Anindya Pradnya Paramitha / Student ID 825713787

POLICY 702 Economics of Policy

Assignment 4: Essay 2 - The Economics of Pandemic
University of Auckland

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Anindya Pradnya Paramitha / Student ID 825713787

Introduction

The unprecedented COVID-19 pandemic reshaped the economic landscape of nations

worldwide. New Zealand, known for its successful pandemic response, was not immune to the
following global economic turbulence. This essay delves into an in-depth analysis of New
Zealand's economic contraction in the aftermath of the COVID-19 pandemic and a policy
intervention proposal aimed at recovery. First, this essay will investigate the factors behind
New Zealand's economic contraction. Then, it will propose a strategic contractionary monetary
policy for the New Zealand government to stabilise the economy post-pandemic. The potential
advantages and risks associated with these policy measures will be examined, underscoring the
importance of synchronised fiscal and monetary strategies. Finally, this essay will compare
Canada's post-pandemic recovery approach, emphasising coordination as a critical factor in
navigating evolving economic conditions.

Analysis of New Zealand’s Economic Contraction Post-COVID-19

According to a report by StatsNZ (2020), New Zealand experienced significant economic

contraction in early 2020. The Gross Domestic Product (GDP) indicated that in the March 2020
quarter, the New Zealand economy shrunk by 1.6% (StatsNZ, 2020). This downturn came after a
0.5% growth in the December 2019 quarter. COVID-19 profoundly impacted the nation's
economic activities in the March 2020 quarter. This influence was evident through travel
restrictions, deteriorating trade conditions, and the globally felt impacts of the virus.
Maani (2021) outlines several key characteristics of the New Zealand economy prior to the
COVID-19 pandemic. The nation had enjoyed a decade of consistent economic growth,
averaging 2% per year, and maintained a high employment rate with a historically low
unemployment rate of around 4%, indicating a robust economic foundation. New Zealand also
stood out among OECD countries by maintaining a fiscal budget surplus, providing the
government with the means to swiftly implement relief policies, including wage subsidies and
tax deferments.

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Anindya Pradnya Paramitha / Student ID 825713787

In addition, the workforce had undergone significant upskilling over the past three decades,
resulting in one of the highest percentages of the population with higher education in the
OECD, leading to a larger proportion of the workforce engaged in technologically driven
professional roles. Moreover, New Zealand's economy was predominantly service-oriented,
with service industries contributing approximately 67% of GDP, complemented by a productive
agricultural sector and a stable food market, enabling the country to supply food to its trade
partners during the pandemic. Tourism had become a significant contributor to the New
Zealand economy, accounting for about 5% of GDP in 2019, with the sector showing promise
before the pandemic.
The effects of the pandemic were most noticeable when New Zealand moved to a level 4
lockdown, restricting non-essential economic activities and significantly affecting the economy's
overall operation (StatsNZ, 2020). Service and goods-producing sectors were notably affected.
Eight of the 11 service industries experienced downturns due to decreased international visitors
and domestic lockdown measures. Transport, postal, and warehousing services saw a 5.2%
drop, while retail, accommodation and restaurants faced a 2.2% decrease, primarily because of
a steep 7.8% decline in accommodation and food services, impacted heavily by dwindling
international visitors (StatsNZ, 2020). Household spending also showed signs of weakening,
decreasing by 0.3% during the March 2020 quarter. Factors contributing to this included a fall in
spending on services such as restaurant meals, international air passenger services, and
accommodation (StatsNZ, 2020).
Furthermore, primary industries also faced a decrease of 1.0% in the March 2020 quarter.
This decline resulted from adverse weather and reduced trading due to COVID-19 (StatsNZ,
2020). Exports and imports also exhibited declining trends. Exports dropped by 2.1%, primarily
driven by services exports. In contrast, imports fell 5.6% in goods and services, indicating the
wide-ranging effects of the pandemic on New Zealand's trade dynamics (StatsNZ, 2020).
Moreover, as highlighted by Stats NZ (2020), the September 2020 quarter observed a
marked rise in the number of individuals without jobs, with a surge of 37,000 people. The
unemployment rate climbed from 4.0% to 5.3%, noting the most prominent quarterly
increment ever recorded. The low 4.0% unemployment statistic in the preceding quarter was

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partially attributed to the national lockdown's restrictions, which hindered many from actively
pursuing employment (Stats NZ, 2020).

