A Treasury economist investigates how NZ would survive an economic shock in China and other markets

Spend long enough with most New Zealand economists and you’re likely to hear them say something about New Zealand being a small, open economy that is therefore very vulnerable to outside shocks.

But
how vulnerable?

Treasury economist Susie McKenzie has tried to answer this question in a new paper, which was recently published by the department. As usual with these papers, the views and findings are hers, rather than Treasury’s.

International trade, measured as the sum of exports and imports, currently makes up about 60 per cent of New Zealand’s GDP. That trade is concentrated in a handful of markets: China, the United States and Australia, which receive 50 per cent of exports and are the source of 45 per cent of imports.

The paper uses what is called a structural vector autoregressive (VAR) model to look at the impact on New Zealand of a GDP, interest rate, inflation or currency shock in these countries.

The model explains the evolution of a set of variables in New Zealand such as GDP and CPI inflation over a period of time.

The paper found that, if the world’s GDP were to suffer a positive “shock” of 1 per cent, New Zealand would experience a 0.25 per cent increase in its GDP within about four quarters, and interest rates would increase by 31 basis points. The exchange rate would peak in the short term and then level off.

McKenzie said the results were symmetric and linear. If the world were to have a 1 per cent GDP contraction, New Zealand’s GDP would contract by 0.25 per cent. If the world’s GDP were to contract by 2 per cent, then New Zealand’s GDP would fall by 0.5 per cent.

Of all the countries modelled, New Zealand is most vulnerable to a GDP shock in China – similar shocks in Australia and the US did not produce statistically significant GDP shocks in New Zealand.

A 1 per cent positive shock to GDP in China would see New Zealand’s GDP respond positively by 0.14 per cent, before falling by 0.08 per cent about a year after the shock. Flipping the result, you find that a shock contraction of 1 per cent of GDP in China would see New Zealand’s GDP hit by 0.14 per cent before increasing by 0.08 per cent.

McKenzie said China used “about 10 years less” data than the rest of the model, which used data going back to around 1990, because of difficulties accessing data.

“It’s really just what the underlying correlations of the model will tell us,” she said.

Shocks in the US do not produce a statistically significant GDP shock in New Zealand, but they do have an impact on CPI and interest rates, probably as a result of the influence of the US Federal Reserve in influencing global interest rates, and New Zealand banks’ exposure to international funding markets.

A 1 per cent increase in US CPI would see a corresponding 0.17 per cent increase in New Zealand’s CPI. A 100-basis-point shock to US interest rates would see New Zealand’s 90-day bank bill rate increase by 38 basis points.

The effect was even more pronounced in Australia, where a 1 per cent positive shock to Australia’s GDP would see the 90-day bank bill rate increase by 40 basis points, while an increase in Australian interest rates would see the same rate increase by a massive 50 basis points.

China is New Zealand’s most significant market by far, receiving 29.3 per cent of exports and being the source of 22.7 per cent of imports. Australia is the next significant, with shares of 12.5 per cent of exports and 10.9 per cent of imports.

Thomas Coughlan is Deputy Political Editor and covers politics from Parliament. He has worked for the Herald since 2021 and has worked in the press gallery since 2018.