Fiscal policy

Fiscal failure

Michael Reddell Fiscal policy, Uncategorized

Back in the far flung days – well, really only just more than two years ago – the National Party went to the election with a fiscal plan under which the government’s operating deficit would have been more or less closed by now. This was the table from that plan.

And in case you are wondering, the PREFU projections that provided the economic base for National’s numbers still had a negative output gap of 0.9 per cent of GDP for the 25/26 year, so it wasn’t exactly a rosy economic scenario. But the deficit was to be more or less closed by now ($1bn for the full year is a bit under 0.25 per cent of GDP, and by the second half of that year – which we are almost in – presumably consistent with a tiny surplus).

There will be an update with the HYEFU next week, but in this year’s Budget – where the government last made overall fiscal decisions – the deficit for 2025/26 was forecast to be $15.6 billion.

Now, to be fair, going into the 2023 election National wasn’t exactly making much of the structural deficits they expected to inherit (I recall at the time noting that there were few or no references to the deficit in the fiscal plan document). And, thus, I guess they’ve been consistent. When the deficit turned out to be more embedded than they’d expected – Treasury having badly misjudged how much tax revenue the economy was generating – National chose not to be any more bothered. They simply chose, in both budgets so far, to do nothing at all about closing the deficits.

This had been apparent in Treasury’s analytical numbers. They publish estimates each year of the structural deficit – ie the bit not amenable simply to the cyclical state of the economy.

This chart was from 2024 budget documents

History is as it is (or, at least, is estimated to be). The medium-term future numbers are, under any government, just vapourware (Treasury uses the future operating allowances the then Minister advises them, which need not bear any relationship to what is actually done when the time comes). But what I’ve highlighted is the move from one year to another, for the fiscal year to which the Budget relates. Thus, in the 2024 Budget Treasury had an estimate as to how big the structural deficit had been for 23/24 and then, given the hard decisions ministers were making, and getting parliamentary approval for, a forecast as to what the structural deficit would be for 24/25. As you can see, in that Budget, the government chose – they had these numbers and associated analysis – to take steps that, taken together, slightly worsened the structural deficit.

The picture from the 2025 Budget was much the same

For a second year in succession, this government’s Budget slightly worsened the structural deficit.

Of course, all the numbers are imprecise estimates, but they were the best estimates available to ministers when they made the Budget decisions.

And recall that a structural operating deficit is akin, in a family context, to borrowing to pay for the groceries even when the family’s employment and income position is pretty normal. A bad practice….for the family, and for the Crown.

It was the Secretary to the Treasury himself who told FEC last week that there had been no fiscal consolidation under this government.

Things haven’t got radically worse in structural terms, but all this has come on the back on deficits under the previous government, and the ever-increasing ageing population fiscal pressures that Treasury has (among other people) warned about for years.

Of course, it hasn’t suited politicians on either side of the aisle to acknowledge Rennie’s point. The government has repeatedly suggested that their fiscal consolidation efforts have helped considerably in bringing about the large cuts in the OCR over the last 16 months, while the Opposition has been content to suggest that something akin to a “slash and burn” approach explains the weakness of the economy over that period. The numbers don’t back up either side – which surely their smarter people actually knew? – because there has been no fiscal consolidation. Sure, the government has cut some spending, but those savings have been (slightly) more than outweighed by new spending. Consistent with that. core Crown expenses as a share of GDP for 2025/26 were estimated at Budget time to be 32.9 per cent of GDP, up slightly on the previous year, and a full percentage point higher than the last full year for which Labour had been responsible. All those numbers are in the public domain, but….politicians……. (In the last full year pre Covid, by the way, spending was 28.0 per cent of GDP.)

Ah, you might be thinking, but what about the interest burden run up by the accumulated deficits of recent years. Surely the incoming government was pretty much stuck with that, making overall expenditure cuts more difficult? And there is something to that, so in this chart I show primary spending (ie excluding the finance costs line from the core Crown expenses table).

It doesn’t really make much difference to the picture: primary spending is still a) far above levels for the June 2019 year (last pre Covid), and b) higher than in the last full year of the previous government, both as a share of GDP.

Spending levels aren’t really my focus. If governments want to spend more then so be it, provided they raise the taxes to pay for the spending. This government simply hasn’t done that, and so the structural deficits stay large, and have been widened a bit (an active choice, not a passive outcome).

In the last couple of days there has been something of a spat between the current Minister of Finance, Nicola Willis, and her National predecessor Ruth Richardson. It seems there is to be a debate between them, after the HYEFU numbers come out next week. But if no one ever really expected Nicola Willis to take anything like a Ruth Richardson approach to public finances, her comments yesterday (as reported in The Post, still seemed extraordinary.

Can the Minister really have been serious in suggesting that any fiscal consolidation – and recall she did none – would have come only at the cost of “human misery”? Fewer film subsidies for example? Or cutting the Reserve Bank budget back a bit more? Or…… (and there is a long list of new initiatives, all choices)? Really?

I’m not overly interested in relitigating the Richardson record, particularly in 1990/91. One can mount an argument that by the time National took office in late 1990, there was already a primary surplus – itself usually sufficient over time to bring finances into order – with the high interest costs themselves somewhat exaggerated (in terms of real burden) by the persistently high inflation of the previous few years. And, as it turned out, even the return to headline surpluses took place sooner than had generally been expected after the 1990 and 1991 fiscal cuts (I was co-author of a Reserve Bank Bulletin article that attracted the ire of Michael Cullen for suggesting that surpluses might not be too far away, and even we were too pessimistic). All that said, fear of large credit rating downgrades was a major consideration at the end of 1990 and into early 1991, and the second failure of the BNZ wasn’t exactly confidence-enhancing. (Then again, the demographics were much less unfavourable back then – in fact quite favourable for the following decade or so, given low birth rates during the Great Depression.)

But whether or not the full extent of the fiscal adjustments back then were strictly necessary is beside the point now. We have much better fiscal data and analytical models, and we have substantial structural deficits on which the government has chosen to make no inroads at all, all while also doing nothing about the medium-term demographic pressures on government finances. The Minister is quoted in the Herald this morning as suggesting (in effect) that the lady’s not for turning, and that she is keeping right on with her borrow and hope strategy – hoping, no doubt genuinely, that one day something will turn up and the deficits she has chosen to run will just go away. If they don’t, we are on a path that – persisted with – takes us in the same direction as, for example, the UK, once – not that long ago – an only modestly indebted advanced economy.

Cross-country comparisons of fiscal situations aren’t made easy by the way New Zealand presents its own data (useful for some purposes, but rendering comparisons hard). But twice a year the IMF produces a Fiscal Monitor publication with a range of indicators presented on a comparable basis across countries. This chart, using data from the October issue, shows the cyclically-adjusted primary balance for New Zealand and other advanced countries (these are overall balances, not operating ones). There are countries running larger deficits, but most advanced economies are running much deficits or even primary surpluses.

When it comes to deficits, the New Zealand government is choosing to do poorly on almost metric you choose to name (history, cross-country comparisons, expectations of the Public Finance Act). And it is choosing to do nothing about it. With an election year next year, not a time known for fiscal consolidation.

I had noticed reports that the Taxpayers’ Union was launching its own campaign on these issues, and the government’s fiscal fecklessness – choosing to do nothing about fixing a problem they inherited. I don’t have anything to do with that but while I was typing this a courier turned up with the props they are distributing to journalists and commentators. I’m sure we’ll enjoy their fudge.

Is it a fiscal fudge though? More like open and outright bad, and rather irresponsible, choices. We need something better.

May Monetary Policy Statement

Michael Reddell Fiscal policy, Monetary policy

Procrastinating this morning, I asked Grok to write a post in my style on yesterday’s Monetary Policy Statement. Suffice to say, I think I’ll stick to thinking and writing for myself for the time being. Among the many oddities of Grok’s product was the conviction that Adrian Orr was still Governor. Mercifully that is not so, even if – despite all the questioning yesterday – we are still no closer to getting straight answers on the explanation for the sudden, no-notice, accelerated departure of the previous Governor. Perhaps responses to OIAs will eventually help, but some basic straightforwardness from all involved – but especially Quigley and Orr himself – would seem the least that the public is owed, especially after all the damage wreaked on Orr’s watch.

