Day: August 24, 2023

Fiscals: we used to keep good company

Michael Reddell Uncategorized

There are plenty of egregious examples of public sector waste (think lavish welcomes and farewells for senior public servants) or lack of discipline combined with questionable – well, really poor – process (think this morning’s post about the sly but huge increase in approved Reserve Bank spending).

But my core interests are macro in nature. There have been a series of posts in the last couple of weeks about aspects of the inflation and monetary policy story in the last few years, including yesterday’s on the external economy backdrop which should, if anything, have made New Zealand better placed than some to have kept core inflation near target (and that without even mentioning our lack of exposure to last year’s extreme European gas price shock).

It occurred to me that it might also be interesting to look at how fiscal balances and public debt levels had changed across the group of advanced countries (with their own monetary policies) that I’ve been using for comparison in these posts. I was less interested in the specific pressures put on monetary policy, since I’ve already written a couple of pieces dealing with the spin the Governor is (yet again) engaging in, trying to downplay fiscal impulse measures (developed for monetary policy purposes) in favour of ones that seem to have no macroeconomic foundation at all. I’ve asked the Bank for all/any analysis research in support of what looks to be a highly questionable alternative view, but am not holding my breath (if there were anything much they’d either have referred to it in the MPS, or they might even have been keen to send it to me by return of email to allay my doubts). So my focus was on fiscal developments in their own right.

Sometimes when one heads off to OECD databases to download lots of cross-country comparative data I already more or less knows the story and just want the hard numbers to illustrate it. Other times I’m taken by surprise. This trawl was one of those surprising ones, and not in a good way at all.

But first the good news. This is my preferred (since all-encompassing) measure of net debt. The OECD doesn’t have data on quite all the countries (and Norway data isn’t up to date, but at last read was about -350 per cent of GDP). These are the OECD’s mid-year estimates for 2023

We have lower debt than the median country. Many people (including me, but certainly not everyone) count this as a pretty good thing. But a debt stock is an accumulation of choices by successive governments over a long time. And I was more interested in looking at how things had changed over the Covid period, so since 2019. After all, every government faced some big spending in 2020, and when economies were temporarily closed down tax takes fell too.

So here is how net general government financial liabilities is estimated to have changed from 2019 to 2023 for this same group of countries.

And this is where the surprises started.

The median country in this chart – Sweden – saw basically no change in net debt to GDP over this period. New Zealand, on the other hand had the third largest increase. Australia had a slightly larger increase, but interestingly that was concentrated in the actual Covid period: from 2021 to 2023 net debt in Australia is expected to have risen by 1.5 percentage points while in New Zealand is estimated to have risen by 7.5 percentage points. Of course, for highly-indebted countries the unexpected surge of inflation typically lowers net debt to GDP – helping the US notably among these countries – although in the UK’s case having a large proportion of inflation-indexed debt on issue prevented that happening (as it was designed to do).

The OECD forecasts include 2024 as well, so we can see how they think net public debts levels will have changed across these countries from 2021 (the end of the big Covid spends) to 2024, which they base more or less on policy as at the time the forecasts are done (so mid 2023). Here’s that chart

No comment needed really.

That’s debt, but what about flow measures? Deficits and the like.

Here, we can’t look at the operating balance measures we in New Zealand usually focus on. And all the measures are for “general government” (all layers) rather than just central government (although of course in New Zealand central government absolutely dominates the numbers). There are two sensible metrics to look at:

  • the primary balance (ie excluding financing costs) as a per cent of GDP, and
  • net lending (so saving minus investment) as a per cent of GDP

Both are available either cyclically-adjusted or plain, and the OECD also identify idiosyncratic one-offs to go beyond the cyclically-adjusted measures to something more like structural balances.  Covid was a common shock, and there are very few identified one-offs for the years focused on here.

The primary balance is a deficit measure pure and simple.  Excluding finance costs makes sense for these purposes not because they aren’t real costs, but because a country with higher inflation will tend over time to have higher interest rates and much of those higher nominal interest rates aren’t a real burden, but just maintain the real purchasing power of the debt.  At present, 6 per cent inflation and 4 per cent bond rates gives you negative real financing costs, but still a significant line item of expenditure on interest.  The other reason for excluding them is that a basic maxim in public finance is that if you are running a primary balance or material surplus, your debt won’t be escalating as a share of GDP (precise definition depends on the relationship between the interest rate and the GDP growth rate).  Countries don’t need to run headline surpluses to see debt ratios stabilising or falling, but sustained primary deficits (especially in cyclically-adjusted terms) are typically a bit of concern –  the sort of thing the IMF might focus on in struggling countries.

