Washington, DC – The authorities took timely, decisive, and well-coordinated policy
actions in response to the pandemic.
Following an initial wave in March-April 2020, infections were quickly
brought under control and, notwithstanding small regional clusters in
August 2020 and February-March 2021, have stayed exceptionally low. The
health policy response, with strict layered quarantine requirements, a
focus on testing, contact tracing, and social distancing, and the ongoing
border closure, has proven very effective.
The size and scope of economic policy support have been unprecedented
and helped avert a much larger decline in economic activity and
employment.
Making use of substantial fiscal space, direct fiscal support measures of
about 19.2 percent of GDP (through fiscal year 2024/25) were put in train.
These measures, among the largest internationally (as a share of GDP), have
included wage subsidies, infrastructure investment, and tax measures to
support business cashflow and investment. Monetary policy has been very
accommodative, with the policy rate cut to 0.25 percent, the Large-Scale
Asset Purchase Program, and the Funding for Lending Program. The
authorities also deployed an array of other support policies, including the
Small Business Cashflow and Business Finance Guarantee schemes, to support
affected firms’ access to finance.
Economic activity fell sharply initially but then recovered faster than
expected.
Following a sharp contraction in the first half of 2020, real GDP began to
recover quickly and had already returned to above its pre-COVID level by
the latter part of the year, ahead of most other advanced economies.
However, while most COVID-related restrictions have been removed, tourism
and education exports lag other sectors in the recovery because of the
closed border. Inflation remained subdued at 1.4 percent in 2020Q4, below
the target range mid-point of the Reserve Bank of New Zealand (RBNZ).
Employment and labor incomes have held up better than expected, with hourly
wages growing modestly in 2020Q4. However, job losses have been unevenly
distributed and concentrated in contact-intensive service sectors. They
have been impacting disproportionally low-skilled workers, youth, women,
and some ethnic groups, highlighting concerns about increasing inequality.
The economy is expected to continue recovering in the near term, though
at a more moderate pace.
Activity is expected to expand at a slower pace in coming quarters given
the impact of the continued border closure and still-high uncertainty. Wage
growth is expected to remain modest. While some spikes—driven by higher
commodity prices and temporary supply chain disruptions—are likely in the
near term, inflation is only expected to durably reach 2 percent in 2023.
Vulnerabilities in business and household balance sheets should be
monitored.
Household and non-financial corporate balance sheets have held up
relatively well during the crisis, and banks remain adequately
capitalized and liquid. However, business insolvency, especially in
disproportionately affected sectors, will likely increase with the expiry of COVID-19 support. Surging house
prices have supported household balance sheets but amplify
affordability concerns for first home buyers and financial stability
risks.
Despite the improved economic outlook, significant risks remain
.
· Renewed domestic outbreaks and the potential for health risks to delay
the opening of the international border constitute important downside risks
to growth, highlighted by the recent lockdown in Auckland, as does
COVID-19’s impact on New Zealand’s trading partners and export commodity
prices. In contrast, faster-than-expected global containment of the virus
could prompt a faster reopening of borders, jumpstarting tourism and
international education, and lead to a more rapid recovery.
· Rising speculative demand for housing, along with historically low
interest rates and structural housing supply shortages, is amplifying the
housing cycle and heightens financial stability and affordability concerns.
Unsustainable house prices relative to income, a tightening of credit
standards, or a sharp rise in mortgage rates could trigger an eventual,
pronounced correction.
While additional stimulus is not currently needed, fiscal and monetary
support should not be withdrawn prematurely
, as output remains below potential and the recovery is still uneven
and subject to heightened risks.
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Fiscal policy
should remain sufficiently accommodative in the near term, as envisaged
by current policy plans, to ensure a successful transition from public
to private demand and limit scarring. While the successful, large-scale
wage subsidy scheme instituted in March 2020 has expired, several
measures are supporting the recovery, including business tax measures
and infrastructure spending. Going forward, the pace of fiscal
normalization needs to be carefully calibrated to support employment
and minimize bankruptcies of distressed but viable firms. The
authorities should stand ready to deploy additional fiscal support,
including public investment and fiscal lifelines such as liquidity and
targeted income support measures, if the recovery falters. In this
respect, the recent introduction of contingency measures to manage
resurgence events is welcome and will help mitigate uncertainty related
to the pandemic.
