Story: Spending in the economy

Page 2. Spending in difficult times

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The ‘Great Depression’

In October 1929, the New York Stock Exchange crashed after a decade of spectacular gains. The total value of shares was halved in just two months, and continued to fall until recovery began in the middle of 1932. The impact of this shock spread through the whole United States economy and to the rest of the world, including New Zealand.

New Zealand’s export receipts fell by 37% between 1929 and 1931. Local unemployment rose sharply to around 12–15% of the workforce (in the United States it reached 25% in 1933).

The multiplier effect

The fall in spending by overseas buyers of New Zealand exports from 1929 to 1931 reduced the incomes of local farmers. The farmers in turn reduced their spending, causing falls in the income of other New Zealanders. This push-on process is known by economists as the multiplier effect.

The multiplier effect continued in the 1930s as more and more people reduced their spending in line with their falling incomes. Businesses cut back on production and laid off workers as a result of the loss of sales, brought about by falling levels of total spending. The economy became trapped in depression.

Not all suffered

New Zealanders’ experience of the 1930s depression varied. Some people were destitute, and others were relatively unaffected – a few even did well. Sales of newly available or expensive goods like electric water heaters and stoves, cars and fashionable clothing increased during the 1930s.

The 1930s depression shocked people because for a long time the economy did not seem capable of recovery. Wage rates fell in the face of high unemployment. Product prices fell just as fast, fuelling unemployment.

The depression shaped the lives of the generation that experienced it – it was a watershed in New Zealand’s economic development and brought to power the first Labour government in 1935, which designed New Zealand’s system of social security.

Keynes’s influence

Economist John Maynard Keynes published a book in 1936 that proposed a solution to the depression. The general theory of employment, interest and money launched a new branch of economics, macroeconomics, which studies the overall picture of economies.

Keynes highlighted the role of spending in sustaining economic activity and employment. He thought that in periods of falling spending by the private sector, the government should increase spending on public works such as new roads, railways or public buildings. If it did, total spending could be stabilised, and economic growth maintained.

This theory became the foundation of economic policy in New Zealand and elsewhere immediately after the Second World War, but was challenged by the phenomenon of ‘stagflation’ that emerged in the mid-1970s.

Spending and stagflation

Following a war in the Middle East in October 1973, the world price of oil tripled. Oil was a significant import for New Zealand, and the economy was hard hit. The world recession which followed the oil price rise made trading conditions more difficult for New Zealand exporters.

The New Zealand government was reluctant to reduce domestic economic activity, so it borrowed money for public works, to maintain overall spending levels, following the Keynesian model.

However the economy stalled and unemployment began to rise, and there was a sharp increase in consumer prices – instead of reducing unemployment, the extra spending led to domestic prices rising at more than 10% per annum. The resulting combination of economic stagnation and high inflation came to be known as ‘stagflation’.

Changing markets

The economic changes had affected the amount of spending on New Zealand products, and producers needed to respond to changing markets – for example to lessen the emphasis on agricultural products for export to Britain (which no longer protected New Zealand’s products in its markets), or to move to less energy-intensive technologies.

The reason why increased public spending led to stagflation was not well understood at the time. Until farmers and businesses responded by adapting production, increased government spending added to inflationary pressures in the economy. Stagflation continued off and on until 1984 when economic reforms were introduced.

How to cite this page:

Paul Dalziel, 'Spending in the economy - Spending in difficult times', Te Ara - the Encyclopedia of New Zealand, http://www.TeAra.govt.nz/en/spending-in-the-economy/page-2 (accessed 23 November 2017)

Story by Paul Dalziel, published 11 Mar 2010, updated 16 Sep 2016