2022 vs 2008

When the National-led government took office in late 2008, the government’s books were in something of a mess. The Treasury’s projections were for operating deficits of 2 to 3 per cent of GDP each year over the forecast horizon. Since the mid 1990s, under governments led successively by National and by Labour, there had been 14 years in succession of OBEGAL surpluses (a very very small one in the June 1999 year). After all those surpluses there was, of course, not much debt (the Decenber 2008 HYEFU shows net Crown debt for the just-completed year at 0.0% of GDP). It certainly wasn’t, in any substantive economic sense, a fiscal “crisis”, but it was pretty substantially unsettling, both politically and at The Treasury (where I was working at the time).

There was a great deal of rhetoric about Michael Cullen, Minister of Finance in the outgoing government, having squandered the fruits of the boom years, and bequeathed a “decade of deficits” (some contemporary political stuff is here).

Over the years I have defended Cullen in a couple of posts (here and here), particularly centred on the 2008 Budget delivered on 21 May 2008. There is no doubt it was an(other) expansionary Budget. As a share of GDP, core Crown expenses were projected to increase from 31.8 per cent of GDP in 2007/08 to 33.4 per cent in 2008/09. The operating balance was projected to drop from a surplus of 2.9 per cent of GDP to one of 0.7 per cent of GDP (dropping away further to tiny surpluses later in the four-year forecast horizon). Against a backdrop of above-target core inflation, it is wasn’t exactly helpful in terms of macroeconomic balance, but in purely fiscal terms it was hard to argue against it very strongly. Recall that in the New Zealand system, ministers set fiscal policy (tax and spending choices), but the Secretary to the Treasury has independent personal responsibility for the fiscal and economic forecasts. The best professional advice the then-government had was that their fiscal policy was consistent with continuing to avoid deficits over the forecast horizon. And the initial level of public debt was untroublingly low.

It was, of course, election year. After 8.5 years in office, Labour was by then running well behind in the polls. One might expect taxpayers’ money to be thrown around with a bit more abandon than usual, but – in purely fiscal management terms – The Treasury assessment told them it was okay.

What were the projections like? By most reckonings it was an overheated economy. The latest unemployment rate available when the numbers were being finalised was 3.4 per cent (lowest of that cycle, lowest for a generation). Core inflation was running above target. Output gap estimates were typically positive. And the terms of trade – boosting nominal GDP and tax revenue – were at fresh record highs.

Treasury expected the economy to slow down. GDP growth over the 12 months to March 2009 was forecast to slow to about 1.5 per cent and over the following couple of years the unemployment rate was expected to rise back to about 4.5 per cent. With a Governor who wasn’t very focused on the midpoint of the inflation target, inflation was expected to remain right near the top of the target range, but ministers (and the public) were told there was likely to be room for the OCR to fall somewhat over the forecast horizon.

It was the sort of environment in which standard fiscal policy advice would be that it was appropriate to be running an operating surplus – not necessarily a large one, but a surplus. And Treasury advised that the government’s tax and spending plans were consistent with continuing to deliver surplus (headline and in cyclically-adjusted terms).

They were, of course, bad forecasts – bad economic forecasts translating into badly-wrong fiscal forecasts. The economic forecasts were completed using data up to 15 April 2008, but by then the financial system stresses abroad had been headline material for months, and oil prices were rocketing upwards towards their peak – higher even in nominal terms than anything we’ve seen this year – reached in July 2008. But if we don’t always expect ministers to agree with Treasury advice or even Treasury forecasts, the published fiscal projection numbers rely on exactly those forecasts (and there is no sign at the time that ministers had a wildly different view). It is fair to note that opinion shifted fast that year – the Reserve Bank’s June Monetary Policy Statement forecasts were finalised on 26 May 2008 (just a few days after the Budget was delivered): they saw the unemployment rate climbing back to 6 per cent over their forecast horizon, but even they – taking fiscal policy as given, but applying their own economic outlook – didn’t see looming fiscal problems.

My point re 2008 is that you can criticise that Budget if you want, but really – given the combination of economic forecasts from The Treasury, and the government’s polling plight – it still looks quite impressively restrained, in some ways a testimony to the 15-year record built up by then of a presumption towards a balanced operating budget (at least) or a surplus. Of course, the more left-wing among Labour’s supporters didn’t much like that presumption – they’d talk about missing out on opportunities etc – but (inaccurate as they were to be) looking through those June 2008 Reserve Bank forecasts, at the time they saw the policy and economic environment as consistent with 2 per cent annum productivity growth.

Against that benchmark of avoiding deficits – at least outside crises – Labour in 2008 might have done something close to “spending it all” (Muldoon’s claim of his 1972 pre-election Budget), but if Labour was going to lose that year, they thought they would still be bequeathing a small surplus. After 14 successive years of surpluses. Debt was projected to rise a bit – lots of capex planned – but, four years out, was forecast to be about 6 per cent of GDP. That 2008 Budget continued the track record, under both governments, of not projecting an operating deficit.

The contrast between Clark/Cullen that year and Ardern/Robertson this year is striking.

Now, in part, the climate has changed. We have become accustomed to deficits once again. Of the last 14 fiscal years, there have been operating deficits in eight of them. Some of that is to have been expected. In the 14 years from 1994 to the 2008 Budget, there had been only a single mild recession in New Zealand and no great natural disasters. By contrast, since 2008 we have had a serious (double-dip) recession in 2008/09/10, the big fiscal cost of the Canterbury earthquakes, and most recently the pandemic and associated severe disruptions to economic activity.

But what hadn’t changed – at least until now – was that governments projected to run balanced budgets or surpluses at times when The Treasury estimated that the economy was pretty full-employed, or even overheated. Now, you might push back that the sample is pretty small – on most metrics, there was excess capacity in the economy (negative output gap, lingering high unemployment, sluggish core inflation) for most of the decade after 2008.

