Gareth Morgan, Director of Gareth Morgan Investments
The bond rate is currently a shade above 8%. The prospect is for inflation to be held below 2%, say averaging 1.5%. The real rate is then 6.5%, still substantially higher than in comparable countries. In the US the same calculation suggests a real rate of 3.5% (7 less 3.5); in the UK 5% (9.5 less 4.5); in Japan 3% (5.5 less 2.5); in Germany 4% (8 less 4); and in Australia 6% (9 less 3). And NZ continues to sport its high rate despite enduring the hardest recession of all of the above.
It’s generally acknowledged the global recession arose because of the rise in real rates choking off private investment. The alternative (interest rate) returns available to funds otherwise available for borrowing by businesses eventually exceeded the returns business projects could yield. The values of physical assets were undermined and consequent negative wealth effects spurned a slowdown in household spending. As households moved to replenish wealth lost by raising their savings rates, real interest rates began to fall. This sequence is observable in the data for the US, UK, Japan, and Australia. Despite lousy quality NZ data, it is probably our story as well. The recovery sequence then is for lower real rates to facilitate a resurgence in investment, both by households and firms. Higher consumption spending can also be expected. So what could wreck this recuperation?
Any individual pressure which drives real rates back up to recession-inducing altitudes, is a threat. This could be any one of the following; (1) A substantial fall in private sector savings rates. (2) A decline in the inflow of foreign capital. (3) Too fast an expansion in private sector investment demands. (4) An expansion of the government’s borrowing requirement.
Returning to the question of why the NZ real rate is so high, the rate of return – in the form of the economic growth generated – on previous overseas borrowing has been disappointing. The steady decline in our growth rate over the last 30 years is testimony. One reason has been the strong competition from our government in the capital markets NZ firms need to tap for investment capital. Permanently high relative real rates is the legacy, crowding out of private investment the ongoing result.
But according to the present Minister of Finance this time it doesn’t matter. The sheer pace of the economic recovery is set to so overwhelm the government with tax revenue, that the long term structural deficiency in the deficit will be no more. Last week’s Reserve Bank forecasts are enough to dupe the politicians into believing the infallibility of their economic policies, and the irrelevance of their deficit negligence. A 7% expansion in the economy over the next 2 years, tempts the delusion that has captivated previous NZ governments. As the economy picks up so does political belief that we’re rich enough to maintain a budget deficit. The tax will come later won’t it ? It is this inability to escape budget deficits even during economic recoveries, t at has resulted in our unenviable cumulative government debt levels, debt leve1~ which ensure high capital costs.
About the Author
