A global recession would then be the best forecast (through a whole variety of channels including, but not limited to, extreme uncertainty – fatal for investment, which can usually be postponed – and wealth losses). Faced with severe adverse shocks, and extreme uncertainty, layoffs happen and firms close faster than replacements emerge.
(The longer run effects will also be adverse, lowering potential GDP in all the countries that participate in the “war”, which consciously and deliberately put sand in the wheels of their own economic performance, but economies adjust – you can have full employment in a highly protected economy with impaired productivity growth (see NZ in the 50s and 60s) or in a high-performing open and competitive economy.)
The direct effects of the tariff war on New Zealand are still probably pretty limited. Our goods exporters to the US face the lowest tariff band, lower than those facing many competitors (eg European wine exporters) and the amounts involved are just a small fraction of GDP anyway. But as pretty much every commentator is now pointing out, the indirect effects will swamp any direct effects. It is perhaps a bit like early 2020 when government agencies were initially focused on the damage to a few New Zealand exporters (lobster, universities etc) from China’s disruptions, only for those modest effects to be totally swamped by the wider global effects and our own experience with Covid (pre-emptive adjustments and lockdowns). In a global recession there is pretty much no place to hide.
But what does, and should, it mean for monetary policy, here and abroad (if the madness persists)?
In the US, it is near-certain that there will be a material increase in consumer prices. Headline inflation will, all else equal, increase over the coming few months. To the extent there is any logic in the madness, that is part of the point. Higher prices in the US increases returns to domestic producers and make foreign produced products relatively less attractive (of course, in many cases, US producers will also face higher costs on imported inputs). From a revenue perspective, it is also akin to a big increase (inefficient and all as it may be) in consumption taxes – reportedly the largest US tax increase in some decades. So prices will rise and real household disposable incomes will fall.
A sensible central bank will always have to play things by ear to some extent. No idiosyncratic event is ever quite like another. It isn’t impossible that the higher tariffs will translate into behaviours consistent with households expecting inflation to be permanently higher. If that happened, the Fed would need to lean against that risk – hold policy tighter than otherwise.
But an alternative scenario might be one akin to an increase in GST. Increasing consumption taxes raises consumer prices and headline inflation. We’ve had three experiments of this sort in New Zealand in our post-liberalisation years: when GST was first imposed in 1986 (a 6%+ lift to the price level) and when it was increased in 1989 and 2010 (each increasing consumer prices by a bit over 2%). On none of those occasions did the Reserve Bank seek to tighten monetary policy in response, and with hindsight that was the right call on each occasion. The lift in prices was (at least implicitly) recognised by the public as a one-off lift in inflation, that dropped out of the headline rate again a year later.
How likely is something like that in the US at present? Given the chaotic policy and political processes, and the fact that – unlike with GST changes – prices won’t all change on one day, perhaps there is less reason for optimism there. And perhaps all bets are off if the public and markets come to think there is a credible threat to sack and replace existing Fed decisionmakers.
But, even if household expectations (beyond 12 months ahead) and behaviour do rise – and surveys and behaviour are two different things – there is still the big hit to real household disposable income to consider. Such hits happen with some GST adjustments (the NZ 1989 one was intended as a fiscal consolidation) but not others (the NZ 2010 GST change was intended as a tax switch). And in addition to the direct effects of the tariffs, there are wealth losses (see stockmarket) and the impact of business disruption and business uncertainty delaying investment spending. Real activity, and pressure on resources and capacity, seem almost certain to ease. All else equal, a reasonable conclusion should be – and market pricing is consistent with this – that the Fed is more likely to need to ease than it would otherwise have thought, consistent with keeping core inflation near to target.