Anyway, here are the OECD’s primary balance estimates for 2023 (Norway, as so often at present, runs off the scale)

So that would be the third largest primary deficit this year or any of these advanced economies. Japan is….well….Japan when it comes to public debt and deficits. Poland is dealing with a big influx of Ukrainians and a huge increase in defence spending, and then there is New Zealand. By far the largest primary deficit of any of the countries we are more prone to comparing ourselves to (Anglos and other north Europeans), in an economy where this calendar year the output gap will be about zero (in other words the deficit isn’t exaggerated by a deeply below-capacity economy). I did check the cyclically-adjusted picture and it looks very much the same, altho the Czech Republic just sneaks past us.

And while the median country in this grouping has seen its primary balance deteriorate (into small deficit – see above) over the Covid period since 2019, New Zealand has had the third largest widening (again, cyclically-adjusted numbers are similar, although we are second worst on that measure)

Adjusting the New Zealand numbers for the OECD’s series of estimated one-offs (mostly around the earthquakes) produces this time series chart.

From which I take two points:

  • We have never (outside Covid peak itself) run primary deficits anywhere near as large as those run last year and (estimated) this year.
  • In almost every year in the history of the chart we have a stronger (cyclically adjusted) primary balance than the median advanced country in this grouping.  Not only were our primary deficits materially larger in 2020 and 2021 (the Covid outlays years), they are still materially larger now.

The other set of measures is for net lending.  I haven’t used these data often here, but they are totally standard framework for analysing macro (im)balances (the Reserve Bank even had a nice chart of these sectoral balances, for firms, households, and general government in the latest MPS.  It is a measure of savings less investment, saving (in the public sector context) typically arising with operating surpluses.  It is set within a national accounts framework, unlike the primary balance (which is more of a pure fiscal thing, since OECD primary balances typically include capital spending).

Here are the OECD’s numbers for 2023

We are fifth from right here, with a rather large gap between government saving and the government deficit, but even that position flatters us because the saving numbers take finance costs into account, and (as discussed above) in the presence of high inflation the numbers for highly-indebted countries (think US and UK) show as worse than they really are. Simply paying out interest equal to the inflation rate is not a real burden (or hence real dis-saving), they just maintain the real purchasing power of the bondholders without worsening the real position of the government. (If you want to know more about this issue in a New Zealand context Google work Grant Scobie did at The Treasury.) Since economies are getting back towards balance this year, the cyclically-adjusted picture isn’t much different for New Zealand.

And here is the change since just prior to Covid

Third from the right when even the median country’s position has deteriorated – and remember almost all of these countries have been grappling with high inflation – is probably not the ideal place for New Zealand to be.

I could, but won’t, show you the time series chart for this measure cyclically-adjusted and with adjustment for earthquake one-offs. I won’t because the picture is so similar to the time series comparative chart for the cyclically-adjusted primary balance. We used to be better than the median, our government sector used to be net lender most years, while now we are a net borrower and quite a bit more so than the median of these advanced countries.

As I suggested towards the start of this post, I was genuinely surprised by these numbers for the last few years. I knew, of course, that New Zealand’s position had deteriorated, and have banged on here about the lack of any robust economic case for running operating deficits last year and this while the economy was overheated or (this year) getting back to balance, and the Reserve Bank was belatedly grappling with the inflation challenge. But if you’d asked me, I guess I’d have assumed that other countries had probably had similar deteriorations. Mostly, they haven’t.

None of this – except the initial debt charts – are materially influenced by the costs of Covid – lockdown support etc- themselves. Those costs were borne, and often were very heavy, in 2020 and 2021, while my charts have focused on the changes in balances from 2019 (pre Covid) to 2023 (post big Covid expenditures and with fully employed economies). They are pure political choices.

