Paul Solman on PBS last week interviewed Nobel Prize winner Paul Romer about how the US should go about containing the virus and open up the economy. He is proposing mass testing the population every two weeks.
He states that each additional unit of testing frees up approximately 9 people who can go back to work. So how to does the cost of 1 test compare to 9 people being able to go back to work? He gives the example where the cost of 1 test each day of the year = $3,650 but the income generated by getting people back to work = $450,000 – these figures are approximate.
With this model he suggest that $100bn a year needs to be spent on testing which means 23 million tests per day or test the population every 14 days in the US. Worth a look.
Below is a useful graph from the ANZ Quarterly Economic Outlook – full publication here. It covers Aggregate Demand in the New Zealand economy and the relative importance of each of the four components AD = C+I+G+(X-M).
C = Private Consumption I = Business Investment G = Government Consumption (X-M) = Net Exports
Notice how consumption and investment become negative during the Covid-19 pandemic – over 15% of GDP in the first quarter of 2021. However it could be expected that net exports will start to bring in much needed growth in the economy – New Zealand is lucky to be a producer of food an inelastic product meaning the demand remains quite stable. With weak domestic demand there is no such need for imported capital goods as business investment starts to dry up. With net exports, Government spending also will be a significant part of a recovery and to offset the deficit in consumption (C) and investment (I).
Income from the tourism industry will be limited in New Zealand as the country closes its borders although domestic demand could offset some of this loss. But with a loss of income and job insecurity this spending might not be forthcoming.
The recovery will require a massive stimulus – monetary and stimulus. For the RBNZ negative interest rates might be considered as a policy option especially with a depressed labour market and the threat of deflation. As the ANZ point out in their publication there are plenty of long-term challenges ahead. But New Zealand is resilient, and has come into this crisis with a lot of advantages:
We have been in a position to respond to the outbreak quickly;
We produce a lot of essential goods domestically and our exports are still in demand;
We have a well-functioning health system and government;
We have plenty of fiscal firepower to respond;
The financial system is resilient; and
The exchange rate and monetary policy can provide a buffer.
ASB bank published some of its forecasting for the Global and New Zealand economies and number of potential routes – read the full article here. They have come up with a central scenario which focuses on what is actually happening at the moment although we know how things can change. They then do an upside and a downside around this central forecast. They also published some graphs that relate to their scenarios – see below.
The ASB also noted that compared to other countries New Zealand is currently in a good position:
The economy is going into a deep but short-lived contraction – the economy will recover.
NZ has more fiscal and monetary ammunition than other countries.
Where the economy actual ends up – how long is a piece of string? Stay safe.
A recent OECD publication shows the economic disruption that is ahead of us. It looks as if the demand tap has been turned off with the lockdown with only essential services available. Some countries could see GDP being reduced by up to 29% – see graph. The majority of the impact comes from the loss of retail and wholesale trade although there are also notable cross-country differences in some sectors.
Germany (DEU) – 29% – closures of car industry
New Zealand – 28% – decline in tourist and leisure activities
Extending the same approach to other economies suggests that the impact effect of business closures could result in reductions of 15% or more in the level of output throughout the advanced economies and major emerging-market economies after the full implementation of confinement measures.
Many countries in which tourism is relatively important could potentially be affected more severely by shutdowns and limitations on travel.
At the other extreme, countries with relatively sizeable agricultural and mining sectors, including oil production, may experience smaller initial effects from containment measures, although output will be subsequently hit by reduced global commodity demand. As New Zealand has also got a significant primary sector does this graph over estimate the impact on its economy?
Governments around the world introduce unprecedented fiscal stimulus packages to compensate those who have been impacted by the enforced lockdown. In New Zealand Finance Minister Grant Robertson announced a $12.1 billion stimulus package to support New Zealanders and their jobs from the global impact of COVID-19 – the largest in the world on a per capita basis. The money is hopefully going to bring as many businesses back from the brink of closure but the crucial aspect of this injection is that it actually does stimulate demand and generate additional spending. Businesses that survive this pandemic and open their doors again will need the demand side of the economy to do its bit.
The lockdown has badly affected the demand side of the economy and it won’t revert back to the way it away was overnight. Will people venture back into areas with large crowds – bars, restaurants, hotels etc? It is essential that demand makes a return in order to inject some inflation into the economy. But with such uncertainty consumers will want to put off a lot of non-essential purchases. Many economists are also concerned with the “output gap.” — the difference between what the economy could produce and what it was producing. The solution to this output gap, particularly one caused by collapsing economic demand, is to invest in infrastructure projects and give consumers cash. If consumers don’t spend then the government should step-in and spend on their behalf to create the demand necessary to return the economy to some sort of normality. One indicator that we shouldn’t be worried at present is inflation – in theory such a stimulus should create inflationary pressure – the 1970’s yes but today this is less likely when you look at the velocity of circulation.
Velocity of circulation of money is part of the the Monetarist explanation of inflation operates through the Fisher equation:
M x V = P x T
M = Stock of money
V = Income Velocity of Circulation
P = Average Price level
T = Volume of Transactions or Output
For example if M=100 V=5 P=2 T=250. Therefore MV=PT – 100×5 = 2×250. Both M x V and P x T are equivalent to TOTAL EXPENDITURE or NOMINAL INCOME in a given time period. To turn the equation into a theory, monetarists assume that V and T are constant, not being affected by changes in the money supply, so that a change in the money supply causes an equal percentage change in the price level.
