Makhlouf on public debt

Gabs Makhlouf has now had his gushy official farewell, even as we await for the SSC report on his conduct and judgement during the Budget leak affair.  His term expires next Thursday (27th) and so with each passing day it looks more likely that the SSC will simply run out the clock, so as to further minimise the risk of an undue embarrassment to them (party to Makhlouf’s choices), to Makhlouf, or to The Treasury.

But, clearly not content with a post-Budget lull and a quiet last few weeks at work, Makhlouf has released a (final?) on-the-record speech, addressing the question “What is prudent debt?” in turn reopening debates, at least on the left, about the government’s approach to fiscal policy.   It is a rather odd affair, as the speech appears to have been given to a bunch of Treasury staff (“the Treasury’s Economic Forum”).

As I’ve written here previously I’m generally not convinced that the Treasury Secretary should be making public speeches.  The primary role of such an official is the administer The Treasury and advise the Minister of Finance (unlike, for example, the Governor of the Reserve Bank who wields independent policymaking power).  And whatever the merit of their views –  and there have been very able Treasury secretaries in other times and other places – in speaking openly they are either constrained to not depart far from current government policy (themselves partisan choices), or they create trouble for the government and undermine the willingness of ministers to engage privately with the free and frank advice officials are paid for.

But on this occasion I don’t have too much problem with the speech being put on-the-record.  It seems to reflect analysis and advice already provided to ministers, in a core area of Treasury’s responsibility, and if that advice itself hasn’t already been published –  and it should have been, pro-actively – it would almost certainly be made available in response to an Official Information Act request.

Moreover, although I have been very critical of numerous of Makhlouf’s speeches over the years (Google “croaking cassandra, makhlouf speeches” if you want examples) this speech was one of the better (not great, not that deep, but not bad) ones I’ve seen.     That doesn’t mean I agree with it all –  that isn’t the relevant criterion –  but that much of it is thoughtful and considered, and doesn’t just parrot glib, but perhaps conventional, cliches.   There is too much reference to “wellbeing” in it for my liking, but that is probably true of every public sector document at present –  please the masters –  and since it is mostly vacuous it is mostly relatively harmless.

Why “prudent” debt.  Because the term is explicitly used in the Public Finance Act –  governments are required to conduct fiscal policy consistent with maintaining a “prudent” level of debt.  They don’t have to tell us what they consider is prudent, but they do have to tell us what debt levels they are aiming at.   Quite what criteria are relevant to determining the prudence or otherwise of a particular level of debt isn’t spelled out, and so although the choices are ultimately for politicians to make, it is appropriate and indeed desirable for The Treasury to offer advice, at least on how best to think about the issue  (I’m less sure it is the place for The Treasury to put a number on prudence, as Makhlouf does, because their values and priorities won’t necessarily be those of the elected politicians.  But so long as they, and we, recognise that, and take their advice for what it is, it is still likely to be a useful contribution to the debate.)

Personally, I found the more persuasive part of the speech to be where he addressed the issue of buffers.   One’s view on how much debt the government should carry in normal times needs to be informed by one’s view of how badly adverse events could throw one off course, in ways that would lead a government to want to carry more debt for a time.  One can think of severe recessions, severe natural disasters, or even things like banking crises. In a severe adverse event, the last thing one wants to find is that one doesn’t have the fiscal flexibility (market or political) to facilitate prudent adjustment and absorption policies.    In a New Zealand context, a buffer of perhaps 20 percentage points of GDP seems sensible and reasonable.   One shouldn’t expect to use it in every downturn, but every few decades something very severe will come along, and one needs to have the flexibility to cope. And, on the other hand, 20 per cent won’t always suffice –  wars happen.

But beyond that, it was less clear how much substance there was to the speech –  or to the, as yet unpublished, supporting analysis.   For example, the Secretary seems (perhaps understandably) hesitant about criticising other countries, but he seemed reduced to trying to argue that there were substantive structural reasons why public debt should (prudently) be lower in New Zealand than it might be in some other countries, rather than just openly saying that levels of public debt in, say, the UK, France, US, Japan, Greece are higher than looks sensible.   His arguments for why debt here should be lower than in other countries don’t amount to much: small size (not clear how this is relevant at all), and exposure to natural disasters.  The latter might have some merit (although Japan’s experience of natural disasters in the last 150 years is much worse than New Zealand’s), but it isn’t exactly integrated to a structured framework.     And one could, quite reasonably, counter that our much more rapid population growth rate would naturally, and all else equal, lead to a higher prudent ratio of debt to GDP than one might observe in most countries (population growth doesn’t really get a mention).  On the other hand, our dismal productivity record might also be relevant, but again it doesn’t rate a mention.  And nor does the distinction between countries with floating and fixed exchange rate (the latter typically need more fiscal flexibility).

It was also a little surprising that, in a speech that bills itself as taking the “long view” there was no mention of how we might best think of past peaks in public debt ratios.  Depending on which measure one uses, thirty years ago public debt as a share of GDP might have been around the peak level Treasury now thinks appropriate.  What should we take from that earlier episode?    And there was no mention at all of the earlier period when, for decades, New Zealand ran public debt to GDP well in excess of 100 per cent of GDP.  How should we think about the prudence, or otherwise, of that record (and wouldn’t, for example, prudent debt levels (share of GDP) for 1913 New Zealand have been considerably higher than those for, say, 1913 United Kingdom?

There were also places where the political strains were showing.    On the one hand, the Secretary to the Treasury is right with the “governments have to ‘invest’ more” line.