There is rhetoric around that somehow the lesson of the last few years is not to ease in the face of adverse supply shocks. But a lot depends on the nature of your supply shock. This isn’t (for example) a case of literally shutting down the economy and people going home (voluntarily or otherwise) to avoid a virus. The labour is still there, the capital equipment is still there. It can all be used – capacity is real – but the demand for resources is likely to diminish quite considerably. Monetary policy cannot (of course) do anything about the longer-term adverse effects of a shift to a more protectionist economy and policy regime. If the regime persists, Americans will be poorer than otherwise. But monetary policy often has a role to play in smoothing the dislocations, in trying to replicate what a market interest rate would be doing – reconciling desired saving and investment plans – absent a central bank. One parallel, for example, is the recession and financial crisis in the US in 2008/09. Monetary policy couldn’t fix the misallocation of resources and bad choices that led to the financial crisis in the first place. To the extent financial crises impair productivity, monetary policy also couldn’t do much about that. But not many people think that simply holding the Fed funds rate at mid 2007 levels in the face of the dislocation and associated severe recession would have made much sense.
What about New Zealand (and countries like us). If we see higher prices directly as a result of the tariff war, they should be fairly scattered and limited. It isn’t at all impossible that we might see import prices, in foreign currency terms, falling as (for example) Chinese manufacturing exporters look for alternative markets where they won’t face 100 per cent plus tariffs. With a fairly limited manufacturing sector ourselves, that terms of trade gain might be fairly unambiguously welcomed. We might get (temporarily) lower headline inflation and slightly higher real disposable incomes.
But, and on the other hand, a global recession would almost certainly more than cancel out that effect. We’d see materially lower export prices for commodities, and lower volumes for many other exports (eg tourism, students). It doesn’t matter that the initial crisis/shock wasn’t generated here, any more than it mattered in 2008/09.
I put this on Twitter this morning
Click to view
(The longer run effects will also be adverse, lowering potential GDP in all the countries that participate in the “war”, which consciously and deliberately put sand in the wheels of their own economic performance, but economies adjust – you can have full employment in a highly protected economy with impaired productivity growth (see NZ in the 50s and 60s) or in a high-performing open and competitive economy.)
The direct effects of the tariff war on New Zealand are still probably pretty limited. Our goods exporters to the US face the lowest tariff band, lower than those facing many competitors (eg European wine exporters) and the amounts involved are just a small fraction of GDP anyway. But as pretty much every commentator is now pointing out, the indirect effects will swamp any direct effects. It is perhaps a bit like early 2020 when government agencies were initially focused on the damage to a few New Zealand exporters (lobster, universities etc) from China’s disruptions, only for those modest effects to be totally swamped by the wider global effects and our own experience with Covid (pre-emptive adjustments and lockdowns). In a global recession there is pretty much no place to hide.
But what does, and should, it mean for monetary policy, here and abroad (if the madness persists)?
In the US, it is near-certain that there will be a material increase in consumer prices. Headline inflation will, all else equal, increase over the coming few months. To the extent there is any logic in the madness, that is part of the point. Higher prices in the US increases returns to domestic producers and make foreign produced products relatively less attractive (of course, in many cases, US producers will also face higher costs on imported inputs). From a revenue perspective, it is also akin to a big increase (inefficient and all as it may be) in consumption taxes – reportedly the largest US tax increase in some decades. So prices will rise and real household disposable incomes will fall.
A sensible central bank will always have to play things by ear to some extent. No idiosyncratic event is ever quite like another. It isn’t impossible that the higher tariffs will translate into behaviours consistent with households expecting inflation to be permanently higher. If that happened, the Fed would need to lean against that risk – hold policy tighter than otherwise.
But an alternative scenario might be one akin to an increase in GST. Increasing consumption taxes raises consumer prices and headline inflation. We’ve had three experiments of this sort in New Zealand in our post-liberalisation years: when GST was first imposed in 1986 (a 6%+ lift to the price level) and when it was increased in 1989 and 2010 (each increasing consumer prices by a bit over 2%). On none of those occasions did the Reserve Bank seek to tighten monetary policy in response, and with hindsight that was the right call on each occasion. The lift in prices was (at least implicitly) recognised by the public as a one-off lift in inflation, that dropped out of the headline rate again a year later.
