It isn’t time to shift the fiscal stance

The media have been reporting a suggestion from the ANZ Economics team that New Zealand’s fiscal policy might be made more stimulatory in response to the actual and expected slowdown in growth that is underway.  When I heard this story reported this morning, I wondered if ANZ had been misreported, but on checking their weekly Market Focus document, it appeared not.

In a piece headed “Time to shift the fiscal stance” here is what they argue

Monetary policy is generally expected to do theheavy lifting when growth slows. However, fiscal policy and local authorities have stabilising roles to play too. Both the government and local authorities have large balance sheets, which allow them to absorb swings in the business cycle more easily than SME’s. It goes against human nature for fiscal policy to be run in a counter-cyclical sense (i.e. crank things up in bad times and wind things back in the good times), but it is sound economics. Of course there are relatively long lags involved, which can make the pursuit of such an approach difficult. But that shouldn’t stifle the concept altogether. 

Fiscal policy could move to a more neutral stance – or even an expansionary one – next year if thinking-caps were put on now. The sacrificial lamb would be nascent operating surpluses. But with net debt sitting around 27% of GDP, delaying or deferring the achievement of surpluses for a year or two is trivial – and as discussed below, the accounts are still running ahead of expectation anyway. Local authorities in rural (dairy) aligned regions could also be pulling forward investment projects. And there is room for rates relief, or at least limiting the magnitude of increase. There shouldn’t be a fear from officials to use the balance sheets at their disposal. The Government sector has a role to play just as monetary policy does, particularly when growth is below trend.

Frankly, I’m still puzzled by the case they are making.  Here’s why:

  • If the OCR were at zero, or very close to it, I would probably endorse their call.  Discretionary fiscal policy can play a useful stabilisation role when monetary policy is reaching its limits.  But the OCR is at 3.25 per cent.  ANZ expect it to be cut to 2.5 per cent, and I think there is a pretty good chance of even deeper cuts.  But even if the OCR gets to 2 per cent (probably not until early next year) there is still a material buffer above zero.  When buffers like that exist, looser fiscal policy tends to be approximately fully offset by tighter monetary policy (in the jargon, the multiplier is basically zero).  That is what happened in the years leading up to 2008, and would no doubt happen here again, given that, on the evidence of its comments and actions, the Reserve Bank would probably prefer to avoid plumbing new lows on the OCR if at all possible.
  • We have the highest real interest rates in the advanced world.  Of course, they are low by historical standards, but higher than other advanced country governments are paying.  Why would I want the government to take on even more debt, at my (future) expense at such relatively high interest rates?
  • Sometimes overseas enthusiasts for more fiscal stimulus argue for more infrastructure spending, citing the allegedly poor state of infrastructure in, say, the United States or Germany.  But the New Zealand government has been spending very heavily on infrastructure for the last decade. Indeed, at the last election I went to a session with David Parker, then Opposition spokesman on Finance, who declared his view that quite enough had now been spent on public infrastructure.  He may have had a variety of reasons for saying so, but when the finance spokesman for a left-wing party makes the case for not increasing public infrastructure spending we should probably listen.
  • How comfortable are we about the likely quality of any new government spending?  Do I need to go much beyond mentioning the economics of Transmission Gully, Kiwirail, and cycle-ways programmes?  Many of the projects governments actually spend money on simply fail to cover their costs.
  • I was left open-mouthed in astonishment at the suggestion that local government could play a part in securing a fiscal stimulus.  I’m sure many councillors would be delighted, but what sort of return do voters and the country get?  The talk of is “pulling forward investment projects”, but the investment project wishlist in often pretty questionable.   Another Dunedin Stadium for some other city?  Or a Wellington Airport runway extension?   Or even more spent on cycle-ways (I live in Island Bay where the Wellington City Council is just pouring money down the drain in a particular pointless (and controversial) “cycleway to nowhere”).
  • It is always easier to increase spending than to cut it later.  We are still living with the aftermath of the 2005 to 2008 fiscal easing.  Why put ourselves through that again if we don’t (yet?) need to?   (And did I mention Australia under Kevin Rudd?)

I can envisage a scenario in which fiscal stimulus could be useful (although if our OCR gets to zero the exchange rate will be much much lower than it is now, with a TWI still above 70) but let’s keep the powder dry for that time.  General government debt in New Zealand is not extraordinarily low (as a per cent of GDP), and even if it turns out that a modest operating surplus was recorded in 2014/15 –  made possible by record terms of trade – the prospects for the coming year are probably worse than they were when the Budget forecasts were done.  There are distinct political limits to how much fiscal stimulus any government can do, even in a crisis, so why fritter away the capacity now?  By all means, have Treasury working up some options, but don’t lose sight of monetary policy as the primary cyclical stabilisation tool.  It works.  And it probably needs to be used more aggressively now,  after being  headed in the wrong direction last year.

