Explainer: What's going on with New Zealand's economy right now and how bad is it really?

As New Zealand transitions back to normal life after the COVID-19 pandemic, a myriad of unusual events are colliding in the economy and it's leaving Kiwis and experts scratching their heads. 

For months the country has been struggling with severe labour shortages which are pushing wages up and giving employees incredible bargaining power. 

But while wages are increasing, so is everything else and the Reserve Bank of New Zealand is desperately hiking the Official Cash rate in an attempt to dampen the country's sky-high inflation.

To add insult to injury, consumer confidence has dropped to the lowest level since 1988 and New Zealand's Gross Domestic Product (GDP) fell 0.2 percent in the first quarter of 2022. 

The GDP drop is stoking fears of a recession while at the same time businesses are paying big bucks to fill vacant positions. 

When most people think of recession they don't think of a booming job market. So what is actually happening in the economy and are we headed for a recession? Here are all your questions answered. 

What is going on in the economy right now?

Infometrics principal economist Brad Olsen told Newshub the economy is in a very unusual position and it's causing uncertainty. 

"There is an extreme amount happening. We haven't seen the sort of conditions that have existed in various ways over the last two and a half years, really since the 1970s or so when the oil shocks came through.

"I say that because what we're facing at the moment is quite a considerable supply shock."

Olsen said Kiwis have money and demand for products is huge which is putting immense pressure on already struggling supply chains. 

Olsen said that combined with huge economic stimulus over the pandemic and a range of other global factors means the economy is "overheating". 

"We are trying to do too much with too little," he warned. 

This is where inflation comes in. As supply struggles to match demand, the price of goods and services increases.

Olsen said it's like two people want to build a house but there is only one builder. Each would-be homeowner decides to offer a bit more for preferential treatment and this pushes the price up. 

"The builders are going to take the best offer - it's the same house at the end of the day, the exact same house that we were going to have to pay hundreds or thousands of dollars more for," he explained

As a result of inflation, the Reserve Bank of New Zealand is being forced to hike the Official Cash Rate in a desperate attempt to lower it. But as interest rates rise, economic growth is hindered and that can lead to a recession. 

"The Reserve Bank is trying to force people to spend less money. People have to spend more on their mortgage because interest rates have gone up, that leaves less money for other things."

Olsen said while interest rate hikes could see New Zealand fall into a recession by the end of the year, it's the only tool the Reserve Bank has to fight the income eroding effects of inflation. 

And Olsen isn't alone in thinking there's a lot going on. 

Milford Asset Management portfolio manager Mark Riggall told Newshub the current economic situation is "almost unprecedented" and "hugely unusual". 

Riggall warned because the situation is so bizarre, it's hard for experts to accurately guess what is coming. 

"Everything is so uncertain in that we've got lots of ingredients, we all see what the ingredients are but how they all fit together and how they will come out in the wash at the end is very much up for debate," he said. 

Is a recession likely?

The uncertainty and recent GDP drop are stoking fears a recession is on the way. But there is mixed opinion about whether we will see a technical recession in the next quarter. 

That's partly because it's hard for economists to make predictions when there are so many overlapping factors. 

A recession is when there are two successive quarters of negative growth, meaning another decline in GDP over the June quarter would put New Zealand officially in recession.

Olsen said in his view a technical recession is somewhat inevitable. 

He said the GDP drop is likely a response to the Omicron lockdown and a lack of staff, which has forced the economy into a position where a recession is almost necessary. 

"It's fairly obvious over the last few years we can't just click our fingers and magic up a whole bunch more people and we can't just magic up a whole bunch more supplies. 

"We know we've only got so many people, we know we've only got so many resources and we need to lower the amount of demand closer to what we can supply. 

"To do that, basically the amount of economic activity we can afford and achieve in New Zealand is lower than what we currently have been doing. To get to that position, you need to have lower economic activity and lower activity for two quarters is defined as a technical recession." 

But Olsen said it's unlikely to be as bad as many people will be expecting because there is still strong demand for employees. 

"People think about a recession as being when the economy turns cold, we go into a crater... like what we saw during the GFC (Global Financial Crisis) and that will be most people's memory of it. 