Yesterday’s Monetary Policy Statement certainly made for a pleasant change of tone. Stuff’s Luke Malpass captured it nicely: “A lack of journalists being upbraided at times for not reading the materials in the hour allowed, or for asking the wrong question, was a change from previous management”. I watched about half of the Bank’s appearance at FEC this morning, and it was as if it was a whole different Bank. Not necessarily any deeper or more excellent on substance, but pleasant, respectful, engaged people accounting to Parliament, as they should. And, setting the standards low here, there wasn’t any sign of attempts to actively mislead or lie to the committee (Orr, just three months ago in only the most recent example).

I don’t have any particular quibbles with yesterday’s OCR decision. It was probably the right thing to do with the hard information to hand, but we won’t know for quite some time whether it really was the call that was needed. The NZIER runs a Shadow Board exercise before each OCR decision where they ask various people (mostly, but not all, economists) where they think the OCR should be at this review and in 12 months time, and invites them to provide a probability distribution. I’m not part of that exercise but I put my rough distributions on Twitter earlier in the week (in truth the blue bars should probably have been distributed in a flatter distribution – we really do not know)

The Bank’s projection for the OCR troughs early next year at 2.85 per cent and, as the scenarios they present reinforce again, there is a great deal of uncertainty about just what will be required (and not just because of the Trump tariff madness and associated uncertainty).

One of the interesting aspects of yesterday was that for only the second time in the six year run of the MPC that there was a vote (5:1 for a 25 point cut rather than no change). But, of course, being the non-transparent RBNZ we do not know which member favoured no change, so cannot ask him or her to explain their position, let hold them to account or credit them when time reveals whether or not it was a good call. As it happens, despite the vote the MPC reached consensus on a forecast track for the OCR and since that track embodies a rate below 3.5 per cent as the average for the June quarter and yesterday’s was the final decision of the June quarter, I’m not sure what to make of what must really have been quite a small difference. The bigger issue remains that there is (almost always) huge uncertainty about what monetary policy will be required over the following three years (the standard RB forecast horizon) and yet never once has any MPC member dissented from the consensus track. Groupthink still appears to be very strong. And notwithstanding the Governor’s claim that there is “no bias” one way or the other for the next move or the next meeting, the track – which all the MPC agreed on – clearly implies an easing bias (even if not necessarily a large one for July rather than August).

Hawkesby, unprompted, was yesterday championing the standard approach under the agreement with the Minister which enjoins the committee to seek consensus and only vote as a last resort. He acknowledged it is now an unusual model internationally, but claims it was preferable because it means – he claims – that everyone enters the room with a completely open mind about what should be done, whereas in a voting model people tend to enter the room with a preconceived view. Perhaps it sounds good to them, but it simply doesn’t ring true (and there is no evidence their model – which, among other things, saw them lose the taxpayer $11bn – produces better results in exchange for the reduction in transparency and accountability.)

It rang about as false as yesterday’s claim from the chief economist that the uneventful (in markets) transition when Orr resigned was evidence for the desirability of the decisionmaking committee. I’m all in favour of a committee (although a better, and better designed committee) but my memory suggested (and the numbers seem to confirm) that there were also no market ructions when Don Brash resigned, in the days of the single decisionmaker model.

There were a few things worth noting in the numbers. First, the Reserve Bank expects much weaker GDP growth than the Treasury numbers released with the Budget last week (Treasury numbers finalised in early April)

and as a result, significant excess capacity persists for materially longer than in the Bank’s February forecasts

And I’m still not sure where the rebound (above trend growth reabsorbing all the excess capacity) is really supposed to come from, on their telling, given that the OCR is still above their longer-term estimate of neutral, and never drops below it in the projection period. Reasonable people can differ on where neutral is likely to be (when the OCR was last at this level, less than three years ago, the Bank thought neutral was nearer 2%, now they estimate close to 3%), but it is the internal consistency (or lack of it) that troubles me.

I had only two more points to make, one fairly trivial, but the other not.

The trivial one first. In the minutes there was this paragraph about the world economy.

I don’t have any trouble with the (“weak world”) bottom line, but two specific comments puzzled me. The first was that difference in tone in the commentary on fiscal policy in China and the US: one might use “sizeable fiscal stimulus” (with no negative connotations) and of the other (and much more negatively) “fiscal policy could place strains on the sustainability of its public debt”. It wasn’t at all clear that the MPC realises that China’s government debt is almost as large as the US’s, and as a share of GDP has been increasing (and is expect to increase) much more rapidly than that of the US.

In a similar vein, this chart from the recent IMF Fiscal Monitor suggests that on IMF estimates China is already in a deeper fiscal hole, needing more fiscal adjustment (% of GDP) than the US to stabilise government debt.

Of course, the rest of the world is much more entangled with US government debt instruments than with Chinese ones, but it was a puzzling line nonetheless.

I’m also at a loss to know quite what the MPC was getting at with the line about ‘the decline in the quality of macroeconomic institutional arrangements [was] likely to result in precautionary behaviour by firms and households’. Not only is it not clear what decline they are talking about – are the Fed and the ECB not still independent, and the PBOC still far from it, and fiscal policy seems to have been on its current track for some years (in multiple countries). Is Congress bad in the US? For sure, but it has been so for a long time. I guess it might have been the relaxation of the German debt brake they had in mind, but….probably not. I was also a bit unsure how all this was supposed to play out. If, for example, there was an increased perceived risk of government debt being inflated away, wouldn’t the rational reaction be to increase purchases of goods and services on the one hand, and real assets on the other to get in before the inflation? Private indebtedness tends to rise when interest rates are modest and inflation fears are rising. In the end, who knows what they meant. Which isn’t ideal. They should tell us.

The more important issue is the Reserve Bank’s treatment of fiscal policy, where the bad old ways of Orr were again on display yesterday, in ways that really should undermine confidence in the Bank’s analytical grasp (and, frankly, its willingness to make itself unpopular by speaking truth in the face of power).

In his press conference yesterday the temporary Governor was asked about the impact of the Budget on the projections and policy decisions. He noted that they were glad to have all the information but that really it hadn’t made much difference, noting that any stimulus from the Investment Boost policy was offset by the impact of spending cuts. This is made a little more specific in the projections section of the document (a small increase in business investment, and on the other hand “on net, lower government spending reduces inflationary pressure”).

Readers with longer memories may recall that this issue first came to light a couple of years ago. Until then, for many years, the Bank had presented the impact of fiscal policy on demand primarily through the lens of the Treasury’s fiscal impulse measure, which had originally been developed for exactly that (RB) purpose. The Treasury has made some changes to that measure a few years ago which, in my view, reduce its usefulness to some extent, but certainly doesn’t eliminate it. Treasury continues to present the numbers with each Economic and Forecast Update. The basic idea is that increased taxes reduce aggregate demand and increased spending increases demand, but (for example) some spending is primarily offshore and thus doesn’t directly affect domestic demand. It is a best approximation of the overall effects on domestic demand of changes in fiscal policy. You can have a positive impulse while running a surplus (typically, if the surplus is getting smaller) or a negative one with a deficit (typically, if the deficit is getting smaller). It is straightforward standard stuff.

And yet two years ago the Bank simply stopped talking about this approach and replaced it with an exclusive focus on government consumption and investment spending (ie excluding all transfers – a huge component of spending – and the entire revenue side). This sort of chart has appeared ever since

and, probably not coincidentally, projections of (real) government consumption and investment have been trending downwards over that entire period. (This was the same vapourware I referred to in Monday’s fiscal post, where both Grant Robertson and Nicola Willis have repeatedly told us – and Treasury – that future spending will be cut.).