And there is certainly an in-principle case for higher investment in New Zealand. The risks I discussed earlier – particularly climate change – will likely need to be managed through major investments. And as we discussed in He Puna Hao Pātiki, many of our social assets – social housing, and the healthcare and education estates – are aged and reaching the end of their useful life. In some places there is a critical under-provision of these essential social assets. High-quality infrastructure investment is needed to support urban growth and the supply of housing. Further investments in this physical capital can support the wellbeing of New Zealanders, and aid the development of our human and social capital.

You might agree or disagree with him, but it certainly reads as if he believes that there are big potential returns (economic and social) to lots more public investment.  And yet he spends the next page walking back from what this seems to imply, arguing (more or less) that it would be better if we had more unemployment so that these projects he favours wouldn’t crowd out private spending.  It is a pretty incoherent stance: if the projects are really as high-yielding as the Secretary makes them sound, we should welcome and embrace them now, even if other spending is crowded out.  And if they aren’t really that attractive, one should be cautious about championing them at any time.  But there is little sign that Treasury has faced or addressed that tension.

There also wasn’t much sign of the Secretary engaging with the record of government failure (perhaps not so surprising in an official more generally, but Treasury are supposed to be the guardians of good spending discipline).    Personally, there are several reasons why I don’t favour higher levels of public debt (and don’t regard the limits of what the market might lend as particularly relevant), including the continued stream of low quality projects governments manage to do even at present.  Wouldn’t a persuasive case for more debt involve, among other things, repeated case studies of the excellent and efficient ways governments spend and invest, with actual economic and social returns coming in at or above estimates generated at the time the relevant project proposal was approved.  This isn’t a benchmark of perfection – any investor, public or private, will get things wrong at times –  but of excellence, including showing how poor projects are recognised early and either remedied or terminated.  Given how weak the governance and accountability are, we should be very wary of letting governments loose with the credit card.

It was also striking that there was no mention in Makhlouf’s lecture of the way in which government social provision is likely to affect private sector savings behaviour.  One can largely agree with the welfare system as it is, and still recognise that without it, it is likely that the private sector as a whole would save more, notably for retirement.  That biases me towards thinking that the appropriate ratio of public debt to GDP in normal circumstances in an advanced country is really quite low.   In fact, for a comprehensive net debt measure, a benchmark of around zero per cent of GDP might be a reasonable starting point, with a resonant round number appeal (a bit like middle-aged people used to look forward to the day they become debt-free –  before governments messed up the housing market).  (As it happens, on the OECD’s broad measure –  general government net financial liabilities –  zero is about where New Zealand is now.)

A few other quick points:

  • it was good to see the Secretary specifically address MMT,
  • and it was good to see him refer, late in his speech, to the government’s growing use of Crown entity debt, in ways that erode the significance of the actual core Crown debt targets. Better perhaps for Treasury to encourage as to think about net debt more broadly – to encompass such things, and the NZSF assets –  than to run with putting a number on the variable the current government chooses to target,
  • it is a debate worth having, but I remain as unconvinced as ever – and I used to run the Reserve Bank’s financial markets function –  by the argument Makhlouf repeats that the government needs to have a significant level of gross debt to support (a) market functioning, and (b) optionality around future borrowing capacity.

Overall, not a bad speech, and better than many of Makhlouf’s.  One can’t help thinking that much of the material and many of the ideas might better have been released in a series of working papers or discussion documents –  to encourage expert debate more widely –  before the Secretary put his imprimatur on an official view.  But, in the end, next week  he’ll be gone, heading for Ireland, and we’ll be left to reflect and debate the best longer-term approaches for New Zealand.

Who knows, but by then we might even have a replacement for Makhlouf announced.  It is pretty shambolic that a week from his departure –  date known long ago –  the recruitment and appointment agency (SSC) hasn’t announced an appointment to what should be the most important public service job in New Zealand.

3 thoughts on “Makhlouf on public debt

  1. A good read. He didn’t touch on the holder of the debt: if domestically owned, the debt is a claim on each other and alters the risk/upper limit of prudenc? e.g. Japan


  2. He might (reasonably) respond that it is the overall NIIP position that matters more than who owns each specific asset class,and he did mention our high reliance on (net) foreign capital. Of course, in the Jap. case most of the JGBs are now held directly by the BOJ.


  3. As noted in the earlier discussion on a debt target or debt range, this misses the point that what matters in borrowing is the financial returns that will be used to repay the loan. The focus of the Treasury should be on the cost/benefit analysis of project and policy proposals. The level of debt is an outcome, not a target. Allowing for non-cash flow returns (economic, social, environmental etc benefits) may lead to a higher ongoing level of Government debt – but the returns achieved should be assessed and monitored by Treasury as a check on, and reminder of, the performance of past decisions.
    Also the source of financing is relevant in a complex Fiat currency world – Government can borrow overseas, internally, or (effectively) equity finance by getting the RB to buy its bonds – raising issues of the interaction between fiscal and monetary policy – making Government overspending a factor in money supply growth, NGDP or inflation targeting.
    Prudence might be about signaling, to stop Governments thinking they can spend as much as they like without evaluating its implications (though they can if the inflationary impacts are acceptable) but arbitrary targets are no substitute for thoughtful and professional economic analysis of proposed projects and policies. Dumbing down Treasury and softening its core role by replacing that with sound bites, wellbeingspeak, and loose arbitrary targets is not the best way forward.


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