Bryce Wilkinson of the New Zealand Initiative was out yesterday with a comment, in the Initiative’s weekly newsletter, on the Labour/Greens proposal to establish a fiscal council. I wrote about – and welcomed – that proposal a week or so back.
Until I saw Bryce’s note, I had forgotten that the New Zealand Initiative had proposed the establishment of a fiscal council. So add their names to the list of supporters: the OECD (the technocratic wing of the European centre-left) favours a fiscal council, the Treasury’s independent reviewer of fiscal policy (a long-time senior IMF official) recommended a fiscal council, the New Zealand Initiative favoured a fiscal council, and even the (fairly right wing) 2025 Taskforce (of which Bryce was a member) favoured looking at something like a fiscal council. And now our Labour Party and Green Party also do. As many other OECD countries now have something of the sort, it all seems to amount to a reasonably strong case.
Of course, doing it well would be a challenge – getting a succession of the right people would really matter. But that is true of many of our public watch-dog and monitoring roles.
As Bryce notes, the current National-led government hasn’t adopted the recommendation.
Why not? Probably, it sees little need given its proven commitment to restoring fiscal surpluses. True virtue is its own witness. Establishing a superfluous agency to attest to its virtue would undermine it. To which our churlish response is that fiscal virtue is as ephemeral as the political winds and John Key’s promise to steer clear of New Zealand Superannuation was less than fiscally virtuous.
And he then asks
So why are Labour and the Greens on the virtuous side of this issue? After all, the last Labour government left National facing fiscal deficits for as far as the average geriatric eye could see.
That observation likely answers the question. Newly found virtue lacks credibility. Governments that can’t make credible commitments are weak governments. However, we hasten to add that this does not make it less of a virtue. A commitment to fiscal virtue is a fine thing.
I’ve already pointed out privately to Bryce that that seemed more than a little unfair to the previous government. Let me explain why.
It is certainly true that when the current government took office in November 2008, official fiscal forecasts showed large deficits for many years into the future. But the last fiscal initiatives of the outgoing Labour government had been the 2008 Budget, the parameters for which were set out in the Budget Policy Statement released at the end of 2007.
Throughout much of the previous Labour government’s term of office, a key theme of fiscal policy developments had been the surprising strength in revenue. It was, in many respects, why the fiscal surpluses were so large during those years – Treasury and the government kept being taken by surprise, and Treasury was (prudently) cautious about treating the surprises as permanent. If it was just a series of one-offs, or something cyclical, it wouldn’t have made sense to increase spending or cut taxes in response.
The Treasury gradually revised upwards their assessment of the underlying fiscal position. Unfortunately, they took a particularly optimistic stance by the end of 2007. I can recall the then Prime Minister making much of the fact that Treasury was now assuming that most of the revenue gains would prove permanent (and thus could support some mix of increased spending and lower tax rates) without the risk of dropping back into deficits. I joined Treasury on secondment in mid-2008 and I have seen documents written to the Minister of Finance during early 2008 stating that reassessment. I was under the impression that some had been released, perhaps as part of the pro-active release of 2008 Budget papers, but on checking that link on the Treasury website, I couldn’t see the paper in question.
But the facts of the reassessment aren’t in dispute. Several Treasury staff produced a paper last year on the process of getting back to surplus, including the background to the deficits. Here is what they had to say
Over the period 2005-2008, the Treasury increased its estimates of structural revenues by around 1 percentage point of GDP each year, and by 2008 the Treasury considered most of the operating surplus was “structural”
When the tax reductions [along with further spending increases] were announced in Budget 2008, the Treasury was still predicting the operating balance to remain in surplus through the forecast period, albeit at a lower level.
With the benefit of hindsight, the degree to which the surpluses were structural was overestimated. Although the tax reductions announced in 2008 turned out to be well-timed from the perspective of stabilising the economy following the GFC, their permanent nature added to the subsequent structural deficits.
Here is the chart from the 2008 Budget Economic and Fiscal Update.
