Bollard, Alan, The Reserve Bank of New Zealand Bulletin
The global financial and economic crisis has confirmed once again that when the world is in shock, it will be turbulent for New Zealand. Good policy frameworks, policy interventions and our economy's structure can help a lot. However, they cannot completely isolate us from the turmoil.
Now, we and the world appear to be on our way to recovery. What shape will recovery take, and what will make it durable? What are the implications for policy? This speech looks at these questions for the global economy, and for New Zealand.
At least for New Zealand, certain basic factors would promote sustainable growth, and reduce the economy's vulnerability, beyond the recovery. First, greater savings by households, to reduce the need for foreign funding of the economy. Second, investment in the economy's productive base, particularly in the tradable sector. Third, greater durability and depth in funding markets, including a lengthened maturity structure for bank funding.
The speech proceeds as follows. First, I review the themes driving the current world recession, and how world recovery appears likely to proceed. Then I turn to New Zealand and look at the impact of the crisis here. Finally, I discuss the path ahead, the lessons learned, and our challenges to make the recovery strong and sustainable.
The world recession in hindsight
The story of the past decade has now been told many times.
Around the world, liquidity and credit grew hugely until the crisis. The expansion was fed by stimulatory monetary policy in the developed world responding to the 2000-01 global downturn, a 'glut' of international capital pouring out of emerging markets and oil producers, and a proliferation of new financial firms, instruments and practices seeking to ride the credit wave. Risk managers and regulators alike struggled to keep up with the growing complexity. Credit expansion and asset price inflation reinforced each other, and oil and other commodity price inflation followed.
The boom proved to be unsustainable. Around mid-2007, US house prices began to fall, and impairments on mortgage loans began rising sharply. Soon, the quality of a wide range of securities and derivatives based on bank loans came under question. With growing panic about who was exposed and how badly, financial firms stopped dealing with each other in September 2008. Short-term funding markets shut down. Some very large firms, including Lehman Brothers, AIG, and Fannie Mae and Freddie Mac, failed or were restructured. The implosion of liquidity crippled the equity and term funding markets.
The widespread reduction in credit availability to the economy, massive loss of wealth, and plummeting business and consumer confidence drove economic recession. Developed-country consumers and firms slashed expenditure on big-ticket durable items such as cars and machinery. Reflecting this, exports and production in upstream economies in the global manufacturing supply chain, particularly in East Asia, collapsed (see figure 1)--but commodity exporters such as Australia and New Zealand were less hard hit.
In the six months to March 2009, global economic activity fell more rapidly than at any time since World War II.
[FIGURE 1 OMITTED]
Policy responses around the world have leaned hard on all conventional measures, and many unconventional ones.
To deal with the liquidity crisis in the financial system, central banks broadened their lending facilities to banks. Governments extended bank deposit and liability guarantees, and intervened to restructure or rescue large or 'systemic' institutions. Several countries have now developed programmes to purge bank balance sheets of illiquid assets and strengthen banks' capital positions.
To deal with the economic slump, governments and central banks have rapidly deployed large-scale fiscal and monetary stimulus. …