The government’s debt target

I’d seen various news stories suggesting that in a speech on Tuesday the Minister of Finance had made the case for sticking with the Budget Responsibility Rules agreed with the Green Party this time last year.  So I thought I should read the speech.    There wasn’t much there.  The rules were restated, including the debt commitment, but there was no case made for following those particular rules, rather than some others.  The furthest the Minister got was the standard fallback line

We must be fiscally responsible. We must ensure that New Zealand is well-placed to handle any natural disasters or economic shocks.

Which doesn’t help, because it doesn’t differentiate the Minister’s rules from those of any other reasonably conceivable alternative.  Resilience to natural disasters or economic shocks is the fiscal equivalent of a motherhood and apple pie standard.

In terms of the government’s self-imposed fiscal rules, the only one that really troubles me is the debt one.    There are also these two

We will deliver a sustainable operating surplus across an economic cycle.

and

We will maintain Government expenditure within the recent historical range of spending to GDP, which has averaged around 30 percent over the last 20 years.

But what of debt

We will reduce the level of net core Crown debt to 20 percent of GDP within five years of taking office. 

In general, debt targets –  with relatively short time horizons to achieve them –  aren’t very sensible as operational rules.   Such a rule can mean that a few fairly small, essentially random, forecasting errors in the same direction can cumulate to produce a need for quite a bit of (perhaps unnecessary) adjustments to spending or revenue.  More seriously, recessions can throw things badly off course for a while, and risk pushing a government into a corner –  either abandon the target just as debt is rising, or fallback on pro-cyclical (recession exacerbating) fiscal adjustments –  even though, in across-the-cycle terms, the government’s finances might be just fine.  No one looks forward to a recession, but governments (and central banks) need to work on the likelihood that another will be along before too long.   Natural disasters –  the other shock the Minister mentioned –  can have the same effect.

Personally, I would be much more comfortable with only two key quantitative fiscal rules:

  • a commitment to maintaining the operating balance in modest surplus, once allowance is made for the state of the economic cycle (cyclical adjustment in other words) and for extraordinary one-off items (eg serious natural disasters), and
  • something about size of government.    Simply as an economist I don’t have a strong view on what the number should be, although as I’ve noted previously it is curious that the current left-wing government, arguing all sorts of past underspends, was elected on a fiscal plan that promised spending as a share of GDP that undershot their own medium-term benchmark (that around 30 per cent of GDP).

The suggested fiscal surplus rule isn’t an ironclad protection (any more than a real-world inflation target in a Policy Targets Agreement is).  There are uncertainties about the state of the cycle and how best to do the cyclical adjustment, and incentives to try to game what might be counted as an “extraordinary one-off”.   That is why the fiscal numbers and Budget plans will always need scrutinising and challenging.  But if followed, more or less, such a rule would be sufficient to see debt/GDP ratios typically falling in normal times, and to avoid things going badly wrong over a period of several decades.  That is probably about as much as one can realistically hope for.

There are those arguing for the government to increase its debt levels at present.    I’m a bit sceptical of that notion, for several reasons.  The quality of a lot of government capital spending –  whether it is cycleways, trains, or roads, just to take the transport area –  often leaves a great deal to be desired.  Advocates of more debt often talk up the relatively low interest rates at present, and suggest those low rates offer great opportunities.  Except that when interest rates have been low –  and if anything still falling –  for a decade, they probably need to be treated as semi-permanent, and thus as revealing something about the perceived economic opportunities advanced economies are offering.  And –  a point I’ve made often –  low as our interest rates are by historical standards, they are still high by the standards of most other advanced economies.

One consideration that might suggest it would be sensible for New Zealand to run higher debt than most other advanced countries is that our population (boosted by immigration policy) is growing much more rapidly than those of most other advanced countries.  All else equal, that should lead to faster growth in future GDP (not GDP per capita, just the total) and future tax revenue, suggesting more capacity to carry debt now.    There is certainly something to that argument at the local level, and hence I hope the government’s talk of facilitating local authority SPVs, which will enable debt to be taken on, serviced by specific property owners’ future rates commitments but outside existing core local authority debt limits, comes to something.     I’m much more sceptical of the story at the national level since on the one hand champions of immigration will stress the idea of immigration providing immediate fiscal gains (a claim there is probably something to, even if –  as Fry and Wilson suggest –  those effects die away over time).   If there is really an upfront windfall, there shouldn’t need to be more debt taken on.  And, on the other hand, for whatever reason, New Zealand’s trend productivity growth rate has been lousy for a long time, suggesting that even if our numbers (of people) are growing faster than in other countries, our (total) GDP won’t be that much faster.  It would be a different story if, say, more people was transforming (lifting sharply) our productivity performance, and future incomes, but there isn’t much sign of that.

