Thursday, 15 September 2011

Earthquakes and monetary policy

From today's Monetary Policy Statement, in which the RBNZ (as entirely expected, and as entirely reasonable) did not change the interest rate:
Repairs and rebuilding in Canterbury will have a substantial influence on the New Zealand economy.  Construction sector activity will be boosted for several years, creating resource shortages in the building industry and other parts of the economy more generally.

The eventual volume of repairs and rebuilding is highly uncertain. Since the March Statement, the Bank has based its projections on a working assumption of $15 billion of reconstruction in 2011 dollars. Recent assessments from the EQC and additional damage from aftershocks have highlighted upside risk to this working assumption. As a result the Bank has revised up its working assumption to $20 billion. The Bank will continue to update this assumption as more information becomes available.

While some properties have been repaired, so far only limited rebuilding has occurred. Continuing aftershocks have hindered planning and building, and made it very difficult to secure insurance for new buildings. It seems unlikely that construction sector activity will pick up as soon as was projected in the June Statement. The updated projections assume major aftershocks soon cease, allowing EQC contractors to step up repairs on moderately damaged properties from early next year. Furthermore, seismic stability would be expected to help free up the private insurance market. It is assumed that rebuilding of severely damaged properties gets under way from the middle of next year.

In terms of the influence on monetary policy, it is the pace of reconstruction and the resultant degree of pressure on resources, rather than the eventual magnitude of reconstruction, that will have the greatest influence on interest rate settings. It is unclear how rapid reconstruction will be.
Earthquakes do bring spending. But only with long and variable lags. Even leaving aside wealth and capital destruction, the unavoidable uncertainty induced by ongoing aftershocks imposes large costs. Nobody knows when they'll be able to rebuild. Add on top of the natural and unavoidable uncertainty the regulatory uncertainty induced by that Council's still deciding who will be allowed to rebuild where and subject to what building codes. Earthquakes just don't seem that great a Keynesian policy prescription.

There's a limit to the extent to which resource shortages in building will wind up generating resource shortages; at least some of the supply pressures in construction will likely be handled by importing workers from a flagging Australian construction sector. Wages will be bid up to the point at which Kiwi construction workers in Oz come back home.

I would like to revise one prior post where I had things partially wrong. I'd not been pleased that the Earthquake Commission's asset base consisted largely of New Zealand government securities and suggested foreign investments as preferable, or at least a portfolio the value of which ought to be higher after an earthquake: construction companies and the like. An earthquake large enough to require EQC's portfolio liquidation would, I'd thought, cause the Kiwi dollar to tank with an NZ credit downgrade. I'd missed that reinsurance inflows would push the dollar higher. So I'd retract the part where I suggested a strong foreign-bias in the EQC investment portfolio; reinsurance inflows for anything big are going to dwarf the currency effects of EQC portfolio liquidation. But it still seems a bad idea to have EQC having to sell off a couple billion dollars worth of NZ government securities at the same time as the government has to go to the debt markets to cover the parts of earthquake cost for which government has assumed responsibility.

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