Back when this started, I OIAed the Bank for any research or analysis backing this change of approach. Had there been any of course they would already have highlighted it. There was none. But the switch had allowed the Governor to wax eloquent about how helpful fiscal policy was being, even as by standard reckonings (Treasury, IMF, anyone really) that year’s Budget had been really quite expansionary, complicating the anti-inflation drive.

The temporary Governor – who is presumed to be seeking the permanent job – seems, whether consciously or not, to be engaged in the same sort of half-baked analysis that avoids saying anything that might upset the government. Yes, on the Treasury projections government consumption and investment spending are projected to fall. But what does the Treasury fiscal impulse measure show?

At the time of the HYEFU last December, the sum of the fiscal impulses for 24/25 and 25/26 fiscal years was estimated to be -0.47 per cent of GDP (with a significant negative impulse for 25/26, thus acting as a drag on demand). By the time of last week’s Budget, not only was the impulse for 25/26 forecast to be slightly positive (this is consistent with, but not the same as, the structural deficit increasing) but the sum of the impulses for the two year was now 0.7 per cent of GDP positive. Fiscal policy, in aggregate is adding to demand (and by materially more than estimated at the last update). And the incentive effect of Investment Boost on private behaviour is on top of that.

Absent some serious supporting analysis from the Bank or its temporary Governor for its chosen approach (focus on just one bit of the fiscal accounts), it looks a lot like an institution (management and MPC) that now prefers to avoid ever suggesting that the fiscal policy effects might ever be unhelpful. After all, all else equal a positive fiscal impulse reduces the need and scope for OCR cuts – and we all know (we see their press releases) how ministers love to claim credit for OCR cuts.

If there is a better explanation, they really owe it to us. If they aren’t any longer happy with Treasury’s particular impulse estimate, they have the resources to come up with their own. But there is no decent case for simply ignoring developments in the bulk of the fiscal accounts. Wanting the quiet life simply isn’t a legitimate goal for a central banker, and if Hawkesby continues with the dodgy Orr approach – and he has been part of MPC all along – it does call into question his fitness for the permanent job. It isn’t the Reserve Bank’s job, except perhaps in extremis, to be making calls on the merits or otherwise of the fiscal choices of governments, but they are supposed to be straight with us (and, by default, with governments) on the demand and activity implications of those choices. They aren’t at present.

The (deeply underwhelming) Budget

Michael Reddell Fiscal policy, Productivity

There were good things in the Budget. There may be few/no votes in better macroeconomic statistics and, specifically, a monthly CPI but – years late (for which the current government can’t really be blamed) – it is finally going to happen.

I went along to the Budget lock-up today (first time ever), mostly to help out the Taxpayers’ Union with their analysis and commentary.

At least from my (macroeconomist’s) perspective there were two areas to focus on when we were handed the documents at 10:30 this morning:

  • productivity and growth-oriented policy measures,
  • fiscal deficit etc adjustment

On the former, the government chose to title its effort today “The Growth Budget”. The Minister spoke today against a backdrop emblazoned repeatedly with that label.

You might remember that back in January the Prime Minister made a big thing of the need to accelerate growth in productivity and real incomes, not just on a cyclical basis. The Minister of Finance in announcing the Budget date in late January went further

They did not deliver.

There was a single growth-oriented initiative in the Budget; a provision under which firms will be able to write off 20 per cent of the cost of new investments in the first year, on top of the regular tax depreciation allowances. Whatever the substantive merits of the policy, the best Treasury estimate is that it will lift GDP by 1 per cent, but take 20 years to do so (the forecast gains are frontloaded, but even in five years time they reckon the level of GDP will have risen by only 0.5 per cent relative to the counterfactual). If that looks small, bear in mind that Treasury’s number seem to assume that this measure may actually worsen overall productivity as the Minister’s press release says they estimate the capital stock will rise by 1.6 per cent and wages will rise by 1.5 per cent (at her press conference she said this was because more people would be employed).

And that’s it. This in an economy where there has been no multi-factor productivity growth now for almost a decade (chart from Twitter this morning)

and, where as regular readers know, to catch up to the labour productivity levels of the leading OECD bunch (US and various countries in northern Europe), we’d need something like a 60 per cent increase in productivity.

It is simply unserious.

Things were no better on the fiscal side. Here, for today, I’m largely just going to rerun the notes I wrote for the Taxpayers’ Union and which are already in their newsletter

“This year’s Budget represents another lost opportunity, and probably the last one before next year’s election when there might have been a chance for some serious fiscal consolidation.  The government should have been focused on securing progress back towards a balanced budget.    Instead, the focus seems to have been on doing just as much spending as they could get away with without markedly further worsening our decade of government deficits.

“OBEGAL –  the traditional measure of the operating deficit, and the one preferred by The Treasury –  is a bit further away from balance by the end of the forecast period (28/29) than it was the last time we saw numbers in the HYEFU.   There will be at least a decade of operating deficits, and even the reduction in the  projected deficits over the next few years relies on little more than “lines on a graph” – statements about how small future operating allowances will be –  that are quite at odds with this government’s record on overall total spending.   Core Crown spending as a share of GDP is projected to be 32.9 per cent of GDP in 25/26,  up from 32.7 per cent in 24/25 (and compared with the 31.8 per cent in the last full year Grant Robertson was responsible for).   The government has proved quite effective in finding savings in places, but all and more of those savings have been used to fund other initiatives.  Neither total spending nor deficits (as a share of GDP) are coming down.

“Fiscal deficits fluctuate with the state of the economic cycle, and one-offs can muddy the waters too.  However, Treasury produces regular estimates of what economists call the structural deficit –  the bit that won’t go away by itself.   For 25/26, Treasury estimates that this structural deficit will be around 2.6 per cent of GDP, worse than the deficit of 1.9 per cent in 24/25 (and also worse than the last full year Grant Robertson was responsible for).   There is no evidence at all that deficits are being closed, and the ageing population pressures get closer by the year.

“Some things aren’t under the government’s direct control.   The BEFU documents today highlight the extent to which Treasury has revised down again forecasts of the ratio of tax to GDP (which reflects very poorly on Treasury who rashly assumed that far too much of the temporary Covid boost would prove to be permanent).  But, on the other hand, the forecasts  published today also assume a materially high terms of trade (export prices relative to import prices), which provides a windfall lift in tax revenue.  Forecast fluctuations will happen, but the overall stance of fiscal policy is simply a series of government choices.  Unfortunate ones on this occasion.

“A few weeks ago the IMF produced its latest set of fiscal forecasts.   I highlighted then that on their numbers New Zealand had one the very largest structural fiscal deficits of any advanced economy (and that we were worse on that ranking than we’d been just 18 months ago when the IMF did the numbers just before our election).  The IMF methodology will be a bit different from Treasury’s but there is nothing in this Budget suggesting New Zealand’s relative position will have improved.    We used to have some of the best fiscal numbers anywhere in the advanced world, but as things have been going – under both governments –  in the last few years we are on the sort of path that will, before long, turn us into a fairly highly indebted advanced economy, one unusually vulnerable to things like expensive natural disasters.”

With just a few elaborations/illustrations

First, here is the chart of tax/GDP

Even allowing for fiscal drag, quite how Treasury thought so much of the lift in tax/GDP was going to be more or less permanent is lost on me. They don’t really say.

Second, here is Treasury’s estimate of the structural (OBEGAL) balance as a per cent of GDP, showing recent years, and the forthcoming (25/26) financial year on the Budget announced today

The government seems to have become quite adept at rearranging the deckchairs (cutting spending that they consider low priority and increasing other spending) but they are choosing to make no progress at all in reducing the structural deficit. There were big savings found in this Budget, but none were applied to deficit reduction. Sure, the forward forecasts showing the structural deficit shrinking – never closing, even by 28/29 – but that is based on wishful “lines on a graph”, suggesting that the government intends to cut core crown expenses by a full 2 percentage points of GDP over the following three financial years, when on today’s forecasts expenditure as a share of GDP in 25/26 (32.9 per cent), will be a bit higher than in 24/25, and very slightly lower than in 23/24. The Ardern/Robertson government got by on 31.8 per cent in 22/23.

