- New Zealand households have experienced a significant increase in their cost of living over the past four years, led by higher interest rates, transport, food, and housing costs.
- Total consumption has been able to grow 8.5% over this time due to large increases in household income and wealth, alongside record net migration.
- The per capita picture, however, is much weaker and likely reflects the impact of monetary policy tightening, as well as growing economic uncertainty.
- Looking ahead, rising unemployment and lower rates of wage growth will pose new challenges for households and likely result in ongoing consumption weakness.
New Zealand households have experienced a significant increase in their cost of living over the past four years, led by higher interest rates, transport, food, and housing costs. The drivers of these increases are common across countries and are now well known. In summary, a COVID-related breakdown in global supply chains was met with too much monetary and fiscal stimulus where the resulting inflation required the most aggressive central bank rate rises since the 1970’s. Statistics NZ estimate that New Zealand living costs have increased 23% since the end of 2019, almost three times the change consistent with the Reserve Bank of New Zealand’s (RBNZ’s) 2% annual inflation target.
Total consumption has been able to grow 8.5% over this time due to strong income growth, healthy household balance sheets, a willingness to spend excess savings and record-high population growth. We explore each of these in greater detail below:
1. Increases in household income have helped offset increases in living costs. Strong income growth over the past four years has largely been a function of a very tight labour market, where the unemployment rate has averaged less than 4%. The median household income increased by 17% between the middle of 2019 and the middle of 2023, the latest data point we have. If we proxy household income with the timelier average hourly earnings, these have increased 24% between the end of 2019 and the end of 2023 (see chart above).
2. Household wealth grew by almost 35% during 2020 and 2021, providing strong support to consumption via the wealth effect. Despite declines in the past two years, average household wealth remains almost 20% higher than pre-COVID (see chart below). Average housing wealth, which is generally found to have a stronger relationship with consumption than financial wealth[1], is 22% higher than pre-COVID. Most academic studies find that changes in housing wealth have their largest impact on consumption immediately, with the impact greatly diminished after two to three years.[2] RBNZ research in 2019 on the New Zealand housing wealth effect suggested that for every $1 increase in house prices, households increase consumption by 2 cents.[3] House price declines are estimated to have a larger impact, with consumption dropping 3 cents for every $1 decrease in house prices. [4]
3. In recent years, households have been willing to use some of the excess savings accumulated during 2020 and 2021. Household savings averaged around 1.5% of after-tax income for the decade prior to COVID (this equates to c.$2.5bn per annum today). Large amounts of additional household savings relative to that rate, or “excess savings”, were accumulated during 2020 and 2021 with the help of the wage subsidy scheme and a lower ability for households to spend on services due to lockdowns. We estimate that excess savings peaked at the end of 2021 at almost $15bn and, since then, about one third of those excess savings have been used to help fund consumption, mostly in 2022 (see chart below). Appetite to continue running down these excess savings will likely be partly determined by households’ perception of their wealth which we discussed above. The academic evidence suggests that changes in housing wealth impact consumption with short lags and therefore, the recent negative wealth effect of lower house prices may mean excess savings won’t be run down much further.
4. Large increases in population via migration. More than 130,000 migrants entered New Zealand last year, and pushing our annual population growth to almost 3% (see chart below). This migration surge is equivalent to almost five years of natural population growth.
While total consumption has increased, the per capita picture, however, is much weaker and likely reflects the impact of monetary policy tightening, as well as growing economic uncertainty. We think consumption per capita gives a better indication of inflation pressure. Given population growth is highly correlated with labour force growth, consumption per capita is akin to an output gap framework that attempts to measure demand within an economy relative to its ability to meet it. Retail sales per capita have collapsed almost 13% since Q2 2021 and dropped 7% over the past year to sit at the lowest level since Q1 2017. Consumption per capita is just 3.5% higher than it was at the end of 2019 and, over the past year, has fallen almost 2.5% (see chart below). This kind of reduction in consumption is like that seen during the Global Financial Crisis and provides a better reflection of the impact of tight monetary policy, in our view.
Looking ahead, rising unemployment and lower rates of wage growth will pose new challenges for households, as inflation returns to target and interest rates begin to fall. While events to date have been stressful, job losses and lower wage growth could see a ratcheting up of pressure on households and further reduce consumption growth. Surveyed measures of the ease with which firms can find labour suggest the unemployment rate could rise rapidly this year to between 5 and 6% (see chart below). These are corroborated by low levels of job advertisements and high rates of job applications per job advertised. An unemployment rate of 5-6% has historically led to wage growth, on an average hourly earnings basis, of 2-4%, roughly half the current rate. While we expect interest rates to decline over the next two years, they are likely to remain restrictive and continue to dampen household consumption.
[1] See Caceres, C. (2019) “IMF Working Paper: Analyzing the Effects of Financial and Housing Wealth on Consumption using Micro Data” WP/19/115
[2] See Case, K. E., Quigley, J. M., Shiller, R. J. (2005) “Comparing Wealth Effects: The Stock Market versus the Housing Market” Advances in Macroeconomics, Volume 5, Issue 1, Article 1.
[3] See de Roiste, M, Fasianos, A., Kirkby, R. and Yao, F. (2019) “Household Leverage and Asymmetric Housing Wealth Effects – Evidence from New Zealand” DP 2019/01
[4] See Caceres, C. (2019) “IMF Working Paper: Analyzing the Effects of Financial and Housing Wealth on Consumption using Micro Data” WP/19/115
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