I can see an arguable case for a country that had rapid productivity growth and rapid population growth to be a net borrower (investment in anticipation of future income gains). But other than the central European countries, rapid productivity growth has been scarce among advanced countries, and although our population growth rate is now rapid again, so are those of Australia and Canada, neither of which is running anything like our net lending deficit.

And in a fully employed economy (as ours is this year) there is just no good case at all for running any sort of operating deficit (the New Zealand specific measure), let alone a material primary deficit.

In flow terms, our public finances now – fully employed economy, and terms of trade which have still been high by historical standards – just aren’t what they once were (under governments of either stripe) until quite recently. And the numbers are still flattered by that boost an unexpected surge of inflation gives to the public accounts – but which you never hear either government or Opposition parties engage with – in that public sector wages (with a considerable element of central control) tend to be slow to adjust. The government recently more or less forced secondary teachers to accept a material real wage cut. They are trying to do the same now with senior doctors. And it is probably the case, in a bigger way, for any moderately well paid public servant who hasn’t changed jobs in the last three years. None of those cuts is likely to prove sustainable (when private sector real wages are flat or rising) longer term if we care at all about the capability and quality of the services we expect governments to provide. Pressures like that really should, but won’t (given the way these things are done), be reflected in next month’s PREFU as part of the big fiscal challenge facing whoever takes office after the election.

There are lots of numbers and concepts in this post. Apologies for that but it is largely unavoidable in trying to do meaningful cross-country comparison. The bottom-line, through all the charts and numbers, is that first sentence of the previous paragraph.

Spending (lots) more….with no parliamentary authorisation

Michael Reddell Reserve Bank Act reforms, Uncategorized

Late yesterday afternoon someone sent me the link to this

Almost two months into the Reserve Bank’s financial year it authorises a 41.7 per cent increase in spending for the current financial year and a 26.3 per cent increase the following year, both relative to the amounts approved in the current five-year Funding Agreement signed in June 2020.

The variation had, apparently, been slipped onto the Reserve Bank’s website the previous day (22nd).

I’m signed up to the Bank’s email notifications. These were the ones from the last week

There was no press release from the Bank, and none from the Minister of Finance either. For huge increases in the spending of an institution whose performance has been under a great deal of scrutiny in the last year or two, the institution actually charged with keeping domestic demand in check to keep inflation at/near target.

The Funding Agreement model, which governs how much of its income the Bank can spend, itself is very unusual. I wrote about it, and the background to it, in a post a few years ago, before Orr took office, when the Reserve Bank Act review was being kicked off. The Funding Agreement model was better than what had gone before – not hard, since previously there were no formal constraints at all on Reserve Bank spending – but not very good at all. The model was set up when the Bank was (overwhelmingly) conceived of as a monetary policy agency, with a few other peripheral functions. The five-year horizon, with nominal allocations fixed in advance, was seen as having the (modest) advantage of providing a bit of financial incentive for the Bank to meet its inflation target: if it didn’t its real spending constraint would be tighter than otherwise. These days, the bulk of the Bank’s staff are devoted to policy and regulatory functions. Most such government agencies are funded by annual appropriations, approved (and scrutinised) by Parliament through the annual Budget process. In that earlier post, I’d come round to thinking that model should be applied to the Reserve Bank too.

The variation slipped onto the website a couple of days ago exemplifies what is wrong with the current system (perhaps especially under the current players – Orr/Quigley and Robertson – but they are only egregious abusers of a poor system).

This is public spending on public functions. We have a Budget for that. There is no obvious reason why, if there really was a compelling case for more money for the Reserve Bank, it could not have been announced at the same time as the Budget. After all, governments have to prioritise, and voters have to make judgements about what they do and don’t choose to spend money on. Taxpayers are the poorer whether or not the spending is through some agency subject to parliamentary appropriation or the Reserve Bank. As it is, the Bank’s financial year began on 1 July, so why the delay in agreeing/announcing this big increase in approved spending?

