Tuesday, 5 August 2014

We're past the peak

Treasury's latest Monthly Economic Indicators came out yesterday (assorted links here), and while reading the economic tea leaves isn't always an easy exercise, this time one clear message comes through loud and clear: we've just gone past the point of fastest GDP growth. We're still growing at a good rate, enough to keep the unemployment rate heading in the right direction, but the oomph we got from the dairy boom and the Canterbury rebuild has eased a bit.
Any one of several graphs from the Treasury chart pack serves to show the picture: here's one on firms' expectations for their own activity levels (always a good gauge).

We could conceivably see the growth rate pick up again, especially if our export markets perk up a bit (Australia in particular has been on the soft side) or if the Kiwi dollar weakens, which again would help exporters. Or maybe Auckland housebuilding will pick up: as Bernard Hickey argues here, "Auckland's housing consents are still lagging its population growth, let alone catching up with the supply gap created between 2004 and 2012". More likely, though, the peak growth rate is behind us, and if we want to have ongoing decent-sized increases in living standards we're going to have to find something to supplement the dairy trade and fill in for the earthquake rebuild.
Slower growth may have one positive side-effect: it could make the Reserve Bank's job a bit easier. At our recent rate of growth (4% at an annual rate in the March quarter, going by the output measure of GDP, 5.2% going by the expenditure measure) we were rapidly eating into the degree of productive slack in the economy. Once it's all gone and we're into "positive output gap" territory, inflationary pressures start developing. And on Treasury's estimates, shown below, we have indeed used up the slack.

We're either at the "used up the spare capacity" point (according to the 'small macro model' and 'Kalman filter' estimates) or indeed beyond it (the 'HP' and 'MV' filter estimates). Either way you can see why the Reserve Bank has already been tapping the brakes (four 0.25% taps to date).
If you're not too convinced by these rather abstruse measures of how close we are to our productive capacity limit - and why would you be, when you look at the Kalman filter's convincing impression of a drunken driver on an icy road - the business surveys get to the same place, as shown below.

The red line is the one to watch. Capacity as a limiting factor to businesses' growth is right up there, at very close to its high over the past 20 years. Naturally, in these circumstances, you'd expect firms to react by investing more and expanding their capacity, and they are, as the graph below shows.

Whether this investment in new capacity will be enough to defuse domestic inflationary pressures remains to be seen. I'm mildly sceptical at the moment: it's a decent sized lift in investment, certainly, but it's not quite on the scale of previous bursts (mid '90s, mid 2000s). And I haven't liked the look of recent official statistics on stubborn levels of domestic non-tradables inflation, or of business surveys showing more businesses expecting to be able to raise their prices faster than their costs. We'll see how it plays out, but I'm leaning towards the view that we may see the odd bit of unpleasant inflation news down the track.

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