Finally, a reminder from Monday’s post

Depending on your measure we were (based on HYEFU/BPS numbers) worst or close to worst in the advanced world. Today’s Budget will have done nothing to improve that ranking. It should have.

The Budget is a lost opportunity, both on the fiscal and the productivity front. A couple of journalists at the lock-up asked for a summary label for the Budget. Some people had snappier versions, but mine was simply the “Deeply underwhelming Budget”.

Fiscal starting points

Michael Reddell Fiscal policy

Not that long ago, New Zealand’s fiscal balances looked pretty good by advanced country standards. Sure, the fiscal pressures from longer life expectancies were beginning to build – as they were in most of the advanced world – but in absolute and relative terms New Zealand still looked in pretty good shape.

Just a few months before Covid, in October 2019, the IMF published its half-yearly Fiscal Monitor, with the helpful cross-country comparative tables (whatever the merits of New Zealand’s own approach to measuring and reporting fiscal balances it doesn’t facilitate international comparisons).

This was how we’d compared with the median advanced country that year and the previous few.

Notes for this and several later charts:

  • “general government” (not central), the only meaningful basis for international comparisons
  • “primary” = ex interest (so reflecting current spending choices not legacy debt)
  • “cyclically-adjusted”, so looking through the state of the economic cycle. For Norway the data are not cyclically-adjusted (IMF only publishes cyclically-adjusted numbers for ex-oil Norway)
  • “advanced countries” = IMF classification for sovereign states (so ex Hong Kong), with Poland and Hungary added.

So under both National and Labour-led governments we were mostly running structural primary surpluses, and surpluses a bit larger than the median advanced country. Since our starting level of net public debt was lower than that of the median OECD country, using cyclically-adjusted overall balances our relative position was a bit stronger still.

Covid, of course, intervened, and in 2020 and 2021 most countries (including New Zealand) had really big fiscal outlays associated with supporting the Covid disruption to economic activity.

So fast forward to 2023. The Covid spending itself was by then a thing of the past.

The IMF released another Fiscal Monitor set of forecasts/estimates in October 2023 just a few days before our election (I wrote about the numbers here at the time). I’ve averaged the numbers for 2023 and 2024, but choosing either year individually wouldn’t make much difference. We now had among the larger structural primary deficits of any advanced country (again, the picture was a little less bad using the cyclically-adjusted total balance).

So that, as estimated by the IMF (who use national numbers for each country but do their own cyclical adjustment), was pretty much the situation the incoming government inherited at the end of 2023. They knew that New Zealand was estimated to have among the largest primary structural deficits advanced world – a choice (and it was pure choice) made by the outgoing government.

So what stance was taken by the incoming government in its first Budget this time last year? This chart is from the Budget Economic and Fiscal Update. Treasury’s own estimate of the structural deficit was that policy choices would widen the structural deficit for 24/25 slightly relative to the estimate for 23/24.

That wasn’t particularly surprising. There were expenditure cuts (and a tax increase) but there were also a number of tax cuts (much as had been promised by National in the election campaign).

Treasury estimates of the adjustments required to get to structural and cyclically-adjusted balance estimates can change with incoming data, but this chart was from last December’s HYEFU

There was still no sign of any improvement in the structural position, based on decisions already made (ie last year’s actual Budget as distinct from lines on a graph about possible future Budgets).

Which brings us to the most recent IMF Fiscal Monitor released a few weeks ago. This is how our cyclically-adjusted primary deficit now compares (for NZ, the IMF uses HYEFU/BPS information – they don’t impose their own guesses about fiscal policy itself): largest structural primary deficit among the advanced countries (and a far cry from the modest structural primary surpluses New Zealand governments ran – chose to run – last decade)

and here is the chart for the structural overall balance (ie including finance costs)

Not quite as bad, but still 4th largest deficits among advanced countries.

As I’ve shown previously, the net debt position is not yet particularly bad. Government debt as a share of GDP is still below that of the median advanced country, but that gap has been closing rapidly.

And one could add to the mix the repeated extension – by both governments – of the horizon for getting back to operating balance (currently, on the standard OBEGAL definition, both National and Labour seem agreed that 2029 is fine, at least until some other shock or pressure comes along).

It isn’t as if the financial markets are going to compel adjustment. If the net debt rises materially further a credit rating downgrade can’t be ruled out, but on its own that wouldn’t matter very much. It is more a question of our own choices and our own sense of fiscal responsibility and accountability.

Of course, there will be plenty of people – perhaps currently mostly on the political left – inclined to the view that if anything our governments should take on more debt. I’d largely agree with them that a somewhat higher level of debt is not likely to either raise interest rates very much or dampen potential GDP growth very much. My aversion to higher public debt is more about the demonstrated weakness of the political process in too many countries – not so much in New Zealand for a couple of decades, but again apparently now. It is easy to promise nice-to-haves (and both main parties have been guilty of this in recent years) when you don’t have to go to the voters and ask them for higher taxes now to pay for the handouts. Much more honest that if you want to increase (structural) spending – new or more expensive programmes – to raise taxes to pay for it. Failing to do that risks taking our country the way of places like France, the UK or the US – even before the demographic pressures really up the ante.

What will we see in the Budget? We’ll see I guess, but the Minister of Finance has announced a cut in the operating allowance for 24/25. That is no doubt fine and good, but relative to the scale of the structural imbalances – see charts above – it is pretty small beer, enough only to improve our ranking in those IMF charts by one place. Perhaps the Treasury’s estimation of cyclically-adjustment will have changed – for better or for worse – but we seem a long way from where we should be. And having chosen not to adjust last year, and with the three-party coalition chasing re-election next year, this year’s Budget was perhaps the only real hope left this term for getting back on fiscal track. To be sure, economic activity at present appears pretty weak, but a well-signalled tougher fiscal adjustment would normally be expected to be met by a looser-than-otherwise monetary policy (rather than further weakening economic activity). That, it seems, is not to be.

(The Opposition, of course, seems to differ only on the mix, not the extent of the fiscal imbalance they created and bequeathed, or the speed – sluggish at very best – with which it should be dealt with.)

But no doubt we will all be looking forward to the “bold” steps to lift economic growth etc

Bad advice on public sector discount rates

Michael Reddell Fiscal policy

A couple of months ago now I wrote a post about the new set of discount rates government agencies are supposed to use in undertaking cost-benefit analysis, whether for new spending projects or for regulatory initiatives. The new, radically altered, framework had come into effect from 1 October last year, but with no publicity (except to the public sector agencies required to use them). The new framework, with much lower discount rates for most core public sector things, wasn’t exactly hidden but it wasn’t advertised either.

My earlier post (probably best read together with this one) was based largely around a public seminar Treasury did finally host in February, the advert for which had belatedly alerted me to this substantial change of policy approach (and sent me off to various background documents on The Treasury website).

As a quick reminder, discount rates matter (typically a lot), as they convert future costs and benefits back into equivalent today’s dollars (present values). The discount rate used makes a big difference: for a benefit in 30 years time discounting at 2 per cent per annum reduces the value by almost half, while converted at 8 per cent the present value of that benefit is reduced by almost 90 per cent.

Until last October, projects and initiatives were to be evaluated at a 5 per cent real discount rate – rather lower than the rates historically used in New Zealand, but not inconsistent with the record low real interest rates experienced around the turn of the decade (recall that the discount rates did not attempt to mimic a bond rate, but took account of the cost of both debt and equity).

The new framework, summarised in a single table, is

and in case there was any ambiguity about where the focus now lay, not only was the non-commercial proposals line listed first but the circular itself made it clear that the non-commercial rate(s) were likely to be the norm for most public service and Crown entity proposals.