But how about Robertson’s second Budget, in 2019? For the 2019/20 year, then just about to start, Treasury projected a small positive output gap (0.3 per cent of GDP), an unemployment rate (4.0 per cent) evidently a little below their view of the sustainable rate, and inflation was projected to be bang on the target midpoint. The government’s fiscal policy choices led Treasury then to project an operating surplus of 0.4 per cent of GDP. Tiny, but still positive. Focusing only on the macroeconomics, one couldn’t really complain. It all looked pretty prudent.

That was the, just three years ago. This is now – same Minister of Finance, same Prime Minister. The macroeconomic environment – at least per the Treasury’s estimates and projections, which the government showed no sign last week of questioning or disowning – has changed, but in ways that materially improve the government’s expected fiscal position. The output gap, for example, is estimated at 2.1 per cent of GDP in 2022/23. The unemployment rate is expected to average about the current 3.2 per cent (evidently well below The Treasury’s view of sustainable), we’ve had a huge upside surprise on inflation, and if the terms of trade are not making new record highs, in 2022/23 they were expected to hang around the very high level of recent years (see chart above).

Not a month ago the Minister of Finance announced his new fiscal rules. The first of them was this

  • Surpluses will be kept within a band of zero to two percent of GDP to ensure new day‑to‑day spending is not adding to debt.

It was, on paper, good stuff. Except that it doesn’t apply now, only in some future era beyond the next election. Because this Budget (for 22/23) projects an operating deficit of 1.7 per cent of GDP, despite all those (projected) overheating economy indicators. In cyclically-adjusted terms, it is probably a deficit of getting on for 3 per cent of GDP – just miles away from the Minister’s own good-stewardship benchmark. Brings to mind St Augustine: “Give me chastity and temperance—but not yet”.

It isn’t as if there is some Covid excuse for these big projected cyclically-adjusted deficits. No more lockdowns (and wage subsidies or equivalent) are planned, MIQ is all-but gone and…….if the sectoral pattern of activity is still different (not many foreign tourists yet, and Treasury projections in which foreign trade remains lower as a share of GDP) the economy is (more than) fully-employed. And on Treasury’s view, inflation remains above target for several years to come.

It is just cavalier – political management rather than responsible economic or fiscal management. And it isn’t even election year yet. When Muldoon in 1972 talked of “having spent it all”, and Cullen in 2008 acted in ways that one might reasonably suggest were much the same, they both probably thought the political odds were against them, that any problems would most likely fall to the opposite party soon to take office (and even if not, there would be three years to sort things out), this time it looks a lot like Robertson and Ardern have done it to themselves, and that fiscal chickens could come home to roost just a few months out from next year’s election. Unless, that is, they are really just giving up on the notion of a balanced operating budget – an idea which shouldn’t be that controversial (see the Minister’s own embrace of the principle).

Take a couple of other contrasts with 2008. By then, for example, the OCR was widely believed to have peaked already (at 8.25 per cent reached in June 2007) and attention was beginning to turn to when, and to what extent, the OCR might eventually be cut. And, to the extent the economy was overheated it was the culmination of a build-up of pressures over years – a fairly long and sustained economic expansion. Oh, and public debt had been steadily falling every year since 1992. Depending on your precise measure, it was basically zero (a little lower even than at the time of the 1972 Budget).

By contrast, Treasury now tells the government to expect lots more OCR increases (so looser fiscal policy is directly working against monetary policy), public debt – while still low by international standards- has risen a lot in the last couple of years, and the overheated economy at present, while real, was sudden, is ill-understood, and could have some distinctly evanescent aspects to it. You might not think it was time for savage structural fiscal tightenings – and I would probably agree – but it certainly isn’t time for choosing to move deeper into cyclically-adjusted deficits. And the precedent it sets for future governments is not exactly welcome – perhaps they too will commit to surpluses only beyond their own electoral horizons.

All the discussion of this year has been premised on The Treasury’s economic forecasts. They were what ministers had in front of them, and they were not disowned by Robertson in delivering his Budget last week. But they have a distinctly rosy tinge to them – I doubt if The Treasury was finalising them now they would be as upbeat – and it is very easy to envisage a much-worse outlook, not just for the medium-term but from now through to the election. Significant core inflation problems have very rarely if ever been resolved without a recession – and such recessions are rarely of the nature of two quarters of -0.1% growth. It isn’t “necessary” – soft landings are hypothetical possibilities, but achieving a fabled soft-landing assumes a state of knowledge (and ability to fine-tune tools) that is evidently rarely – and perhaps especially unlikely at present, since if governments and central banks had the level of knowledge required we should not have been in this overheated inflationary mess in the first place. That isn’t a criticism of any individual or agency, but an observation about the evidence of our eyes – here and abroad – over the last couple of years.

There was a famous line from the US 1988 vice-presidential debate. Senator Dan Quayle, the Republican nominee, had noted that he had as much congressional experience as Kennedy had had when he ran for President. But the memorable line of the night was Senator Lloyd Bentsen’s response

“Senator, I served with Jack Kennedy. I knew Jack Kennedy. Jack Kennedy was a friend of mine. Senator, you’re no Jack Kennedy.

It came to mind when thinking about the contrast between Michael Cullen and Grant Robertson. One, miles behind in the polls, nonetheless projected surpluses (on best professional macro forecasts) in his last Budget. The other, on projections (valid or not) of an even more overheated economy, with more severe inflation problems, having already overseen (somewhat inevitable) increases in public debt) drops into significant projected deficits – complete with gimmicky handouts. And it isn’t even election year yet.