Figure 1: COVID-19 Impact Toward New Zealand’s Economy

LRAS SRAS1

SRAS

C
P2
Price Level
P1 B
P A

AD2
AD

AD1

Q1 Q2 Q

Real GDP

Figure 1 depicts New Zealand's economic downturn during the COVID-19 pandemic. The
initial equilibrium point A signifies the economy before the pandemic. The shift from AD to AD1
represents the decline in aggregate demand due to travel restrictions, reduced household
spending, and a drop in international visitors. This decrease aligns with the 1.6% economic
contraction noted in the March 2020 quarter. Simultaneously, the move from SRAS to SRAS1 on
the diagram mirrors a drop in New Zealand's production capacity. The reduction in employment
in retail and accommodation further amplifies the supply-side constraints. The new equilibrium
B in the diagram, marked by a price increase from P to P1 and a GDP decrease from Q to Q1,

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suggests stagflationary pressures characterised by reduced aggregate demand and supply

amidst heightened inflation (StatsNZ, 2020).
The Consumer Price Index (CPI) in the March 2020 quarter saw an uptick of 0.8% (StatsNZ,
2020). The annual inflation rate during this period reached 2.5%, its highest since September
2011, with domestic inflation consistently above 3% (StatsNZ, 2020). Although the impact of
COVID-19 measures on price collection was minimal for most of March 2020, its broader
economic implications are evident in the inflationary trends. Factors such as the 11% spike in
cigarette prices due to a tobacco tax increase and a rise in rents, especially in Wellington and
other areas outside of Auckland and Canterbury, further exacerbated inflationary pressures
(StatsNZ, 2020). Conversely, while there were decreases in international airfare and petrol
prices, these were overshadowed by the inflationary contributors, emphasising the overarching
influence of COVID-19 on New Zealand's inflation dynamics (StatsNZ, 2020).
In response to the recession brought about by the COVID-19 pandemic, the New Zealand
government actively engaged in a combination of expansionary monetary and fiscal policies to
stabilise and stimulate the economy. The Reserve Bank of New Zealand (RBNZ) initiated
monetary policies, such as slashing its policy rate to 0.25% in March 2020 and implementing a
Large Scale Asset Purchase (LSAP) program worth NZD 100 billion over two years (OECD, 2022).
These actions were aimed to increase liquidity and encourage lending in the financial sector.
Furthermore, the fiscal strategy adopted was comprehensive. In 2020, the government
announced an initial support package and a NZD 50 billion COVID-19 Response and Recovery
Fund (CRRF). This fund was aimed at economic stimulus and significantly invested in public
health measures (Maani, 2021).
The Wage Subsidy, which cost NZD 14 billion and covered a substantial portion of
businesses and employment at its peak, was a key element of this package (Maani, 2021).
Additionally, investment in infrastructure support for households, workers, and businesses
were critical components of the fiscal response to ensure sustained economic activity and the
protection of livelihoods (OECD, 2022). These monetary and fiscal interventions can be
correlated with the shift from AD1 to AD2 in Figure 1. These policies aim to increase aggregate
demand and drive the economy towards a new equilibrium point C at P2 and Q2.

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Anindya Pradnya Paramitha / Student ID 825713787

Strategic Policy Interventions

According to Dyer (2021), in response to the COVID-19 pandemic, the New Zealand
government introduced a diverse economic policy approach encompassing fiscal and monetary
measures to alleviate the economic repercussions. The fiscal policies included a NZ$23 billion
stimulus package, equivalent to 7.7% of GDP, which comprised increased healthcare spending,
permanent social spending increments, business tax changes, and a temporary tax loss carry-
back scheme. Specific sectors, such as aviation and tourism, received targeted support through
debt funding agreements and grants (Dyer, 2021).
The most substantial component was an eight-week wage subsidy, covering full-time and
part-time workers, amounting to 4.9% of GDP. Measures such as rent freezes, suspension of
tenancy terminations, mortgage repayment deferrals, and support for SMEs were
implemented. On the monetary front, the Reserve Bank of New Zealand (RBNZ) reduced the
overnight lending rate, engaged in government bond purchases, and established various
lending facilities, aiming to provide liquidity and support to the financial sector and businesses.
The RBNZ also cooperated with the Federal Reserve in the United States to ensure access to US
dollars during market stress. These combined fiscal and monetary measures aimed to stabilize
the economy and facilitate recovery (Dyer, 2021).

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Anindya Pradnya Paramitha / Student ID 825713787

Figure 2: Expansionary Fiscal & Monetary Policy

LRAS

SRAS1
SRAS2

Price Level

P3 C

P2 B
P1 A
AD2
(With policy)
AD2
(Without policy)
AD1
Q1 Q2 Q3

Real GDP

Figure 2 illustrates New Zealand's economic conditions and adjustments during the
pandemic and the subsequent proposed policy interventions. At the outset, New Zealand's
economy was positioned at equilibrium point A, characterised by the price level P1 and real
GDP Q1, where the Aggregate Demand curve (AD1), Short Run Aggregate Supply (SRAS1), and
Long Run Aggregate Supply (LRAS) intersects. The pandemic brought numerous economic
challenges but made certain adjustments (Maani, 2021). The movement from AD1 to AD2
(Without policy) represents the natural progression of aggregate demand in the wake of the
pandemic without government intervention.
This change can be attributed to gradually recovering consumer confidence, minor
international economic upticks, or natural post-pandemic adaptations as New Zealanders adjust
to a new normal. Maani (2021) explains that New Zealand's success during the pandemic can be

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Anindya Pradnya Paramitha / Student ID 825713787

attributed to its unique characteristics and early measures. Simultaneously, the shift from
SRAS1 to SRAS2 can be linked to the natural adjustments in costs of production as firms scale
up their operations post-pandemic. The intersection of AD2 (Without policy) and SRAS2
established a new equilibrium point B at the increased price level P2 and GDP Q2.
To counter the adverse economic ramifications, the New Zealand government introduced
expansionary fiscal and monetary policies to push the aggregate demand even further to the
right – from AD2 (Without policy) to AD2 (With policy). The combined effects of these shifts
lead to a new equilibrium point C at price level P3 and GDP Q3.

