A big boost

Yesterday's Half Year Economic and Fiscal Update, the 'HYEFU', has got well picked over - except from one important perspective: what's the overall stance of fiscal policy? Is it boosting or braking GDP growth?

The answer to that question is given by the 'fiscal impulse'. If you're not a fiscal policy wonk, the fiscal impulse is the difference between one year's fiscal balance (surplus or deficit) and the next year's, when the balances have been adjusted for the impact of the business cycle. When you've taken out those cyclical effects (eg a strong economy boosting the tax take) what's left is the impact of changes to fiscal policy. If the (cyclically adjusted) deficit is getting larger, for example, fiscal policy is becoming more stimulatory. If a surplus gets bigger, policy is becoming more contractionary.

Here are the HYEFU estimates of the impulse. For the (June) 2019 year, there's a stonking great positive fiscal boost to GDP, of the order of 2% of GDP, followed by an extended period of mildly contractionary fiscal policy.

You might well wonder, given that the economy grew by a roughly-on-trend 2.7% in the year to June 2018, why there's a thumping great boost from fiscal policy underway. And the answer is, it's an accident. Here's what was intended back on Budget day in May, compared with what's actually happened.

The government meant to give the economy a decent kick along from fiscal policy in the year to June '18: it never happened. Planned expenditure didn't go to schedule: "lower-than-forecast expenditure in 2017/18 has resulted in expenditure now in 2018/19 that was previously expected in 2017/18 driving up the impulse in this year" (from p15 of the HYEFU 'Additional Information' document).

Why? Who knows. I'd guess a combo of institutional inertia, and capacity constraints in areas like infrastructure and housing. It might be useful if someone in Treasury had a decent look: at some point we may well want to turn on the fiscal taps in a hurry, and it'll be no good if too little is 'shovel ready', as the jargon goes.

As it happens, moving the fiscal boost from 2017-18 to 2018-19 may not be a bad thing. It's still an anomalously pro-cyclical fiscal stance in an economy that doesn't need it, but on the other hand it does provide a hefty dollop of cyclical insurance against the risks lurking in the global economy (well laid out in the 'Risks to the Economic Outlook' section of the HYEFU).

Hopefully this fiscal impulse analysis will still be possible in the future. The HYEFU said (p32) that "The Treasury is currently reviewing these indicators [the cyclically adjusted fiscal balances, and the fiscal impulse] to ensure they remain useful to users and fit for purpose. Any changes to these indicators will be signalled prior to their publication". I hope that's not code for "we always knew these things were down the by-guess-and-by-God end" - as they are - "and we're not going to run with them any more". Something half-way towards an answer still trumps no answers at all.

More positively, there was a big step up in the quality of information provided on the government's capital spending plans. In the past you could go cross-eyed trying to find how much of the spend was opex and how much capex, where the capex spend was going, and whether it was enough to add to the national stock of infrastructure (you need to spend quite a lot just to keep depreciation at bay). That's hugely improved: the 'Core Crown Capital Spending' bit starting on p33 is excellent, and I particularly liked the clear explanation of the 'Multi-year capital envelope'. And in the bowels of Treasury is someone who managed to explain (on p30) the 'top-down' adjustment in Plain English. Give that person a chocolate fish.

Our financial cycles

Two economists at the University of Auckland, Caitlin Davies and Prasanna Gai, have come up with a really useful bit of practical macroeconomics. They've devised a Financial Cycle measure for New Zealand - an indicator of the overall tightness or looseness of financial conditions. Their paper, 'The New Zealand financial cycle 1968–2017', is available here in the online version of New Zealand Economic Papers.

Financial conditions indices (FCIs) are an established thing overseas. They were always relevant - changes in financial conditions have played a lead part in many business cycles, and even when not the lead have been important channels for propagating non-financial shocks - but have naturally become of greater interest since the GFC. As Davies and Gai say (p1), "Recent [academic] work ... suggests that strong credit growth and house price booms are good predictors of crisis and significantly shape macroeconomic outturns".

In the States, for example, there are a herd of them. The chart below shows five FCIs - three produced by various regional Federal Reserve Banks (Chicago, Kansas City, St Louis), two by the private sector (Bloomberg, Goldman Sachs) - plus a market-derived measure, the VIX, which is the volatility investors expect from holding the S&P500 index and which can be backed out of the prices for S&P500 options. They've all been normalised to be comparable, as described here by the St Louis Fed. Higher values for these indices mean tighter conditions.

You can see, for example, how financial conditions (ex the VIX) had been tightening ahead of the GFC, and then hit all-time highs for financial distress and unavailability of credit through the GFC itself. And if you subscribe to Austrian or Minsky style theories of business cycles, you'd argue that the pronounced period of unusually easy monetary conditions you can see in 2004-2006 sowed the seeds for the over-exuberant risk-taking that fuelled the eventual GFC bust.

Highly useful and informative things, these FCIs. And now we've got one of our own. To get it, Davies and Gai went the principal components route - take a bunch of finance and credit indicators, and see if there's a common influencing component in the background - and found that yes, there was. It combines six variables into an overall index: real credit, credit to GDP, credit to the M3 measure of money supply, real house prices, real share prices, and housebuilding to GDP.

