Can New Zealand's economy recover without a housing price surge?
New Zealand's economic recovery is expected to continue, but this time, it's not relying on rising house prices. Most forecasts predict a modest 5% increase in house prices this year, with some even expecting half that. This shift in dynamics has sparked interest in whether the economy can thrive without the traditional boost from housing wealth.
Michael Gordon, a senior economist at Westpac, explores this intriguing possibility. He acknowledges the skepticism surrounding the idea but highlights that it's already happening. Retail spending has been consistently rising over the past five quarters, even as house prices remained relatively stable. However, he emphasizes that this trend might not be sustainable in the face of subdued house price expectations for the year ahead.
The recent economic literature suggests a fascinating solution. Gordon proposes that the 'housing wealth effect' is more accurately described as an 'income expectations effect'. This effect drives both spending and house prices higher. Historically, when house prices were rising, people were more inclined to spend, believing their houses were 'saving' them money. However, the relationship between housing wealth and household spending is not always strong, especially in recent years due to the volatility caused by Covid and policy responses.
Despite the absence of house price increases in many areas, lower interest rates are still making a difference. Retail sales volumes rose by 0.9% in December, exceeding expectations. Gordon points out that when people expect their incomes to rise, they tend to spend more and push house prices higher. The magnitude of this effect depends on the responsiveness of the supply side, which has been historically slow in New Zealand but shows signs of improvement.
Simplicity chief economist Shamubeel Eaqub offers a different perspective. He acknowledges that regions have experienced economic growth without house price growth. Eaqub emphasizes the significant role of the residential property mortgage market in providing capital for investments. Without rising house prices, the availability of capital for businesses and individuals is reduced, potentially impacting growth. However, he argues that growth can still occur, albeit at a slower pace.
Eaqub highlights that economic growth has occurred before house prices boomed, and some of it was quite strong. He points out that post-2000, some economic growth might not have been of high quality. Looking back at New Zealand's history, there have been periods of economic growth without a rapid increase in house prices, and some regions have experienced growth without consistently high house prices.
The downturn, according to Eaqub, was primarily driven by the drop in disposable income as the cost of essentials rose. However, there is pent-up demand for various activities, from home improvements to business investments. People have postponed plans, and recessions often involve postponed activities rather than completely eliminated ones. Maintenance and expansion will still occur if customers are present, creating a chicken-and-egg scenario.
Eaqub believes that growth is evident in the provinces, with positive news for sheep and beef farmers. He attributes this to good wool prices, dairy prices, and the sale of brands businesses. The availability of capital and the reduction in interest rates are expected to act as catalysts for growth. However, the most significant unknown factor is whether banks will be lending, as this will impact both the price and quantity of credit, which is essential for supercharging the economic cycle.
