A year ago the Minister of Finance gave a pre-Budget speech in which he restated the fiscal rules Labour and the Greens had campaigned on. Among them
We will reduce the level of net core Crown debt to 20 percent of GDP within five years of taking office.
Here was what I said at the time
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.
I see I omitted to mention that other pro-cyclical fiscal risk that a (point) debt target exacerbates: the temptation to spend up further in good times to keep debt from undershooting the target.
And so I am pleased see reports today of another pre-Budget speech from the (same) Minister of Finance, in which he said
The Government will scrap specific debt targets in favour of moving towards a target range, Finance Minister Grant Robertson has announced.
The current target, part of Labour’s Budget Responsibility Rules, is to reduce net debt to 20 percent of GDP by 2021/22. When that target is achieved, it will be replaced with a debt range.
Robertson did not specify what this was, but said Treasury had provided him with advice.
“At this point we are looking at a range of 15-25 percent of GDP, based on advice from the Treasury,” Robertson said.
Does it create risks? Yes, it does, and that is why I would still favour dropping debt targets altogether. There will be increased pressure for more spending up front. But, operated responsibly, the proposed new debt-range provides only trivially greater amounts of flexibility. Why? Because no one ever expects the government will keep debt/GDP at a constant point every single year, but if they take the new range seriously people will expect them to keep within the sort of range all the time. It is wide enough, it should be able to encompass the effects of most booms and busts, but only if in normal times debt/GDP is kept close to the midpoint of the range. You probably give yourself a degree of freedom to have debt fluctuate between 19 and 21 per cent in normal times, but you always have to remember that a recession could be along any time. A couple of years in which revenue is 2 percentage points of GDP below average and you will be on course for the top of the debt target range pretty quickly if your starting point is anything much higher than 21 per cent. Tax revenue as a share of GDP fell from 31 per cent in the year to March 2006 to 25 per cent in the year to March 2011, and (a) while the economy started from a materially positive output gap, and (b) there were some tax cuts, a fall of a couple of percentage points of GDP is easy to envisage, and necessary to plan around.
My own preferred approach, without a debt target, is as I outlined it last year.
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.
The focus would be on the first of those, the structural balance rule.
Part of the necessary scrutiny and challenge would be provided by that fiscal council the government consulted on last year, but about which nothing has been heard for months.