However when the velocity of money is falling, monetary policy which would otherwise cause inflation doesn’t seem to do so. The velocity graph (USA) above shows that you need to go back to 1949 to find a time when it was lower than today, and it was actually rising rapidly after the postwar lows. Remember that this graph was before the Covid-19 lock down. Velocity needs to increase at rapid rate to cause any inflation.
We have no idea of how the future is going to unfold because we have never seen anything like this before – to quote Rogoff and Reinhart – This time it is definitely different.
With more that 6.6 million Americans filing for unemployment benefit this week this brings the total number of Americans who have lost their jobs in recent weeks to 17 million. Janet Yellen predicts that the unemployment rate will be greater than that during the Great Depression. However unlike the 1930’s the underlying economy is in much better shape and the current downturn is health driven.
Congress passed a $2.2 trillion economic stimulus bill at the end of March that extends unemployment benefits to more workers and provides loans for small businesses to keep their employees on payroll. Most Americans will receive a direct payment of $1,200 from the stimulus, as well. Lawmakers are pushing to pass another spending package to provide additional funding to small businesses, hospitals, and state and local governments, in particular.
Below is the interview with Janet Yellen on today’s PBS News.
With countries around the world imposing a lock down for its population the global economy is entering a recessionary phase. Levels of unemployment not seen since the Great Depression of the 1930’s are anticipated – in the US 10 million people now looking for unemployment benefit. With this level of unemployment the demand side of the economy takes a hit and consumers who are worried about job security ‘batten down the hatches’ and start to be a lot more conservative with their spending – only essential items. One significant advantage for New Zealand is the fact that we have large primary sector which allows us not only to feed the population but also export – Fonterra exports 95% of local production to 140 countries. The panic buying that was seen in supermarkets around the country led to a government advertising campaign saying that we have plenty of food (and toilet roll) so no need to stockpile necessities. However this panic buying seems to have eased off and although doing the shop at the supermarket maybe slower than normal, people are getting their food okay – Good Friday tomorrow sees the supermarkets shut so they can restock.
On world markets New Zealand’s major primary export product prices have been declining as a percentage (see graph above) but what is encouraging is that this decline has been from a strong position which is unlike those in other sectors of the global economy. Meat and dairy sales surged prior to coronavirus with sales values rose 7.4% ($649 million), to $9.5 billion in the 2019 December quarter. On the contrary stock markets around the world have taken a significant hit with some declining over 20% but also coming from much weaker positions.
Other factors that help the primary sector
NZ dollar The 11% decline in the NZD/USD exchange rate gives the primary industry some protection against the fall in global food prices. Remember a decline in the value of the NZD makes our exports cheaper.
Oil prices The cheaper oil prices have been passed on at the pump and this has reduced costs for the primary sector.
Inelastic good Food is a necessity good as people need to eat – i.e. very inelastic. Therefore food related products are expected to holdup better than most. Even in the worst of downturns there will still be demand for food.
Restaurants, bars and cafes
With the closure of eating establishments during the lock down the profile of global food demand has changed as people buy more provisions from the supermarket. This has meant that supply chains have had to adjust and reallocate resources to online etc. When the country comes out of the lock down there is a supply issue for firms to get up and running again but let’s not forget the demand side. Will consumer behaviour have changed? Will people still want to go to restaurants and bars as before? One interesting statistic to lookout for will be the activity in these areas.
Not all rosey Even though the points above suggest that things might not be too bad for the primary sector, one has to be aware of the recent drought conditions in the North Island and parts of the South Island which were classified as a large-scale adverse event by Agriculture Minister Damien O’Connor. Also with Covid-19 and border restrictions there are labour shortages in some industries with up to two-thirds of the workforce coming from overseas, half on Recognised Seasonal Employer (RSE) visas and half backpackers. Further concerns are the transport links into Asia for exports as the airline industry cuts back on international schedules. Important to remember that the vast majority of commercial flights carry cargo.
All that being said I think we are quite lucky to be in New Zealand.
Like after the GFC in 2008 can China kick start the world economy? The FT’s global China editor James Kynge explains why China’s indebtedness means it is probably both unwilling and unable to launch a stimulus package like that of 2009. A lot depends on how quickly their own economy can bounce back and if it is a L U V W shaped recovery. Also can it act as a locomotive for the rest of the world. The video below contains some excellent graphs concerning China’s debt problem.
Although from 2011 the video below from the PBS Newshour shows reporter Paul Solman and Simon Johnson – former IMF economist and now at MIT. Johnson explains the different types of recoveries – L U V W shapes.
The Tutor2u Covid-19 presentations had a very good circular flow diagram by Richard Baldwin from VoxEU.org. I have used it in my teaching this week – great for NCEA Level 2 Growth standard and A2 Unit 4.
Below is a link to a very good interview with Corin Dann and Don Brash this morning on National Radio’s ‘Morning Report’. Former Reserve Bank Governor Don Brash says that the major Central Banks need to act together and reduce interest rates to offset the impact of Covid-19. The Central Banks he refers to are: US Fed, Bank of England, Bank of Japan and the European Central Bank. Good discussion of the impact of the NZ dollar on trade and the fact that just the past month in New Zealand, the virus may have cost as much as $300 million in lost exports to China. Worth a listen