But then note the specific timing. The Minister of Finance signed the variation on 31 July. Orr and Quigley only signed it, and then had it slipped onto the website, on 22 August. It doesn’t take more than five minutes to get a document across the road to the Reserve Bank, and even if they wanted Quigley’s signature on it (it just needs any two Board members), and they wanted a physical rather than electronic signature, a return courier to Hamilton could no doubt have been done in 24 hours. Most probably, they didn’t want the variation to be known any earlier because……last week was the Monetary Policy Statement, when the Bank was having to acknowledge it hadn’t yet made much progress in getting core inflation down and that interest rates might be higher for longer, when the Bank would face a press conference and an FEC hearing, and when they’d do the quarterly round of making some internal MPC members available for interviews. It came on the back of those stories a couple of weeks ago [UPDATE: the week MoF signed the variation] about the Minister and the Public Service Commissioner having meetings with government department chief executives urging upon them fiscal restraint. The last of those Bank media interviews appeared a couple of days ago. It was bureaucratic gamesmanship, presumably abetted/approved by the Minister, to minimise budgetary scrutiny and accountability on what is a huge increase in allowed spending.

By law, they had to publish the Funding Agreement variation on the Bank website as soon as possible after it was signed. They did that, even if you had to be eagle-eyed or lucky to spot it. The Minister must present a copy to Parliament within 12 sitting days. Had the agreement been signed on 31 July (when Robertson signed it, but not the others) that would have been this month. As it is, perhaps he’ll do it in the next few days, but it could be November/December, after the election.

Under the old Reserve Bank Act, Funding Agreements were subject to parliamentary ratification. In a way, it was a bit of a charade, as there were no consequences if it was voted down (it isn’t mandatory for there even to be a Funding Agreement) but it did establish a principle, and did allow a parliamentary debate and a spotlight on proposed Bank spending). In one of the very worst parts of the Reserve Bank Act reforms – that genuinely took things backwards, rather than just made botched or inadequate improvements – the government removed the provision from the Act requiring parliamentary ratification, and thus the platform for parliamentary debate (about a level of spending which in absolute terms is no longer small).

We also, at this point, have no real idea what the Minister has approved this spending increase, in straitened times, for, or why he approved it. There is, of course, no ministerial press statement, and there is no hint of a huge spending increase in the Minister’s latest letter of expectation (although this must have been underway for months, and I had a clearly well-informed email months ago encouraging me to ask questions and lodge OIAs then, which I didn’t get round to doing).

All we have at present is this

which is clearly designed to emphasise the new functions, but there is just no way they can be costing any significant part of the extra $48m. And in any case, we simply can’t take as trustworthy anything Orr and Quigley say any longer, abetted by Robertson, without explicit verification.

(One problem with the Funding Agreement model is that it includes capex so we don’t even know yet the split between ongoing operational spending and capex items).

There should, eventually, be some transparency. One positive aspects of the recent legislative reforms was a requirement that the Bank must publish a budget (previously I had pointed out the Bank’s funding was an untransparent as that of the SIS)

By law, the variation to the Funding Agreement slipped onto the website on Tuesday had to accompanied by an updated budget. But, so far, there is no sign of one. There are budget numbers in the 2023/24 Statement of Performance Expectations released a while ago, but they bear no relationship to the numbers in this variation (and there is no substantive mention of the Funding Agreement, or any variations to it, in that document). I’ve searched their website and can find nothing else.

We have no details, Parliament has no say, and the Minister and Governor and Board chair arranged to ensure the really big increase in funding was (a) kept just as low profile as possible, and (b) wasn’t disclosed at all until the quarterly round of scrutiny for the Bank had conveniently passed.

It is a travesty on multiple counts. The system is bad enough – spending should be occurring only with parliamentary approval, but the law doesn’t require that – and the application seems, if anything, to have been worse.

Since I assume that they will, after their fashion, eventually obey the law no doubt a “budget” will eventually appear. Even then it is unlikely to be very revealing, although might give a hint of a sense of the breakdown between bloat and actual increased statutory responsibilities. I’ve lodged Official Information Act requests with the Bank, The Treasury, and the Minister of Finance to understand better just what is going on, including how much (if any) pressure there was on the Bank to cut back on non-priority spending. One day, in a month or two, we should have some answers to that.

UPDATE (Friday)

This appeared in the comments last night

If I’m looking at the right page this detail now appears to have been removed. It was interesting that Quigley’s signature was affixed electronically, so that (of course) the long delay was not a matter of waiting for him to come to Wellington. Re the final point, there may well have been a Board meeting recently, but since the variation document itself reflected an agreement between the Bank and the Minister it would be (very) surprising indeed if the Board had not already approved the variation before MoF signed it on 31 July.