"What I think we're more likely to see this time around is that because the economy is overheating, we need to move from a boil down to a simmer and to bring that temperature down… going away from a boil is down and therefore a recession. But we don't feel like it's the absolute catastrophe that we have seen previously."

Olsen's more optimistic view is shared by Riggall. But Riggall isn't expecting a recession in the next quarter - pointing to several positive elements in the economy including the border reopening. 

He said this is backed up by retailers who say spending is generally holding up as people make the most of their post COVID-19 freedoms. 

"I think the reopening boom is alive and well and can sustain us for a while. I don't know how long but it can sustain us for a while."

Riggall said the incredibly tight job market will also help because as long as people still have jobs, they can weather higher costs better. 

"We know that people are complaining about high prices, inflation, cost of fuel, cost of food at the grocery store. That's an issue but while everyone has still got a job, people are thinking of sucking up and spending some of their savings." 

What would a recession mean for jobs?

There might be plenty of jobs now but Olsen said that will undoubtedly change as higher mortgage rates bite. 

"Now is probably the best time ever to ask for a pay rise, the time will not last," he warned. "It won't stick around forever because as you start to see the economy trying to do less, those interest rates go up…People have got to make some difficult decisions."

Olsen said while he doesn't expect to see mass job losses, businesses won't need as many new staff as demand drops. 

"Realistically, we would expect to see the labour market soften, we would expect the unemployment rate to start to tick up a touch but we're not expecting it to get to the position where there are huge, huge amounts more people out of work. "

It's a view shared by Riggall who said while businesses are desperate for staff now, as people spend less that demand will drop. 

"As things start to suffer in terms of consumer demand, you will see some of the bosses start to go, 'You know, what do we really need this?' And start to pull back a little bit… That will be the first sign that the labour markets are starting to rebalance."

But Olsen said because most businesses are facing worker shortages it's likely bosses will simply not fill vacant positions, instead of getting rid of staff. 

What do experts think will happen by the end of the year? 

Looking towards the end of the year both Riggall and Olsen have a fairly gloomy outlook. 

Olsen said realistically economic growth has to slow otherwise we can expect a pretty hard stop, which is the last thing experts want. 

"We've got to bring the speed down because at the moment it's looking likely things might tip over unless we slow it down," he warned.

He said if inflation keeps rising the essentials will become unaffordable and the country will be in a dire spot. 

Olsen said the economy will likely slow by the end of the year as people's mortgages roll over. 

"It does feel like a sort of reset or reckoning is coming. It looks like it's coming towards the end of the year, just given the disruption still from COVID and the time that it takes for some of these hits to come through." 

Riggall meanwhile said the start of next year is likely to be when the country is hit the worst. 

"That's where we are going to get a lot more information as to how things are tracking. At the moment, it's all speculation but in six months, we're going to have some real data in hand which will show us how these things are impacting."

He said the issues will become clearer by 2023 and signs the economy is suffering will become more obvious. 

"We will start to see signs that the economy is not quite as resilient or isn't as resilient then it is now, because some of the savings have been drawn down and consumers are a bit fatigued."

But Riggall said if the interest rate hikes work and Kiwis spend less, the Reserve Bank might be able to slow the increases by then. 

How bad is it? 

When it comes to the general view of New Zealand's economic position, Olsen warns the country is in a "very bad position". 

He said Aotearoa is facing huge challenges and some difficult decisions will have to be made over the next few months. 

"We're in a very difficult and challenging position. There are no good options. There are a lot of compromises, there's a lot of difficult decision-making to go through. 

"We've somehow got to slow down the economy enough so that we can actually stop it from burning out, but not so much that it stalls and collapses around us. It's a very delicate balance." 

Riggall agreed, warning the country is heading for a very challenging time. But he said in general we're in a good place to respond. 

"The economy is at a good starting point. It's just the headwinds that we're being buffeted by are very, very strong. We are in a good spot but we are running into a storm," he concluded. 

One thing they could both agree on, they don't envy the Reserve Bank which is tasked with guiding the country through the upcoming economic storm.