Figure 2.6 – Total Crown OBEGAL
Source: The Treasury
That document was signed off by the Secretary to the Treasury as representing his best professional assessment of the economic and fiscal outlook, incorporating the effects of announced government policy. In New Zealand – unlike many countries – the forecasts are those of the professional advisers, not those of the Minister of Finance.
On the basis of the economic and fiscal information available to it, the Treasury has used its best professional judgement in supplying the Minister of Finance with this Economic and Fiscal Update. The Update incorporates the fiscal and economic implications both of Government decisions and circumstances as at 9 May 2008 that were communicated to me, and of other economic and fiscal information available to the Treasury in accordance with the provisions of the Public Finance Act 1989.
Secretary to the Treasury
14 May 2008
The projected surpluses by the end of the forecast period were tiny – essentially the budget was projected to be in balance by then. The economic and revenue outlook had worsened over the first few months of 2008, after the broad parameters of the Budget had already been sketched out in the BPS. As we now know, New Zealand was already in recession by May 2008. But on best Treasury advice, the then Labour government thoiught they were leaving an essentially balanced budget, on top of an already very low debt level, not deficits.
Of course, the government was wrong in that assumption. But, specifically, Treasury was wrong in its best professional advice. Perhaps the government would have run quite expansionary discretionary fiscal policy anyway, even if Treasury had been less optimistic about how permanent the revenue was. They were, after all, behind in the polls, and the PM’s office – didn’t Grant Robertson work there? – would no doubt have been putting a lot of pressure on the Minister of Finance. But that hypothetical didn’t arise. They didn’t have to make such awkward political choices – their own professional advisers told them they could have tax cuts and spending increases, and still keep the budget in (modest) surplus. The Opposition National Party shaped its, more generous, tax cutting promises on much the same sort of Treasury forecasts and estimates. (And a few years earlier, the 2005 election had partly been a bidding war as to how best to spend the surplus – not whether there really was a structural surplus).
It wasn’t Treasury at its finest. It is, perhaps, a reason to be cautious about just how much a fiscal council might add. Would such a body, faced with similar circumstances – a long succession of revisions upwards in revenue – have really reached materially different judgements about the outlook then? Perhaps. We can’t know, but back in 2008 Treasury was using its best professional judgement, and the mistakes were still made.
There is a bit of a tendency afoot to suggest that the current National-led government has done a better job of fiscal management than the previous Labour government did. I’m not really convinced by that story. I’d accept that the previous government might have had an easier job than the current government has – since one inherited modest but growing surpluses, while the other inherited deficits. The current government had some nasty shocks (earthquakes) but also some of the best terms of trade in decades and the weakest wage pressures. But if we expect our politicians to be guided by professional advice in areas like this, the previous government did what most orthodox opinion advised them to, keeping on delivering surpluses and reducing outstanding debt. Probably they should have emphasised tax cuts more than spending increases, but this particular debate is about overall fiscal balances.
By the end of Labour’s term, government spending as a share of GDP was rising a lot – but then Treasury was telling the government the money was there to spend. And for all the talk of how the new Labour/Greens rules commit a new left-wing government to keep spending at around current National government levels, that level is around the average level that prevailed under the previous Labour government.
There are things I’d criticise about the previous government’s policy. Allowing big structural surpluses to build up, as happened in the first half of the term, set the scene for a big spend-up later (which would have been big tax cuts if National had won in 2005). It is probably better to recognise the limitations of knowledge and typically keep both surpluses and deficits small. But it is easier to say in hindsight than it might have been at the time. And in 1999, the severe fiscal stresses of 1990/91 were pretty fresh in everyone’s memory.
Of course, this note has been a defence of the previous Labour government. The Greens don’t have experience in government, and don’t have the same degree of historical credibility. So in that sense, no doubt Bryce Wilkinson is right to argue that part of the motivation for the recently announced package is the desire to use commitments like this to help establish some credibility (even at the expense of burning off some of their own loyalists).