How likely is something like that in the US at present? Given the chaotic policy and political processes, and the fact that – unlike with GST changes – prices won’t all change on one day, perhaps there is less reason for optimism there. And perhaps all bets are off if the public and markets come to think there is a credible threat to sack and replace existing Fed decisionmakers.
But, even if household expectations (beyond 12 months ahead) and behaviour do rise – and surveys and behaviour are two different things – there is still the big hit to real household disposable income to consider. Such hits happen with some GST adjustments (the NZ 1989 one was intended as a fiscal consolidation) but not others (the NZ 2010 GST change was intended as a tax switch). And in addition to the direct effects of the tariffs, there are wealth losses (see stockmarket) and the impact of business disruption and business uncertainty delaying investment spending. Real activity, and pressure on resources and capacity, seem almost certain to ease. All else equal, a reasonable conclusion should be – and market pricing is consistent with this – that the Fed is more likely to need to ease than it would otherwise have thought, consistent with keeping core inflation near to target.
There is rhetoric around that somehow the lesson of the last few years is not to ease in the face of adverse supply shocks. But a lot depends on the nature of your supply shock. This isn’t (for example) a case of literally shutting down the economy and people going home (voluntarily or otherwise) to avoid a virus. The labour is still there, the capital equipment is still there. It can all be used – capacity is real – but the demand for resources is likely to diminish quite considerably. Monetary policy cannot (of course) do anything about the longer-term adverse effects of a shift to a more protectionist economy and policy regime. If the regime persists, Americans will be poorer than otherwise. But monetary policy often has a role to play in smoothing the dislocations, in trying to replicate what a market interest rate would be doing – reconciling desired saving and investment plans – absent a central bank. One parallel, for example, is the recession and financial crisis in the US in 2008/09. Monetary policy couldn’t fix the misallocation of resources and bad choices that led to the financial crisis in the first place. To the extent financial crises impair productivity, monetary policy also couldn’t do much about that. But not many people think that simply holding the Fed funds rate at mid 2007 levels in the face of the dislocation and associated severe recession would have made much sense.
What about New Zealand (and countries like us). If we see higher prices directly as a result of the tariff war, they should be fairly scattered and limited. It isn’t at all impossible that we might see import prices, in foreign currency terms, falling as (for example) Chinese manufacturing exporters look for alternative markets where they won’t face 100 per cent plus tariffs. With a fairly limited manufacturing sector ourselves, that terms of trade gain might be fairly unambiguously welcomed. We might get (temporarily) lower headline inflation and slightly higher real disposable incomes.
But, and on the other hand, a global recession would almost certainly more than cancel out that effect. We’d see materially lower export prices for commodities, and lower volumes for many other exports (eg tourism, students). It doesn’t matter that the initial crisis/shock wasn’t generated here, any more than it mattered in 2008/09.
I put this on Twitter this morning
Click to view
and, of course, once the recession really took hold we got a big decline in (imported) oil prices but it wasn’t enough to stop the terms of trade overall falling by 10 per cent.
Assuming the tariff madness persists (see mercurial and unpredictable occupant of White House) it is very difficult to see how we – and other countries – avoid something similar this time round. I’m glad I’m not an economic forecaster paid to put specific numbers to it – this is just another case of extreme uncertainty making all but the most highly conditional numerical forecasts barely worth the paper they are written on – but the direction is clear, the severity of the shock is clear, our (non-unique) exposure is clear. All else equal, the OCR is likely to need to be a lot lower than otherwise, and since it is starting out still above neutral and with core inflation not far from target, that suggests a lot lower in absolute terms. To be clear, this is not a forecast, but in past serious downturns – demand led – short-term interest rates have often fallen something like 5 percentage points (in New Zealand, but also actually in the US).