In the earlier post I outlined a bunch of concerns about this new approach, both around the substance and what it might mean for future spending (and, for that matter, regulatory) pressures, and around what appeared to have been quite an extraordinary process, with no public consultation at all. Treasury officials at the seminar had, however, assured me that it had all been approved by the Minister of Finance, which frankly seemed a little odd given the (then) new government’s rhetorical focus on rigorous evaluation of spending proposals etc.

Anyway, I went home and lodged an Official Information Act request with The Treasury. They handled it fairly expeditiously but it took me a while to get round to working my way through the 100+ pages they provided. This was the release they made to me

Treasury OIA re Public Sector Discount Rates March 2025

and this was their advice to the Minister of Finance, already released but buried very deep in a big general release on a range of topics.  I’ve saved it here as a separate document.

Treasury Report: Updates to Public Sector Discount Rates 30 July 2024

None of the released material allayed any of my concerns. In fact, those concerns are now amplified, and added to them is a concern about the really poor quality, and loaded nature, of the narrow advice provided to the Minister of Finance on what can be really quite a technical issue but with much wider potential political economy implications. There was an end to be achieved – officials were keen on lower discount rates – and never mind a careful. balanced, and comprehensive perspective. It was perhaps summed up in the comment from one principal adviser who noted “I get a bit lost on the technical back and forth on SOC vs SRTP” but “I support moving to 2%”.

Somewhat amazingly, even though all the documents talk about how a change of this sort really should have ministerial approval – this is even documented in the minutes of The Treasury’s Executive Leadership Team meeting of 12 March 2024 – in the end all they did was ask the Minister to note the change they (officials) were making. All the Minister was asked to agree to was process stuff around the start date and future reviews. I’m surprised that there seems to have been no one in her office – her non-Treasury advisers, who in part are supposed to protect busy and non-technical ministers from officials with an agenda – who appears to have appreciated the significance of what was going on or thus to have triggered a request for more and better analysis/advice. Or even, it appears, to have raised questions about what was behind the comment in the Consultation section of the paper that “To manage risks of raising external expectations and a risk of prolonged debate, we have not consulted publicly”. Were there perhaps alternative perspectives then that the Minister should have been made aware of? (The only people consulted were other public sector chief economists – whose agencies will typically be keen on getting project evaluation thresholds lowered – and a few handpicked consultants.)

What became more apparent in the papers was that this entire project had got going under the previous government (Labour, but with Greens ministers) when the Parliamentary Commissioner for the Environment had suggested in 2021 that public discount rates should be reviewed with a view to adopting a model that would discount future benefits (relative to upfront costs) less heavily. Treasury had undertaken in 2022 to the (then Labour majority) select committee that they’d do a review. Things seemed to get their own momentum from there, and nothing about either a change in fiscal circumstances – back in 2021/22 even Treasury was keen on spraying public money around – nor a change in government seems to have prompted a pause. Had the new Minister of Finance, or her office, been more alert to the implications, perhaps they’d have called a halt to the work programme (but on this occasion I’m reluctant to put much blame on the Minister, as she appears to have been so badly advised by The Treasury).

The only advice the Minister of Finance appears to have been provided with is the short paper linked to above. It has just over two pages of substance (the rest is process, plus a four page technical appendix – which I’d imagine that, for a noting recommendation only, a busy – and non-technical – minister would not normally read).

It is striking what the Minister is never told:

  • there is no mention in the paper that the practical implication of the new approach Treasury was planning to take was that most public sector projects and proposals would be evaluated primary at a 2 per cent real discount rate rather than the (standard) 5 per cent rate previously.  They mention that the SOC-based rate is being increased, in line with the increase in bond rates, but never that this discount rate will no longer be used much.
  • there is no attempt in the paper to the Minister to explain, or justify, the new approach under which discount rates for years beyond year 30 would be evaluated at even lower discount rates still (there are arguments for and against, but none of it is mentioned and nor are the implications drawn to the Minister’s attention).
  • they note the distinction that one rate will be used for commercial projects and one for non-commercial things, but offer no analysis or advice on either why such a distinction should be introduced or how, either conceptually or practically, the two would be distinguished (they promise they would develop future guidance, but this still appears not to have been done). 
  • they never draw the Minister’s attention to the fact that one can evaluate projects at any rate one chooses but that it does not change the fact that there is a real cost –  in debt and equity finance – which isn’t a million miles away from the Social Opportunity Cost (SOC) approach they were planning to move away from.    Projects that passed a cost-benefit test at a 2% (or 1%) discount rate but failed to do so using an 8 per cent rate would, if approved, simply be being subsidised by taxpayers. 
  • they never drew to the Minister’s attention that they were planning to leave the rate of capital charge at 5 per cent, now inconsistent with either approach to discounting and project evaluation  

There is also no engagement with some of the conceptual issues raised by what Treasury was planning. This is from my previous post

It is all very well for Treasury to say that every proposal will have to have numbers presented with both a 2% and 8% discount rate, but if they cannot answer simple questions like these (or alert the Minister to them) then all they’ve done is introduced a pro-more-spending muddled model.

Perhaps most breathtaking was the bold claim (offered with no supporting analysis at all) that “The updated discount rates will not change the dollar volume of spending, since individual spending proposals will continue to be prioritised within a budget constraint (fiscal allowances).”

It is the sort of claim that if a first year analyst had made you might take them aside and explain something about incentives, political economy, and what was and wasn’t fixed in the system. This paper was written and signed out by a highly experienced Principal Adviser and a highly experienced Manager, and the policy had been signed off by the entire Executive Leadership group.

Never once it is pointed out to the Minister that budget allowances (whether capital or operating) are hardly immoveable stakes in the ground, enduring come hell or high water from decade to decade. (Why, this very morning, the operating allowance for this year was altered again). Or that the overall effect of what Treasury was planning to do would mean that more projects (spending proposals) and more regulatory initiatives would pass a cost-benefit test and show a positive net present value. And that while, in any particular year, an operating allowance might bind (so that only – at least in principle – the most highly ranked projects (in NPV terms) would get approved, over time if more projects and regulatory proposals showed up with positive NPVs the pressure would be likely to mount – whether from public sector agencies or outside lobby groups – for more spending and more regulation. (In fact, Treasury never even pointed out the operating allowance is a net new initiatives figure and higher taxes can allow higher spending even within that self-imposed temporary constraint.) And that even if a National Party minister might pride herself on her government’s supposed ability to restrain spending, time will pass, governments will change, and future governments that are predisposed to spend more will hold office. Sharply lowering discount rates – to miles below the actual cost of capital – was just an invitation to such governments. It seems like fiscal political economy 101…..and yet not only is this issue not touched on in the advice to the Minister there is no sign of it in any of the other documents Treasury released to me. You wouldn’t get the sense at all either that the fiscal starting point was one in which New Zealand now had one of the largest structural deficits in the advanced world, with even a projected return to surplus years away.

Treasury seems to have just wanted lower discount rates.

You get this sense in this extract from that short paper to the Minister

Goodness, we wouldn’t want anyone debating the appropriate discount rate would we, so let’s just render it moot by moving to an extremely low rate (in a country with a historically high – by international standards – cost of capital). Or, we don’t anyone fudging their cost-benefit analysis – but isn’t Treasury supposed to be some of gatekeeper and guardian of standards – so we’ll just make it easy and slash the discount rate hugely. And as for that claim that a 5 per cent discount rate – miles below any credible estimate of cost of capital or private sector required hurdle rate of return – incentivises decisionmakers to focus on the short-term, there is no serious (or unserious) analysis presented to the Minister suggesting this was in fact so (that lots of projects with compelling cases were missing out), nor any attempt to suggest that capital is in fact costly, and that when it is costly there should be a high hurdle generally before spending money that has payoffs only far into the future.

There is, you should note, no corresponding paragraph outlining the incentive effects and risks around what Treasury was planning to do.