And I can only endorse Bryce’s final observation on the fiscal council proposal.
So three cheers to Labour and the Greens for this initiative. May they stick to it.
11 thoughts on “Fiscal policy: in defence of the last Labour government”
Michael, my tongue is not in my cheek. Please explain for all your readers how it could be considered virtuous — fiscally or otherwise — to allow private banks to create 98% of our sovereign nation’s money supply, in preference to having our very own RBNZ create not just the 2% that is notes and coins, but 100%. Then, banks would be not money creators, but money lenders, that took in deposits from their customers, aggregated them, and then on-lent to borrowers, making an honest living from the difference between the interest rates that they paid savers and the interest rates that they charged borrowers — exactly like almost all economics textbooks erroneously say that they do now, and all high schools, polytechnics and universities also teach, erroneously, (and in the universities’ case, unlawfully) that they do now.
Interesting question – not sure how it is related to the post tho – for another day. I’m not sure I’d call it “virtuous”.
Don’t think peer to peer lending works on a large scale. Banks create contracts with customers quite separately from the contracts with savings depositors due to scale. Easier to manage the flow of funds and the investment of the funds when the legal contracts between borrowers and the banks depositors are independent of each other.
But which came first; the loan or the deposit?
One can’t exist without the other. A saver wants to be paid to save or those savings would go to other investments. NZ. Banks are intermediares. They want to earn a margin.They encourage savings by offering an interest rate. In order to pay that interest they need to lend out to generate a return in order to pay savers. If there are not enough local NZ savers they go overseas and draw on overseas savers to lend to our locals.
NZ households have $160 billion in savings. NZ households have around $170 billion in debt. NZ households also have investment property debt around $60 billion. Therefore total Nz household debt has a shortfall of around $70 billion which is funded by overseas savers funds in the form of foreign investment bonds. NZ households also have another $60 billion invested in KiwiSaver and investment funds.
Yes we know all that.
The answer is the loan came first. Under our credit/dept based money system the money for the deposit can’t exist until it is created as a loan by the bank (the banks asset). When it is used/spent it becomes a credit or “savings” and the banking systems liability. Simple no? Surprising how many people are not aware of the way it works.
Frankly its a merry go round so it is a circular argument. You can argue and argue endlessly as which comes first and there is no right or wrong answer. Yawn. It does not really matter. At the end of the day thats what makes the financial markets work. Took us centuries to get to this level of sophistication where trillions gets traded every single day. So what is your point?
I don’t want to keep you up and we’re not really on topic but, as PJM pointed out, the implications of money creation are profound and yes it does matter that money (debt and credit) can be conjured out of nothing but a promise. Every time you use your credit card or take out a loan money is created.
The closure of the gold window with the US default on it’s Bretton Woods undertakings in 1971 marked the start of virtually unlimited growth in debt well beyond the growth in the economy that supports it. Worse; the system will collapse if it doesn’t expand in this way. There is no going back now and, while I agree we certainly have a sophisticated system, it’s one that carries the seeds of it’s own destruction.
Here’s a chart of US total credit market debt and GDP for comparison. That wee kink in the hockey stick is the recent recession/depression.
US banks come and go all the time. Not quite the same over here in NZ and Australian banks do have government guarantees.
What I hate about councils, boards, commissions, etc is that they appear to be based on the premise that some ex partner of a law or consulting firm, or ex Treasury official, etc who wants to take life a bit easier and work part-time is somehow smarter and wiser than the professional staff who do the work in these organisations. That might be the case when you get some really top notch people but in general it isn’t and you often get a bunch of these people arguing with each other and actually slowing the process down and not adding value at all!
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Labour ran 9 years of surpluses under Helen Clarke and Michael Cullen. But at the cost of infrastructure spending. Our infrastructure in roading, in rail, in bridges, in water and in sewerage was left to decline. The infrastructure bill I estimate is a shortfall of around $40 billion which makes it rather difficult for any future incoming government.