Recommendation: Maintain Price Stability

Implementing both policies at once risks overheating the economy, especially if the
combined stimulus is larger than the output gap, which leads to a high inflation rate (Hubbard
et al., 2010). For example, one of the challenges in New Zealand has been the rapid
appreciation of house prices (Fitchett & Jacob, 2022). While fiscal policy can be directed at
supporting affordable housing initiatives, monetary policy, especially interest rate decisions,
can influence borrowing behaviours and, indirectly, housing demand. An overly expansionary
monetary policy might exacerbate this trend, potentially leading to housing affordability issues
and financial system risks. A contractionary monetary policy should be implemented to
maintain price stability, especially when concerns about inflation result from expansionary fiscal
policies (Hubbard et al., 2010).

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Anindya Pradnya Paramitha / Student ID 825713787

Figure 3: Contractionary Monetary Policy for Price Stability

LRAS LRAS2

SRAS1
SRAS2

Price Level

P2 B

P3 C
P1 A
AD2
(Without policy)
AD2
(With policy)

AD1
Q1 Q3 Q2

Real GDP

Figure 3 depicts contractionary monetary policies in response to high inflation brought

about by earlier expansionary policies during the pandemic. Initially, the country's economy is
at equilibrium point A. Without any intervention, the aggregate demand curve shifts further
rightward from AD1 to AD2 (Without policy), likely due to the sustained impact of the previous
expansionary efforts. Concurrently, the short-run aggregate supply curve moves from SRAS1 to
SRAS2. This combination takes the economy to equilibrium point B with a higher price level of
P2 and real GDP of Q2, indicative of elevated inflation rates without any countermeasures. To
address this, New Zealand should implement a contractionary monetary policy, shifting AD1 to
AD2 (With policy). This policy could entail raising interest rates or reducing the money supply,
aiming to reduce demand and inflation (Hubbard et al., 2010). These changes will result in a
new equilibrium C, moderating the inflationary tendencies and moving towards price stability.

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Anindya Pradnya Paramitha / Student ID 825713787

Whereas without the policy, the equilibrium would be at point B or even further outward,
causing an uncontrollable inflation.
New Zealand can draw valuable lessons from Canada's response to the inflation surge
following expansionary policies during the pandemic. Both nations share similarities in their
economies, focusing on trade, natural resources, and services, making Canada's strategies
particularly pertinent for New Zealand (Cross, 2023). In response to the onset of COVID-19 in
March 2020, Canada implemented unprecedented expansionary fiscal and monetary measures
(Cross, 2023). The Bank of Canada drastically reduced interest rates and expanded its balance
sheet, while the federal government incurred substantial deficits, surpassing historical wartime
records. These policies were largely successful, as evidenced by the rapid economic recovery,
with GDP surpassing pre-pandemic levels by 6.6% in Q4 2021 and substantial job creation, with
employment levels reaching 98.6% of pre-pandemic levels in December 2021. Despite aiding
initial economic recovery, continuous stimulus further boosted demand, triggering an inflation
rate surge to 8.1% by July 2022 (Cross, 2023).
In response, the Bank of Canada significantly raised its policy interest rate from 0.25% to
4.50%, recognising that the price increase was not just a temporary event caused by supply
issues as initially thought. However, Cross (2023) notes that government spending did not slow
down even after interest rates rose in 2022. Debt kept growing as the government tried to
shield people from rising prices and increase social aid. In addition, fiscal actions taken before
2022 continued to push up inflation. Therefore, Cross (2023) emphasised the need for
coordinated fiscal and monetary strategies to curb inflation efficiently.
The lesson that New Zealand could take from Canada is that by implementing expansionary
policies during the pandemic, New Zealand is already taking a step in the right direction.
However, a contractionary monetary policy should be implemented to keep prices stable to
avoid an inflation surge that Canada experienced and that New Zealand is going through. In
addition, coordination with the ongoing fiscal policy should be maintained to avoid debt.

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Anindya Pradnya Paramitha / Student ID 825713787

Conclusion

New Zealand's economy faced a significant contraction following the COVID-19 pandemic,
marked by declining trade, employment challenges, and rising inflation. To counter this, this
essay prescribes a contractionary monetary policy following the mix of expansionary fiscal and
monetary policies that the government has implemented. The emphasis is striking a balance
between these policies to prevent inflationary pressures, and ensuring effective coordination
between fiscal and monetary strategies are crucial. The experience of Canada, while initially
successful, urges the need for synchronised policy actions to address inflation and avoid
government debt efficiently.

Word count: 2,689

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