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Friday, June 24, 2011

2007-08 oil shock caused "substantial" decline in New Zealand's GDP say Reserve Bank economists

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In a recent report, two New Zealand Reserve Bank economists have estimated the real effects of oil price shocks on New Zealand’s GDP. The economists conclude --
  1. a 5% permanent increase in retail fuel prices implies a decline in NZ's GDP of 0.3%
  2. a succession of oil price shocks such as those in 2007-08 had "a substantial effect on real GDP in New Zealand"
  3. New Zealand's oil use is different, leaving us more vulnerable to oil shocks. Faced with oil shocks New Zealand households and firms have only one third of the ability to lower the amount of oil they consume, compared with the United States.
  4. real wages decline in response to an oil shock, as they are eroded by inflation.


Why is the Reserve Bank not listening to its own economists?
Oil prices spiked in 2007-8, and retail fuel prices have increased by about 25% since mid-2010. Average fuel prices for the last quarter to March 2011 are now higher than those at the height of the 2007-08 price spike. (NZ Energy Quarterly March 2011)

If a 5% fuel increase implies a 0.3% decline in real GDP, then a 25% increase implies GDP falling by around 1.5%. Such a decline is in line with the projections of the UK government -- see my previous post here
Why are these conclusions of Reserve Bank economists being almost completely ignored in the Bank's most recent official forecasts for "growth". And why, given the advice from his own economists, is the Governor Alan Bollard, still prepared to "look through" oil shocks (code for ignore?) and their inflationary impacts?

The report has a very narrow focus on GDP.
It does not seriously examine the other direct and indirect and very serious impacts of oil shocks on the economy. These are summarised in the UK report on peak oil and include --
  • deterioration in New Zealand's balance of payments as an oil importer - set to worsen as we become even more oil import dependent
  • higher inflation and increased input costs -  found to be large for NZ in a 2005 Reserve Bank Bulletin "Oil prices and the New Zealand Economy" by Felix Delbruck
  • lower investment
  • real wages decline (this is mentioned briefly)
  • higher unemployment
  • consumer and business confidence falling
  • tax revenue falling
  • social unrest

New Zealand is at far greater risk from oil shocks
This is because we have much less capacity than other nations to lower our oil use (one third the capacity of US). The report identifies three reasons --
  1. much of our oil use is essential for agriculture and forestry, or for long-distance transport between New Zealand cities. Similar conclusions were reached in a 2005 Reserve Bank Bulletin "Oil prices and the New Zealand Economy" by Felix Delbruck
  2. compared to the US we use less oil for leisure, so we have less capacity to voluntarily reduce consumption
  3. New Zealand households do not have the wealth to substitute to newer and more fuel-efficient cars. We are one of the most car intensive nations on earth, but our fleet is one of the oldest (average age 12 years)

Oil shocks cause recessions
A graph from the report shows that in 2007-08 oil as a percentage of NZ GDP moved above 5%.

Studies from other economies confirmed that once this threshold is reached, nations go into recession
Why would we expect New Zealand to be immune? Mainstream commentary has concentrated on sub-prime mortgages and the credit/debt bubble as the cause of the global and New Zealand's financial crisis. But the price of oil is another underlying cause of New Zealand's recession that has been totally overlooked by business commentators and politicians

As far as I can judge this is the only recent New Zealand-based report examining the effect of oil shocks on our economy. The focus on GDP is narrow and tells only a small part of the story. But at least it's the beginning of a discussion. The Report should now become a catalyst for an urgent debate on these issues by business commentators and politicians. The Report was presented at universities late last year and was published in February 2011. Since then there has been no mainstream commentary on it’s conclusions that I can discover. So sadly, I'm not holding my breath on that one.


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