What about some numbers/pictures.  Here is a chart (including Treasury forecasts) of core Crown net debt as a per cent of GDP.  This isn’t the variable the government (and its predecessor) choose to target, since it excludes assets held in the New Zealand Superannuation Fund.  But it is all just money, and NZSF assets could be liquidated in quite short order if necessary.  (Even this variables excludes some government on-lending (“advances” in Treasury parlance) which seem to be about 5 per cent of GDP).

net debt 2018

After a serious recession and a weak recovery, and a series of pretty costly natural disasters, this measure of net debt peaked at a level lower than we’d had a decade earlier.   The estimate for June 2018 (from HYEFU numbers) is debt of 8.5 per cent of GDP.  On current plans –  as communicated by the government to Treasury – debt would drop away to 3 per cent of GDP by 2022.  At that point, it wouldn’t be quite as low as the 2007 or 2008 levels –  reached after a sequence of huge, unexpectedly large, and economically unnecessary surpluses, and partly reflecting a prolonged expansion in which the economt ran ahead of medium-term capacity –  but it  would be pretty close.

There is no easy metric for what an appropriate level of government debt is.  And the agency issues around government debt are much more severe than those for private debt –  governments aren’t spending their own money.  The parallels here aren’t exact either, but a typical middle-aged household is likely to have debt materially higher than 3 per cent –  or even 8 per cent –  of their GDP.

What about some cross-country comparisons?  Here I turn to the OECD and, in particular, their series on general government (ie not just central) net financial liabilities.  I start from 1995, because that is when the OECD has data for almost all countries.

net debt OECD

I thought there were a couple of interesting points here:

  • for all the talk of governments piling on debt since the 2008/09 recession, net debt in the median OECD country (orange line) last year wasn’t materially higher than it had been 20 years previously,
  • but total net debt over all the OECD countries (the grey line) has increased very substantially.  Of the big OECD economies –  US, Japan, Germany, France, Italy, UK –  only Germany doesn’t have a much higher debt ratio now than in 1995.
  • small OECD countries seem to have been much more conservative in managing their public debt (yellow line).  That group includes – at one extreme –  Greece and –  at the other – Norway.  The median net debt of those countries is materially above where it was in 2007, but it isn’t much different than it was in, say, 2002 (15 years earlier).

New Zealand doesn’t have the lowest net debt by any means (Norway has net financial assets of 280 per cent of GDP). In fact, we mark out something around the lower quartile.  We’ve had some disadvantages the other small countries didn’t –  earthquakes –  but on the other hand we’ve had an unusually strong terms of trade and weren’t constrained (as many of them were) by being in the euro.  But it looks hard to make a strong case for actively pursuing lower net debt from here.  It isn’t as if, for example, there is any sign of the economy overheating.

(Things not shown are often as important as those shown.  Unlike many of the more indebted countries, we do not have a large unfunded pension liability for public servants in New Zealand.  Those liabilities are not included in these debt numbers.)

Feckless governments in other countries don’t necessarily make for much of a benchmark. And, as above, I’m not actively calling for New Zealand governments to take on more debt.   But simply producing a sequence of modest cyclically-adjusted operating surpluses  (NOT several per cent of GDP) over the next few budgets would seem to be about as much as it would be sensible –  from a macroeconomic perspective –  to ask from a government.

And, on a final note, I am increasingly uneasy about one aspect of the Labour-Greens budget responsibility pledges that seems to have disappeared almost totally.

This was the promise

  • The credibility of our Budget Responsibility Rules requires a mechanism that makes the government accountable. Independent oversight will provide the public with confidence that the government is sticking to the rules.

  • We will establish a body independent of Ministers of the Crown who will be responsible for determining if these rules are being met. The body will also have oversight of government economic and fiscal forecasts, shall provide an independent assessment of government forecasts to the public, and will cost policies of opposition parties.

But nothing more has been heard.   I wrote about it here, and suggested that the idea should be broadened to become a Macroeconomic Advisory Council.  That still seems sensible to me, especially as the Reserve Bank reforms the Minister has announced to date do nothing to strengthen effective scrutiny of the Reserve Bank. But for now, it would be good if the Minister could update us on what has happened to the Fiscal Council promise.