The Reserve Bank’s MPC has its latest OCR review announcement out this afternoon. They are in a difficult position: they have only an acting Governor (who was responsible for the Bank’s macro and monetary policy functions when the really bad calls in 2020 and 2021 were made), a deputy chief executive responsible for macro who has no expertise or background in the subject, and so on. Being an interim review, they won’t have a full sort of forecasts and scenarios of the sort done for the quarterly MPS. They’ve also continued the madness of scheduling OCR reviews a week before the CPI comes out so they won’t even have a good read on the baseline – pre tariff madness – state of core inflation. And policy out of Washington (and Beijing and Brussels) can shift by the day.
Most people seem to expect the MPC to stick to the 25 basis point cut foreshadowed at the last MPS. On the domestic macro data they’ll have to hand – all from before the latest tariff madness (which even Jerome Powell has noted is worse than had been expected) – that would be perfectly defensible.
But so would a somewhat larger adjustment. After all, the external environment has changed, the effect is not likely to be small (or to be fully reversed even if we woke up tomorrow to find the last week had just been a bad dream), and even the government, channelling Treasury, is now warning of the adverse economic effects and risks. It isn’t time for dramatic emergency moves – that time may come, although one hopes we never need to see a 150 basis point cut ever again, as in late 2008 – but a rate that seemed fitting, to the New Zealand inflation outlook, 10 days ago, shouldn’t seem right today. And for all that they have only an acting Governor they may feel less locked into Orr’s February commitments than he might have were he still there. The risks are pretty moderate, especially as on the Bank’s own estimates the OCR is still above neutral and the output gap is estimated to be materially negative.
What are some counter-arguments? There is always the “six weeks doesn’t make any macro difference” so why not wait until the (full forecasts) and the May MPS. Perhaps there will be fuller information. I don’t think it is particularly compelling as it seems quite unlikely that the fog of war will have disappeared by next month (the macro implications will just be starting to become apparent), and if a large adjustment is eventually needed it may be best to get started. If it isn’t eventually needed a larger move today doesn’t take the Bank beyond where it thought things would level out at.
I heard one market economist on the radio this morning suggests that a larger cut today might rattle people. Quite probably, but most likely they should be rattled. This is a really serious economic policy shock Trump has launched on the world.
And then there is the exchange rate. People – reasonably – note that in severe downturns the New Zealand exchange rate usually falls a lot. That will tend to raise the prices of tradables, all else equal. It hasn’t really happened yet – if anything the TWI is a bit stronger – but it seems a pretty plausible story. It is just that in serious downturns previously – most notably 2008/09 – the direct price effects of a lower exchange rate ended up being outweighed by the disinflationary effects of the downturn on non-tradables inflation. An exchange rate adjustment is likely to be part of the overall response to the tariff madness shock, but not a substitute for action by the MPC.
We’ll see this afternoon what the MPC has come up with, but we shouldn’t be surprised if they do cut by more than 25 basis points, and doing so would probably be the right call. If they don’t, then I guess even more attention than usual will be paid to the wording of their statement, recognising that with the loss of a Governor some changes in wording may just be idiosyncratic – linked to one person’s stylistic or other preferences.
Michael Reddell spent most of his career at the Reserve Bank of New Zealand, where he was heavily involved with monetary policy formulation, and in financial markets and financial regulatory policy, serving for a time as Head of Financial Markets. Michael blogs at Croaking Cassandra - where this article was sourced.
4 comments:
It may be considered by some as madness but maybe the current moves are correcting madness.
So, the tariffs are bad, and Trump is now an even bigger monster than we ever imagined.
The general trend I can see from some "experts" is to basically cry about it rather than ask the question.
How the hell did we become so weak and our economies so fragile and why did we rely upon US benevolence?
When prices rise in the USA do they have benefits, mimimum wage, living wage, super etc etc indexed to it to compound the effect like we do, or can their sytem absorb some of? Are they obliged to limit inflation and do they have devices other than the cash rate? They specilaise in penniless immigants and with endless land available, avoid upward pressure on house prices.
Lol, so many of the people who scream about the evils of neoliberalism are now screaming about evil Trump bucking neoliberalism.
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