Take Five: A recession may be coming. Here are five key questions answered

Monday, 30 May 2022

Adrian Orr has said that interest rates were returning to normal after being low during the Covid pandemic.

It’s been a tricky couple of years to be an economist. When Covid-19 arrived in New Zealand, we were warned to prepare for skyrocketing unemployment and plummeting house prices.

It didn’t happen. Growth rebounded quickly, and house prices took off at an incendiary rate.

Now, we’re looking at predictions of a downturn again – this time as the Reserve Bank battles to calm the inflation.

Reserve Bank governor Adrian Orr addressed the “R” word at a select committee hearing on Thursday, when he said there was a risk that raising interest rates could push the country into a recession. So what does that mean?

* Reserve Bank may be forced to 'keep hiking until something breaks'

* Skyrocketing house prices should not be part of the post-lockdown recovery, but what does this mean?

1. What is a recession, anyway?

The technical definition of a recession is two consecutive quarters of falling gross domestic product (GDP). Basically, the economy contracts for six months.

2. Why would that happen now?

The Reserve Bank has been responding to the rapid increase in inflation with fairly aggressive interest rate hikes.

Last week it doubled down, predicting that the official cash rate (you can read more about the official cash rate here) could go to 4%, higher than previously forecast. This makes a lot of borrowing more expensive, which means consumers and businesses have less money available for other things and are less keen to spend and invest.

The Reserve Bank has to get the balance right and slow inflation without knocking the economy out at the knees. Because it takes a while for interest rate increases to be felt, there is a risk it could “overshoot” and push up rates more than it needs to, leading to a recession.

There may be more economic trouble on the horizon.

The other problem it has is that domestic inflation could well slow quite quickly, but overseas factors that New Zealand cannot control, such as supply chain problems, could continue to put pressure on prices here.

3. So how likely is a recession?

It’s hard to know.

Brad Olsen at Infometrics says it’s “inevitable”, but ANZ chief economist Sharon Zollner isn't forecasting a recession (though she notes that economists have a terrible track record on this).

A normal recession would involve a shock to exporters, denting their incomes, which would then flow through to the “person on the street”.

But there are signs what’s happening now is different as consumers are already struggling with rising prices.

4. What would it be like?

A normal downturn would be felt by “average” people through higher unemployment, maybe a fall in wage growth and the failure of some businesses.

What’s strange is that the labour market is really tight right now. That is, not many people are unemployed. So a recession now could feel quite different to a “normal” one.

In some ways, it might not feel a whole lot worse than the current conditions – people might be worried about house prices, concerned about spending money because of high prices, and trying to save their cash.

“At the moment consumers are saying times are terrible when the labour market is the tightest it’s ever been,” Zollner says.

She said we would probably see business insolvencies and people focusing on paying down debt to free up resources.

Consumers also tend to feel the pinch of a recession beyond the point where growth has turned positive again.

5. How do we get out again if we do have a recession?

The normal path of recovery is that the Reserve Bank cuts interest rates.

Eventually, the paying down debt and freeing up resources turns into people and businesses rebuilding, feeling more confident and the economy growing again.

A reset, where supply and demand become more in sync, would allow the country to start moving again.

ASB senior economist Mark Smith says New Zealand has been through a lot in recent years and how the economy responded would depend on how long-lasting a downturn was.

In the global financial crisis, Chinese strength helped us to rebuild, but this time China is one of the source of the concerns.

Smith says a real concern is that we get into a self-fulfilling loop of feeling worried, cutting spending, and thus slowing things down more quickly.

He recommended people try to get out and “do their bit” if they could.

“If you put it in perspective, New Zealand is still a pretty good place in the world to be.”