Rising global debt, a big risk for New Zealand

Graeme Wheeler

Extract from Speech

Auckland, September 2, 2017

The Reserve Bank’s monetary policy has been an important driver in the last five years behind above-trend growth in the economy and employment.

The New Zealand economy has generally performed well in the last five years.

It has been a remarkable five years, especially with the challenges thrown up by the global economy and an over-heated domestic housing market.

The economic scene

On the international front, we have seen increasing use of unconventional monetary policies, sluggish international trade, sharp swings in commodity prices, a continued rapid build-up in global debt, and unexpected political developments in Europe, the UK and the US.

Back home, we have experienced the strongest migration surge since the 1800s, probably the longest period of negative tradables inflation since the Great Depression, a 75% decline in dairy prices before recovering, a major shift in resources to the non-tradables sector to support the Canterbury rebuild, and annual national house price inflation reached 21%.

GDP growth

Despite these challenges, GDP growth has averaged 2.8% and employment growth 2.5%. Both exceed the trend rate of growth for the period of flexible inflation targeting up until 2012. Headline CPI inflation averaged 1% due to 4½ years of negative tradables inflation, while core inflation averaged 1.4%.

Over the past five years, the Bank’s monetary policy has been an important driver behind the rate of output and employment growth, and the path of non-tradable inflation and inflation expectations. Long-term inflation expectations remain well anchored at the target mid-point of 2%.

Financial stability

New Zealand has also had a stable financial system.

LVR restrictions have reduced financial stability risks as house prices became increasingly stretched. Requiring new borrowers to have a greater equity contribution in their house purchases reduced the overall riskiness of banks’ mortgage portfolios.

Nationwide annual house price inflation has declined to 1% due to LVR restrictions, the tightening in bank lending, the rise in mortgage rates and increasing concerns about housing affordability.

LVR, a temporary measure

LVRs are not expected to be a permanent measure, but their removal would require a degree of confidence that financial stability risks won’t deteriorate again.

However, debt-to-income ratios have risen in recent years, and with the underlying drivers of housing demand (population growth, low interest rates) remaining strong and demand outstripping supply, there is a risk of a housing market resurgence (and a sharp lift in high LVR lending) if LVRs were removed at this time.

Greatest Risk

In the absence of major unanticipated shocks, prospects look promising for continued robust economic growth in New Zealand over the next two years.

The greatest risk we face at this stage relates to the inflated global asset prices and the continuing build up in global debt.

If growth in the global economy slows, we have some scope to buffer our economy. We have greater room for monetary policy manoeuvre than central banks in many advanced economies.

Our official cash rate is 1.75%, above the zero and negative interest rates of several advanced country central banks – and the Bank has not grossed up its balance sheet by buying domestic assets.

With a budget surplus and low net debt relative to GDP, there’s also flexibility on the fiscal policy side.

Graeme Wheeler is Governor of Reserve Bank of New Zealand. He will move from this post on September 23, 2017 to pursue other interests. The above is a part of his address to the Northern Club, Auckland on August 30, 2017. For full speech, please click Reflections on the stewardship of the Reserve Bank

The picture appearing here was taken at the Sixth Annual Indian Newslink Sir Anand Satyanand Lecture held on July 25, 2016 at Pullman Hotel, Auckland at which he was the Guest Speaker.

(Picture by Narendra Bedekar, Creative Eye Fotographics)

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