New economic conditions index shows no double-dip recession in second half of 2010, but growth not flash either

A new economic conditions index indicates the New Zealand economy is not re-entering recession, although neither does it inspire confidence a strong pick-up is underway, BNZ economist Craig Ebert says.

The release of the inaugural Business New Zealand-BNZ Performance Composite Index (PCI) comes against the backdrop of some economist expectations for official figures to show negative economic growth in the fourth quarter of 2010 after a 0.2% contraction in the third quarter. Both Prime Minister John Key, and Finance Minister Bill English, have said there was a possibility of two consecutive quarters of contraction in the second half of 2010, meaning the economy entered a 'double-dip' recession after five quarters of low or flat growth.

The new PCI moulds together the results of the monthly Performance of Manufacturing Index (PMI) and Performance of Services Index (PSI) into an index representing 80% of the New Zealand economy, Ebert said. Like the PMI and PSI, a PCI score above 50 indicates expansion in combined activity from the previous month, while a score below 50 indicates contraction.

"It made sense to agglomerate the information content of the long-running PMI and more newly minted PSI survey. Apart from increasing the sample size, the PCI offers a bigger picture take on the economy’s pulse. And not only from an “overall” point of view, but by way of the production, new orders, employment, and other sub-detail of the PMI and PSI surveys," he said.

Two versions to choose from

There were two versions of the index due to technical issues, such as the weights given to each index in compiling the overall PCI, Ebert said.

"One of these strictly adheres to the proportion that each of the PMI and the PSI represents of GDP. According to the national accounts, manufacturing makes up about one-eighth of real production-based GDP, while the services sector (excluding Government administration and defence) is measured at approximately two-thirds. Sure, even these weights, and definitions of manufacturing and services, are open to debate, and they change over time. However, to be clear, this is the basis on which the GDP-weighted PCI has been constructed," Ebert said.

"The strength of the GDP-weighted PCI, of course, is its representativeness of the industries that comprise the economy. However, it is also the case that it relies upon a PSI survey that is not only shorter-running, but has, for the meantime, a sample size less-deep in respect of the wider sector it purports to represent," he said.

"In regard to this caveat, we thought the other valid way of combining the PMI and PSI was simply to throw all the responses together and see what bubbled to the surface. It’s democracy in action. We denote this as the free-weighted PCI. Sure, this, like the GDP-weighted PCI, is not perfect. But we think the two should capture the bounds of belief in the economy’s performance, while leaving readers to assign the emphasis they prefer.

Over time (since April 2007, when the PSI began), the free-weighted PCI had clearly been choppier than the GDP-weighted PCI, even in seasonally adjusted terms, technically because of its higher weighting toward the PMI, which had had a rougher ride over recent years, Ebert said.

"Yet the free-weighted PCI also arguably gave a better warning of the degree of recession the economy was entering in 2008/09," he said.

"Since about mid-2009, however, the two composite indices have been similar enough. And, funnily enough, they were at very similar levels in their latest reading, for January 2011. Of course, this simply meant they both portrayed a lack of follow-through, on what was only a faint growth signal over the closing stages of 2010.

'No double-dip, but doesn't inspire confidence in recovery'

The GDP-weighted PCI was a seasonally adjusted 51.3 (from 52.2 in December) while the free-weighted PCI was 52.2 (from 52.6), Ebert said.

"While still positive, these results don’t inspire confidence of a strong pick-up being underway," he said.

"This has been the net result of the PSI pulse almost stalling in January, while that of the PMI picking up. Yet, combined, they also remained in expansion mode, as they have been since late-2009. This bears mentioning, as there have been a lot of commentators starting to conclude the NZ economy is re-entering recession. This is not the message of the Composite indices (nor the range of other business surveys, for that matter).

"More that earlier optimism has given way to a sense of frustration. Quite different to how things looked a couple of years ago, including by way of perusing the Bank of New Zealand-Business New Zealand Composite indices," Ebert said.