There was a time when you could count on The Treasury for really good and serious policy advice. If this paper is anything to go by, that day is long past. Changes of this magnitude should have been done only with the Minister’s explicit approval and should probably only have been done after serious and open public consultation. And the Minister was entitled to expect much better, and less loaded, advice than she received on this issue, where what Treasury was planning ran directly counter to the overall direction of the government fiscal policy and spending rhetoric. The Minister herself probably should have had better and more demanding advisers in her office, but really the prime responsibility here for a bad, muddled and ill-justified change of policy rests with The Treasury.

(And in case you think I’m a lone voice in having concerns, here is a column from a former very experienced Treasury official who had considerable experience in these and related issues)

[Further UPDATE 21/5. Consultant and former VUW academic Martin Lally has added his concerns on the substantive issues in two posts here

https://nzae.substack.com/p/social-rate-of-time-preference-lally-one

https://nzae.substack.com/p/social-rate-of-time-preference-lally-two ]

A pre-Budget speech

Michael Reddell Fiscal policy

In a pre-Budget speech this morning the Minister of Finance announced that this year’s operating allowance – the net amount available for new initiatives – was being reduced from $2.4 billion to $1.3 billion (speech here, RNZ story here). Operating allowance numbers in isolation don’t mean a great deal (what happens to the rate of general inflation matters a lot) but a cut like that, at the very end of the Budget process, can probably be taken at face value. On its own, it is equivalent to about a quarter of a per cent of GDP.

Readers will recall my post last Thursday presenting the IMF’s Fiscal Monitor numbers, which show New Zealand being expected to have the largest general government primary structural deficit this year of any advanced economy. Cutting spending by $1.1 billion will, all else equal, probably shift the New Zealand government to having the second largest advanced country deficit.

If the headline sounded encouraging, reading the full text of the speech left me less encouraged.

First, it sounds as if more handouts are still part of the plan.

And second, although there is talk of a “significant savings drive” freeing up “billions of dollars”

there have been no announcements of things the government is going to stop spending money on, or of agencies/departments it is just going to close down. I guess it is still a few weeks until the Budget itself so perhaps something is coming, but there isn’t even a taster in this speech.

And third, it seems pretty clear from the speech that this operating allowance cut is mostly about avoiding yet another fiscal update in which the date for a return to operating surplus is pushed back yet again.

And note that the small surplus Treasury projected for 2028/29 was on the Minister’s slightly dodgy new ex-ACC measure of the operating balance (one that The Treasury did not endorse). On the more usual operating balance measure, HYEFU showed 28/29 as the 10th year in succession of deficits. From what the Minister said this morning, that is likely still to be the case in the BEFU numbers.

I’m not going to object to the cut to the 25/26 operating allowance – which is a policy lever chosen by the Minister, not something for Treasury to “forecast” – but without specifics we might reasonably be sceptical about the durability of the cuts.

Late in the term of the previous government, the then Minister of Finance was solving his problems with forecast fiscal outlooks by telling Treasury he’d stick to low operating allowances in future years. Willis seemed to be doing something a bit similar last year (Treasury noting the tension between inevitable cost pressures and those headline numbers they are required to use, as advised by the Minister). That really was vapourware. This year’s cut is likely to have more substance to it, since it will directly affect appropriations for the 25/26 financial year.

But without specifics on what the government is going to stop doing or paying for, there has to be a bit of a suspicion that what is effectively going on is across the board (real) cuts, with no real idea as to what the impact or opportunities for durable savings might be. This was the second item in the Minister’s three-point list.

But we already had one round of generalised savings last year. After the approach of the previous government it was always likely that most agencies would have some fat to cut (while still delivering things the government says it wants/needs). Whether that is still the case must be an open question. No doubt agency CEs – under tighter fiscal rules than, say, the Reserve Bank (see last week’s post) – will ensure that their departments stay within their budget, whatever it is set at. But at what point do inroads start being made in capability? It certainly isn’t as if economywide productivity growth is running at 2 per cent per annum.

It would all be a great deal more reassuring if there were specific announced things the government was no longer going to do. But, for example, all the subsidies in the system still seem to be continuing.

And finally, a reminder of the starting point. In my post last week I included this chart

As a reminder, this used the 2024 HYEFU and 2025 BPS as the base for the New Zealand fiscal data.

When I was writing that post last week I remembered writing some similar critical pieces in the run-up to the 2023 election, where the numbers were based on the then Labour government’s stated fiscal plans. The October 2023 IMF Fiscal Monitor came out just a few days prior to the election. This was the same chart – for structural primary balances – for 2024, as published in that edition.

In relative terms, we had the 5th worst structural deficit forecast then and have the worst now (maybe second worst with this morning’s announcement). In absolute terms, the IMF’s October 2023 estimate of the structural primary deficit for 2024 was 3.4 per cent of (potential) GDP. Last week’s new IMF estimate for the structural primary deficit for 2025 was 3.7 per cent of (potential) GDP.

To repeat a point from last week’s post, these are not operating balance measures but rather encompass all (non-interest) spending and revenue. The lines between opex and capex are often very blurry and malleable in government accounts, and not only does it often make sense to look at overall primary balances rather than operating ones even when looking at just your own country, it is only way in which meaningful cross-country comparisons can be done.

The fiscal bottom line still appears to be that things are no better, in structural cyclically-adjusted terms, than they were 18 months ago, and may even be worse. We should no doubt be thankful for small mercies – this morning’s announcement may be one – but the outstanding imbalances are large and do not yet seem to being addressed seriously. Those imbalances are bad, both absolutely and in international comparison terms. They are political choices. Unfortunate ones.

Fiscal failure

Michael Reddell Fiscal policy

The IMF’s twice-yearly World Economic Outlook and Fiscal Monitor publications have come out in the last couple of days.

If there is gloom in the GDP numbers (eg this chart for the advanced countries, and we don’t score a lot better on the comparable one for the 2019 to 2025 period which encompasses the whole Covid and inflation/disinflation period), much about that is outside the direct or near-term control of any particular government.

My focus was on the fiscal numbers. We already know, from the published Treasury forecasts, that New Zealand’s fiscal position doesn’t look good. Last year’s Budget slightly widened an already uncomfortably large (estimated) structural fiscal deficit.

But the great thing about the IMF publications is that they enable meaningful cross-country comparison, something that is quite impossible just with what Treasury produces for New Zealand. (If The Treasury was seriously committed to improving debate and analysis on fiscal issues in New Zealand they would start routinely producing estimates for New Zealand in an IMF format, alongside their own preferred New Zealand format.)

I put this chart on Twitter this morning, and it appears to have caught some attention. You can see why that might be.

(For the selection of countries I’ve used those of the IMF advanced country grouping for which there are numbers – that excludes, notably, Taiwan and Singapore – omitting Norway (where the IMF reports only ex-oil numbers, which aren’t reflective of the overall state of Norwegian public finances) and adding Poland and Hungary. Poland, in particular, is now about as well off – in real GDP per capita terms – as New Zealand.)

I regard this as the best core measure of flow fiscal imbalances.

In interpreting the chart, however, there are a few points worth making.

First, it is a measure of “general government” not just central government. That is the only sensible basis for international cross-country comparisons. In New Zealand, local government is small relative to central government so the numbers are dominated by central government choices.

Second, the IMF states that they do their New Zealand fiscal projections based on the December 2024 HYEFU and the 2025 Budget Policy Statement. They have an independent set of macroeconomic projections and then recast the New Zealand fiscals into their internationally comparable format. They are not taking an independent view on what the government will or won’t do with fiscal policy in next month’s Budget (and are also not taking account of recent defence spending commitments).

Third, this is a measure of the primary deficit (ie excluding net interest) not the overall balance. Some countries have a large stock of outstanding public debt which they are stuck paying interest on (the US is a good example). That interest is, of course, part of the overall deficit, but it is a reflection of past choices. The primary balance is a reflection of current policy choices. As a general rule of thumb, if a country is running a primary surplus, pretty much however small, that country’s fiscals will eventually come out okay. If not, course corrections are necessary.