Here's what the results look like, in raw form: for this New Zealand index, you read it the other way round to the US ones, in that higher values show easier financial conditions. The authors say that "Our measure of the New Zealand financial cycle appears to be broadly consistent with the main economic developments during the period", and I agree. You can see, for example, the surge in credit availability in the mid 1980s following banking deregulation, and the subsequent bust after the 1987 sharemarket crash. You can also see our experience of the GFC.

The authors usefully superimposed their financial index results on the business cycles identified by Viv Hall and John McDermott. The FCI for this comparison has been expressed in smoothed cyclical terms showing whether it is rising or falling (there's econometrics behind this we don't need to explore here), but same diff. Here's how they compare.

"Of the six contractionary episodes during the past fifty years, five occur less than three years after a peak in the financial cycle", the authors say (p8), and while I wouldn't immediately leap to cause and effect (and they don't either), it's a suggestive pattern.

The authors modestly say (p14) that their work "should be regarded as a tentative first-step in constructing a set of stylised facts on the financial cycle in New Zealand", but it's more than that. We had a rather large gap in documenting our recent macro history, and they've filled it. They've also created something that could easily be kept up to date, and serve as a real-time indicator of trouble brewing. As they mention, it's of obvious relevance to macroprudential policy: you might want to keep a weather eye out for where the FCI is before, for example, tightening or loosening LVRs. Indeed, you'd wonder why the RBNZ hadn't developed an FCI of their own by now.

And you can see extensions to it. This FCI is based on whatever quarterly series were available all the way back to 1968, and for a paper looking at the grand sweep of history, that's fine and unavoidable. But you can easily imagine an FCI using data that became available only more recently:I think it's highly likely, for example, that moves in corporate credit spreads, unavailable back to 1968 but available for more recent years, would feature strongly. And I think it's plausible that you could get to a monthly FCI: the Americans certainly have, and the Fed of Chicago has even gone as far as producing a weekly one (conditions are currently on the easy side of normal).

In any event this is a great start: I hope there's someone out there - the RB? a bank? the University itself? - who'll take up the baton and turn this into an ongoing up-to-date macro indicator.

In their prime

Our latest monetary policy targets agreement requires policy to "contribute to supporting maximum sustainable employment within the economy", and the Reserve Bank now spends a fair bit of each Monetary Policy Statement reporting on where we are relative to the maximum sustainable level, using a suite of different labour market indicators.

In the latest Statement, the Bank said that "employment is near its maximum sustainable level" (p22). It might be above it: "Evidence reported by employers suggests the labour market is currently tight, and that employment is above its maximum sustainable level" (p22). Or it might be below it: "some other indicators of the labour market suggest that employment may still be below its maximum sustainable level. One example is the job-finding rate" (p23). But overall we look to be there or thereabouts.

While the Bank deploys a whole battery of perspectives on the state of the labour market, one line of attack that doesn't appear is what is happening to what the Americans call the "prime age labour force", those aged 25 to 54. They're the bedrock of the labour force - they're typically out of education and not yet contemplating retirement - and the argument is that it's the state of the core  labour force that matters most for things like wages growth.

Overseas what's happening to the prime age labour force consequently gets quite a bit of air time: here, for example, is the Wall Street Journal's graph explaining the November US jobs report (from 'Did the Job Market Slow in November? Here’s How It Compares', if you've got access).

Interestingly, despite the long post-GFC expansion in the US, neither the participation rate nor the employment rate for prime age people have got back to where they were just before the GFC, and there is a mix of structural and cyclical trends going on: there looks to have been a gentle trend downwards in participation even before the GFC hit.

The corresponding numbers for New Zealand don't get much focus at all (they weren't mentioned, for example, in Stats' news release on our latest employment data), so in the spirit of inquiry I went and dug them out to see what they might be able to tell us (they're easily calculated from the data in Infoshare). Here are the headline unemployment results.

The unemployment rate for prime age people is, as you'd expect, markedly lower than for the labour force as a whole. And it's certainly signalling a tight market: the latest unemployment rate (2.0%) is getting close to its all-time low (1.5% in late 2007). You'd imagine that a fair chunk of this low rate is frictional unemployment, and that there's precious little cyclical unemployment left.

Here is the participation rate picture. It's harder to interpret: we're in uncharted territory, as the prime age participation rate has been hitting record highs. Can it keep on rising? Is there still a large reserve of people who could be tickled out into employment? Who knows, but you'd guess that the reservoir must be getting lower. We're down to only 14% of prime age people who are not in the labour force, and who are doing things like looking after young or elderly family.

The prime age participation rate is usefully splitabble into male and female participation rates, and here they are.

The overall rise to record levels of prime age participation is largely driven by a sharp and ongoing rise in female prime age participation, and like in the US there are surely both structural and cyclical things going on. That drop in the male rate over 1986-2000, for example, may well reflect the post-Rogernomics shrinking of traditionally male-dominated activities like meat processing. Changing social attitudes about (for example) who should stay at home and look after the kids will be in there, too. So it's very hard to unpick the purely cyclical component. I don't have any good feel at all for where the prime age female participation rate might peak.

Overall, the data don't give any huge overlooked insights into where we are relative to maximum unsustainable employment, mostly because the grand sweep of history and the changing attitudes to who works, and works at what, overlap the more cyclical aspects you'd like to isolate. If there is one useful extra bit of data, it's the prime age unemployment rate, which is confirming the RBNZ's "there or thereabouts" assessment.