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Monetary policy
should continue to be data dependent and will likely need to remain
accommodative for an extended period. Tightening should be avoided
until inflation and employment objectives are sustainably achieved. The
RBNZ has additional room for monetary easing, potentially including
negative policy rates, in case downside risks to the recovery
materialize. Conversely, should the recovery proceed at a
stronger-than-expected pace, a gradual withdrawal of monetary stimulus
can be carefully considered. Surging house prices should be addressed
primarily through fiscal, regulatory, and macroprudential measures,
though monetary policy may have a role if house prices pose risks to
the inflation objective.
The authorities’ shift from job retention to active labor market
policies is appropriate.
The shift from wage subsidies to active labor market policies, including
the expansion of training and Flexi-wage subsidies, will facilitate the
reallocation of workers. The permanent increase in unemployment benefits
from a relatively low level is welcome and will strengthen automatic
stabilizers.
Financial sector policies should maintain resilience against financial
risks.
Financial vulnerabilities are rising from the unwinding of relief measures,
banks’ concentrated exposure to residential mortgage lending, and elevated
household debt. The increased resource allocation for the RBNZ to
strengthen supervisory and regulatory functions is welcome. The ongoing
Phase Two Review of the RBNZ Act is an opportunity to ensure that the RBNZ
has adequate operational autonomy and a sufficient degree of flexibility to
respond to financial stability risks by having the full macroprudential
policy toolkit at its disposal. The extension of the implementation of the
2019 Capital Review, raising banks’ required capitalization starting in
July 2022, mitigates risks of a premature tightening of lending conditions
while maintaining the commitment to further increase banks’ capital buffers
over the medium term.
The deployment of macroprudential tools to address housing-related
risks is welcome.
The reinstatement of loan-to-value ratio (LVR) restrictions in March and
further tightening for investors from May 2021 will help mitigate stability
risks. Additional tools, including debt-to-income ratio limits, caps on
investor interest-only loans, and higher bank capital risk weights on
mortgage lending, are under consideration and could play a useful role in
addressing housing-related risks.
Tackling supply-demand imbalances in the housing sector requires a
comprehensive approach.
· Achieving long-term housing affordability depends critically on freeing
up land supply, improving planning and zoning, and fostering infrastructure
investments to enable fast-track housing developments. Steps taken to
support local councils’ infrastructure funding and financing would
facilitate a timely supply of land and infrastructure provision. The reform
of the Resource Management Act is expected to reduce current complexities
in land use that restrict infrastructure and housing development and
contribute to efficiency in strategic planning. Increasing the stock of
social housing also remains important, and the Residential Development
Response Fund’s plans to deliver 18,000 public houses and transitional
housing space, undertake rental housing reforms, and provide assistance to
low-income households are welcome.
· Mitigating near-term housing demand, particularly from investors, would
help moderate price pressures. Introduction of stamp duties or an expansion
of capital gains taxation could reduce the attractiveness of residential
property investment. The authorities should differentiate in these
approaches between first home buyers and investors, while continuing to
provide selective grant and loan assistance to first-time buyers.
Structural policies should aim at fostering durable, inclusive, and
green growth.
Expanding research and development spending and product market reforms can
help accelerate productivity growth. The ongoing reform of the Overseas
Investment Act is an opportunity to streamline the foreign direct
investment approval process and deepen connectivity with global markets. In
this context, the government’s intention to use the new national interest
test sparingly is welcome. Infrastructure spending should aim to reduce the
existing infrastructure gap, and the post-COVID-19 recovery offers
opportunities for a re-orientation of investment towards low-emissions
infrastructure and technology. Labor market policies should focus on
supporting displaced workers and disadvantaged groups, while promoting
reallocation of resources and long-term human capital accumulation.
The mission would like to thank the authorities and counterparts in the
private sector, think tanks, and other organizations for frank and
engaging discussions.