose their jobs will be able to collect unemployment benefits, but many others will be the partner of someone who is working, so they will not qualify for a benefit.

My initial response to the estimates is that the Treasury is overconfident about how quickly the economy will recover. I will be interested to see what other economists say about this. It depends on how much account the Treasury has taken of the effects of business closures rippling through the economy.

Treasury seems to be assuming that the world economy will only decline by about 3 percent in the best case, and 6 percent in the worst case. That also seems to be a little optimistic.

• The Chinese economy was already slowing sharply before the virus struck, and it is uncertain how quickly it will recover.

• The US financial sector is very shaky. The collapse in the value of shares and bonds means that many debtors have had to stump more for collateral for their loans. It is not clear that all will be able to do it. Many large corporates have burnt up their cash reserves and are finding it difficult to find credit. There are huge risks around derivatives linked to the price of oil. The Federal Reserve is trying to shore the financial system up with more credit, but it is still not clear that they will be successful.

• As they recover, the nations of the world are like to pull back from dependence on international trade and try to be more self-sufficient. That will increase the cost of producing everything that people need and make life more difficult for exporting nations.

I suspect that as we go out of the shutdown, the New Zealand economy will face stronger headwinds than the Treasury is assuming. The world is not just dealing with a health crisis; it is also facing a financial crisis.