Fourth, the IMF numbers are presented on a calendar year basis but the New Zealand fiscal year ends on 30 June. The IMF appears to move New Zealand numbers six months forward (thus they show a significant primary deficit in 2019, which was probably capturing New Zealand outcomes for the year to June 2020. Thus the 2025 numbers shown in the chart above probably already capture what the Minister of Finance has told us she is going to do, in aggregate, in next month’s Budget.

Fifth, the series is cyclically-adjusted. Booms and busts – economies running temporarily above or below capacity – do not, at least in principle, affect this particular series. The IMF estimates (like the Reserve Bank) that New Zealand has a negative output gap in 2025 (while, say, the United States in these projections has a positive one).

Sixth, it is not a measure of the operating balance (the focus of New Zealand domestic analysis and commentary) but of the overall (primary) fiscal balance. Most countries don’t use an operating balance measure, so it can’t readily be used for international comparisons. Total balances (operating and capital spending) can make more sense for fiscal analysis as the line between operating and capital expenditure is pretty blurry for government. In a private business, capex is intended to generate (net) revenue, but that isn’t often the case with government capital expenditure – even if, which can’t be assumed, that capex passes some overall cost-benefit test.

Taking all that into account – which clearly wasn’t going to fit in my original tweet – what should we make of the chart, which shows New Zealand estimated to have the highest cyclically-adjusted primary deficit of any advanced economy this year?

First, it didn’t used to be so. The IMF table I drew from only goes back to 2016 but the comparison over time looks like this

We used to be better than the average advanced economy. Once upon a time, not so long ago. But not now. We also had the large primary deficit of this group of countries in 2023 and 2024 and were second largest in 2022. (In fact, when I looked at the IMF’s table of this series for “emerging market and middle income countries” still the only countries with a larger primary deficit than New Zealand for 2025 are China and Romania. Ukraine probably is too – the estimates aren’t there for 2025 – but then being invaded by your neighbour probably counts as a decent excuse.)

There can be a case for cyclically-adjusted (or structural) primary deficits, even large ones. Wars, for example, are often financed by a mix of debt and taxes. Pandemics can be another example – big disruptions to output and activity almost from out of the blue – and so no one really quibbles much over primary deficits in (calendar) 2020 and 2021.

But we don’t face a war or a pandemic. Our politicians – first Labour and now the National-led coalition – have simply chosen to run large primary deficits. Structural deficits – primary or otherwise – don’t arise from nowhere, and they certainly aren’t fixed by sitting by and hoping for something to turn up (they also aren’t fixed by – as in last year’s Budget – cutting spending and adding a new tax and using the proceeds to cut other taxes, leaving structural deficit measures little changed (slightly wider on The Treasury’s estimate)).

In case you are wondering about the overall structural balance picture, here is that chart

We don’t have the largest overall structural deficit among advanced countries, but there aren’t many worse than us.

And we are heading in the wrong direction.

Much of the commentary on New Zealand emphasises that our net general government debt is still relatively low as a share of GDP. But that picture is changing quite fast.

The US (98 per cent) and UK (95 per cent) used to be – and in my memory – relatively low debt countries too.

These New Zealand structural fiscal deficits aren’t some consequence of Covid but a series of choices to act, and not to act, by both governments in succession. It is on the current government’s stated intentions for the second of its three Budgets that we are estimated to have the largest cyclically-adjusted primary deficit among advanced countries.

It is a far cry from the laudable record of fiscal management – again under governments of both main parties – that we enjoyed not so long ago at all. At least back then when we had feeble productivity growth and weren’t closing the gaps on the rest of the advanced world we had an enviable record of fiscal stewardship. These days, productivity and real GDP per capita growth is lousy, and we are running big deficits and rapidly increasing debt.

It is a choice, but it is a bad one.

And since we know The Treasury estimates that we have a fairly large structural operating deficit, that judgement (“a bad one”) holds true even if, as perhaps they would claim, the level of general government capital expenditure was all passing robust cost-benefit tests on credible discount rates.

Really?

Michael Reddell Fiscal policy, Treasury

A few weeks ago an invitation dropped into my email inbox to attend a joint Treasury/Motu seminar on recent, rather major, changes that had apparently been made to the discount rates used by The Treasury to evaluate proposals from government agencies.

It was all news to me, but when I went over to The Treasury’s website I found that the new policy had come into effect on 1 October last year (relevant Treasury circular here) and that the work on this major policy change had apparently going on for a long time, dating back to the days of the previous government (the two consultant reports are both dated June 2023). All the papers Treasury has released are here (I have also now lodged an OIA request for other relevant papers, including advice etc to current or former Ministers of Finance).

The new discount rates are shown here

This is a dramatically different model than what had been used until now, when all projects were required, as a starting point, to be evaluated using a 5 per cent real discount rate.

I have read all the papers The Treasury released and went along to the seminar on Monday, and came away even more troubled – about both the public policy and analytical dimensions – than I had been initially. Why, you might ask, should commercial projects be evaluated at dramatically different rates than non-commercial projects? Who is going to decide what counts as “commercial” and what as “non-commercial” (and should so much hang on what must, at the margin at least, be something of a line call)? And why would a change of this magnitude, which will materially affect advice going to ministers across the whole of government have been done with no public consultation whatever (and Treasury confirmed to me that this had indeed been the case, and that such consultation as there had been had only been with other government entities)?

But, first, those acronyms: SOC (social opportunity cost) and SRTP (social rate of time preference). Under certain restrictive conditions these two things should be the same, but estimates of them are rarely even close. There is a vast literature on this stuff, going back many decades.

Here is how The Treasury describes the two approaches

There is quite a bit of (questionable) editorial in these descriptions, but the gist is fine: SOC is designed to capture the cost to “society” of funding some public sector proposal (funds could be used for other purposes and projects by firms or individuals), while SRTP attempts to capture how much current consumption “society” (however represented) is willing to give up in exchange for more future consumption.

For decades, Treasury has used a SOC-based approach here, and in my view were right to do so. Of the other countries shown in the various reports, it seems that a majority also use the SOC approach while a small group of European countries used a SRTP approach.

Treasury and their consultants all seem to agree that on straightforward commercial projects, the SOC approach is the only sensible one to take. To do anything else – to use a materially lower discount rate – would be to skew the playing field in favour of the government investing in commercial projects that the private sector could do just as well. In that sense, moving to an 8 per cent real discount rate for unquestionably commercial projects is a step in the right direction (although I suspect that even at 8 per cent, the discount rate is likely to be lower than the hurdle rates of return required by many/most private sector companies in deciding on investment proposals).

A common argument that claims this is okay is based on the fact that government bond yields are typically lower than those for corporate bonds. I’ve long thought (and written about here) that that is a deeply flawed argument, because a key reason government bond yields are lower than those of private sector securities (no matter how large the corporate) is that government’s ability to pay is secured on the coercive power to tax, and that risk (to us, as taxpayers) needs to be priced in evaluating proposals to spend public money. All the more so when one realises that the likelihood of draconian tax increases to meet government obligations is probably pretty strongly correlated with adverse economic circumstances in the wider economy (and thus for the ability of taxpayers to comfortably pay). I’ve also long been uneasy about the idea that public sector proposals should be evaluated at rates that are probably below private sector hurdle rates because of the utter absence of market disciplines government agencies and politicians as decisionmakers face. When people who face no market disciplines want to take our money – tax now, or via debt – and use it on long-term projects, it seems not unreasonable that their schemes should be evaluated on at least as demanding a basis (but ideally more demanding) as private commercial entities do. After all, it is a pretty widely-accepted stylised fact that cost over-runs and execution failures are more the norm than the exception in major public projects in New Zealand (not only New Zealand of course). Remarkably, in none of the Treasury papers nor in the seminar on Monday was there any mention of incentives and disciplines: government failure was all but unknown in a land of benevolent and wise social planners.