ANZ don’t mention it as a reason, but perhaps they are uneasy that further cuts in the OCR will fuel the house market. Perhaps, but if the outlook really is as  gloomy as they suggest it might become, then  income growth will be taking a hit as well (wage expectations are already falling), and New Zealand will be increasingly less attractive to migrants.  Real interest rates are hundreds of basis points lower than they were in 2008, and in most of the country real house prices are still lower than they were then.  The OCR is generally cut for a reason – that demand is weakening at any given interest rate.

China matters to New Zealand, and to the world

Not infrequently one hears our political leaders sagely warning against the risks of over-dependence on trade with China.  From those of a more historical bent, one sometimes hear talk of parallels with our historical dependence on UK export markets.

My impression is that those warnings and comparisons are mostly misplaced.  In practice, comments often centre on the dairy industry –  a sector in which the overwhelming bulk of domestic production is exported.    New Zealand’s dairy industry is the eighth largest in the world, but New Zealand is the largest dairy exporting country.   Decades ago, almost all our dairy exports went to the UK.  But perhaps more importantly, there were then very few other possible export markets at all. There wasn’t much global trade in dairy products.   People sometimes worry that our exports are concentrated in whole market powder, a product which New Zealand produces more of than any other country, and China consumes (and  currently imports) far more than any other country.  But even this seems overstated as a vulnerability, since the world dairy market seems (in aggregate) to be able to do quite a lot of substitution between products.  One way of seeing this is simply to look at how closely the prices of skim milk powder and whole milk powder move together.  Skim milk powder is a much less important product for New Zealand (and China).

powder prices

China matters to New Zealand, as it matters to the rest of the world, largely because it is now a large economy.  In PPP terms, China’s economy is estimated to now be around the same size as that of the United States.  That is a somewhat misleading comparison, overstating the absolute economic importance of China (since most of China’s GDP occurs domestically at its –  much lower –  domestic prices).   But equally comparisons of GDP at market prices tend to understate the importance of China, and are complicated by year-to-year exchange rate fluctuations.  Another way of seeing the importance of China is to look at the contribution to total global growth.

This chart is drawn from the IMF WEO database, using PPP-based nominal GDP data.
contributions to world gdp growth
On this measure, in the decade to 2004, China, the US, and the euro-area countries accounted for similar shares of global growth.  In the last five years, the euro area has accounted for very little of the growth in the world economy while China has accounted for more than twice the US’s share of global growth.   Again, it probably overstates the importance of China’s growth, but even if one could get some “true” numbers as the basis for comparisons, the stark change in the share of where world growth is occurring would remain.

And, if anything, simply using the make-up of world GDP as the basis for comparison probably understates the importance of China’s demand in the last few years.  In addition to showing strong growth in GDP (domestic value-added), China also recorded a very sharp reduction in its current account surpluses (while those in the euro-area have increased).  As recently as 2007, China was recording current account surpluses of 10 per cent of GDP.  China will have accounted for a larger share of the growth in world demand since 2009 than its share in the growth of world production.  Much of it was credit-fuelled, driven by policy choices that appear to have actively worsened credit standards across the economy   –  but as far as the rest of the world was concerned, it was still demand at a time when that was what the West was short of.

Of course, these data are only to 2014, and China’s growth now appears to be slowing quite rapidly.  If growth slows to, say, 3 per cent, China will still be contributing as much to the growth in real global GDP as the United States this year.  But the impulse effect of such a slowdown in growth might be quite large.

In absolute terms, China is still probably not quite as important to the world economy and financial system as either the United States or the euro-area.  In part, that reflects the less developed financial system, and the weaker connections between the Chinese financial system and those of the rest of the world.  For good or ill –  mostly probably the latter – the Chinese government has the ability to mask more problems for longer, and even to use policy more aggressively to actively counter the effects of a slowdown (at what might prove to be a considerable longer-term cost to the efficiency of its own underperforming economy).    If one is looking for risks of an economic explosion in the next few years, one would have to focus on the euro-area.  But what is happening in China is both hard for outsiders to interpret, and likely to be very important to the state of global demand.

Developments in global dairy prices matter enormously to New Zealand.  Developments in China matter a lot.  But they are (largely) two separate issues.  China matters to us (and other countries) primarily because, like Europe and the US, it is a very large economy, not because of the volume of direct trade with New Zealand.  China also looks like a rather rickety economy, and one which continues to fail to deliver living standards for its people that match those generated by market economies, whether in East Asia or the West.