Listener: 13 June, 1987

Keywords:  Macroeconomics & Money;

The good news is that the economy is on track, performing largely as might have been expected given the liberalisation policies applied to it. But what do we mean by ‘on track’? In early 1985 I was visited by an International Monetary Fund mission on its annual review of the New Zealand economy. As they were about to go, after an hour discussion, I asked them what other country had gone through similar policies, so that we might get some idea of where we were going.

They replied in a word – ‘Chile’. (Hence the Australian joke that the New Zealand economy has moved so far to the right that it is now located in Chile.)

Chilean economic liberalisation is most notorious in the profession for the sacking of all university academics who disagreed with Pinochet’s (Chicago-style) economic policies. But that country (like Argentina, Brazil and Uruguay) has gone through a very characteristic pattern following the rapid removal of controls and a widespread switch to a more market mechanism.

Initially economic production and investment boomed, but the economy then entered a recession, typically associated with a speculative financial boom and an overvalued real exchange rate. Because of the overvaluation, at least in part caused by the speculation, exporting became unprofitable and importing profitable. The financial consequence was that the country has a large balance-of-payments deficit and ran up substantial foreign debts.

The production consequence is that the economy contracts and unemployment rises while investment falls. The resulting recession is prolonged; typically about 12 quarters (ie, three years). Even as the country comes out of the recession it faces massive foreign debts, while it does not have the productive capacity to service the interest payments because of the investment cutbacks.

Sounds familiar? The New Zealand economy began its last cyclical upswing in the September quarter 1983, following the four-quarter recession, which had been typical in every postwar recession for which we have records.

The upswing appeared to be coming to an end in June quarter 1984. Again, that would have been typical in that the previous three booms had all been four quarters long, although up to 1974 they were eight quarters in length. Four-quarter booms are associated with longrun stagnation, eight-quarter booms with long-run economic growth.

However, the upswing did not end in mid 1984. As a result of the July devaluation and the following liberalisation measures, the boom continued through to September quarter 1985. This eight-quarter boom was associated with the strongest economic growth for a decade.

Then the economy plunged into a recession. Just before the downswing it appeared that this was going to be a standard recession. However, its sharpness soon became apparent, and the possibility of a severe recession could not be ruled out by December 1985. In particular, following the floating of the dollar in March 1985 and a number of other measures which released a speculative boom, the exchange rate had risen so that the currency was now more overvalued than in July 1984, before the devaluation.

At this stage an interesting little ‘wrinkle’ in the Latin American pattern needs to be mentioned. Some of those economies did not enter their long recession immediately. Instead they experienced a short recession, followed by a very weak recovery before the plunge.

This may have almost happened in New Zealand. Last September the economy was still in recession, but some observers saw some buoyancy. If it was there, it was short-lived. In March 1987 the economy was in its sixth quarter of recession – postwar record. Moreover, while the data is not yet to hand, it seems certain that it is still in recession. Indeed, it is not difficult to argue that the economy will be depressed until at least the end of 1987 – that would be a minimum of a nine-quarter recession, and twice as long as any previous one.

Some people even wonder whether we shall follow the Latin American experience with a 12-quarter, three-year recession. I counsel caution. First, because we have never previously experienced a recession of this length, it is very difficult to forecast its future. Second, the cutting back on macroeconomic research has left us over-dependent upon opinion rather than analysis. ‘Light at the end of the tunnel’ comments flourish in such ignorance, as do overly pessimistic assessments. What I can report is that top forecasters, who lay their reputations on the line by publishing their predictions, offer gloomy outlooks.

And it is not merely: How long before the recession ends? The Latin American experience warns that the upswing may be associated with too much debt and not enough productive capacity.

So if the good news is that the economy appears to be on the track one would expect from the liberalisation measures, the bad is that it is not necessarily the track we would choose.