But commercial projects (ones that are clearly so) are the easy bit of all this. The latest change was at least a step in the right direction. And the Treasury circular is clear that

The real problem arises in respect of the “non-commercial proposals”. You will look in vain in the Treasury Circular for any official justification for using such wildly different discount rates for the two types of proposals, with the far lower discount rates for those proposals that – almost by assumption – are subject to fewer market-type tests and greater uncertainty (including about specifying benefits and objectives). It will be interesting to see how The Treasury framed advice on this issue to the Minister of Finance. One hopes they mentioned that even so-called non-commercial projects have an opportunity cost – a real burden on taxpayers whose money could be used for other things.

Now, in fairness, the background papers briefly mentioned some arguments (including suggestions that future generations are not represented in today’s market prices, but may be represented by a benevolent government decisionmaker – although it is never clear why (eg) families are less likely to internalise interests of future generations than governments, the latter being individuals facing re-election every three years, and no effort is made to evaluate the actual demonstrated interest in or ability of past or present governments to effectively represent those interests). However, the main paper Treasury cites, that by academic economist Arthur Grimes, has just three recommendations at the end, and not one of them is for anything like this stark (although he notes that “long-term payoffs to projects for which the populace is likely to have a lower rate of pure time discount compared to that for generalised consumption could have a lower [social discount rate] than the default rate….This proposal…is one which warrants further investigation). Grimes was a little sharper in his slides on Monday, but even then his proposal was only for lower discount rates for “some non-market activities” (and quite whose preferences were to guide the choice of “some” wasn’t clear).

What that 2 per cent discount rate for non-commercial proposal does is to ignore the actual opportunity cost of funds (that 8 per cent, or more) and preference – in ranking possible proposals for using scarce societal resources – non-commercial proposals (that generally won’t cover the social cost of capital) over commercial ones. And that is quite regardless of the character of the individual non-commercial proposal, a category that even in concept covers a vast array of possibilities. It is really quite extraordinary, and perhaps all the more so to see it adopted by this government, which came into office focused (at least rhetorically) on low quality government spending, the rapid run-up in debt under the previous government. (I had been unsure until Monday whether these policies had simply been adopted by Treasury, but I was assured by Treasury officials that they had in fact been signed off by the current Minister of Finance).

Now, to be clear, there are some caveats. First, discount rates aren’t everything. All too often cost-benefit analyses have simply been ignored, even when done. And if one looked at the table of discount rates used in other countries that was presented on Monday, the only country using a lower discount rate than the New Zealand 2 per cent is Germany – a country that many of the great and good think does far too little government capital spending (their debt brake – a very sensible initiative in my view – acts as a constraint presumably). In a New Zealand context, simply changing discount rates won’t of itself get more projects off the ground.

But both operating and capital allowances are fluid over time – they are no sort of anchor – and there is no real debt constraint at all. What the change to discount rates will do is make many more non-commercial projects look to pass a cost-benefit assessment, creating pressure from interested parties on governments to raise taxes or take on more debt “because, you can see, so many good projects just aren’t being funded”. And going by the mood of the room on Monday – most attendees seemed to be public service affiliated – many officials will think that just a fine thing indeed (there were people getting up and thanking Treasury for making this change, which would make such a difference to their preferred types of schemes). What was the Minister of Finance thinking when she signed this off?

Especially as the entire thing seems like an indeterminate muddle.

First, there is this table from the Treasury circular, designed to assist agency CEs and CFOs in doing their cost-benefit analyses.

So things that politicians or officials happen to think are good for people (“merit goods”) – whether we value them or not – get evaluated at a much more favourable (lower) discount rate than other stuff. But even setting points like that aside, one is left with more questions than answers. Take schools for instance. Most are provided directly by the state with no charge at point of use, but not all are, and there is no technical reason why a quite different operating model couldn’t be chosen. Same goes for health and hospitals. Are they “commercial” or “non-commercial”? How will Dunedin hospital – a long-lived capital project – be evaluated (if at all)? Does a different discount rate get used if a PPP is involved (see final item in the “commercial” column), than if the government provides the finance directly? And if so, why? And “social housing” is in the right hand column, even though housebuilding and rental operations are directly amenable to commercial models (perhaps with income subsidies to poor users). One could go on.

I asked about some of these specifics at the seminar on Monday, and got no better than handwaving answers, along the lines of “well, we don’t really know, but time and experience will tell”. It was pretty breathtaking really, but then I came home and reread the official circular and that was more or less exactly what they’d told agencies too. It was there in the text above that table, and also in this “The Treasury may publish further guidance as we gain experience with the new PSDRs.”. May…..how helpful.

Now again, to be fair, the circular notes that agencies will be required to stress test proposals by presenting evaluations done at both high and low discount rates. And there will be plenty of public sector proposals where it may not make much difference (where the costs and benefits are both substantially spread through time), but for anything with a major long-lasting capital commitment (think infrastructure) the difference will be enormous. And there is just no guidance, either to agencies, or to enable the public to have a sense of how proposals are likely to be evaluated by officials.

But in case you were thinking that surely not too much would be done at 2 per cent, there was this final guidance to agencies

That is pretty much everything central government actually does.

The whole thing is rendered even more unsatisfactory by this note at the end of the Treasury Circular

If the social cost of capital estimate is 8 per cent real – per this new guidance – it is hard to see any decent basis for keeping the capital charge rate, which incentivises agencies to use scarce capital prudently, at 5 per cent. And whatever the capital charge rate is set at – 5 or 8 per cent, or something higher still – our Minister of Finance and Treasury are happy to evaluate almost all central government department proposals at a discount rate of 2 per cent, far below our cost of capital to enable and fund such activities. I’m happy to agree that there are probably a handful of things that might appropriately be evaluated at below the cost of capital, but….they are few indeed (and probably contentious across different groups in society). And the approach Treasury and the Minister have taken just increases the risk of more uneconomic proposals being adopted over time, with more of a bias towards proposals where there are fewer solid external benchmarks. That seems less than ideal, especially in a government that touts its commitment to “turbocharging” economic growth and productivity.

(I’m also not really persuaded by the case for generally declining discount rates on all non-commercial projects, especially beginning at such a short horizon (30 years, which seems to be shorter than those other countries that adopt this approach), but it would be largely irrelevant if these projects were being evaluated at discount rates nearer the cost of capital.)

Finally, in a country where so much is subject to public consultation, what possible grounds were there for moving ahead on a change of such (potential) magnitude with no wider consultation whatever?

The Secretary to the Treasury defending govt fiscal policy

Michael Reddell Fiscal policy, Treasury

I wasn’t envisaging writing anything more for a while, but….Welllington’s weather certainly isn’t conducive to either the beach or the garden, and the Herald managed to get an interview with Iain Rennie, the new Secretary to the Treasury (not usually the sort of stuff for 27 December either).

I’ve always been rather uneasy about heads of government departments doing interviews, on anything other than operational/internal matters for which they have specific personal responsibility. When they get onto policy it is never quite clear whether they are expressing their own views or championing those of the minister, and even if the former they are inevitably somewhat constrained by the views and tolerances of the minister. The primary responsibility, after all, of heads of policy agencies is provision of free and frank policy advice to the minister.

Rennie does a bit of self-promotion, claiming that he is the sort of “change agent” the Minister of Finance has asserted that she wanted, and that he is at his best reforming things. I guess time will tell on the former claim – although count me sceptical – but his previous years in senior positions (Deputy Secretary at Treasury, State Services Commissioner) weren’t exactly known for being a reforming era, and it wasn’t obvious that he was an exception to that. And he was responsible for the appointment and reappointment of Gabs Makhlouf, who took Treasury in more of self-indulgent direction than one driving forward hardnosed and rigorous policy advice.

He claims to be keen on The Treasury being more upfront and public about its view on possible reforms. I’m not sure that’s wise – hardly likely to strengthen effectiveness with the Minister when, as is inevitable at times, those views are very much at odds with those of the government – but I guess that is their call. Lets see, for example, what they come up with in the Long-term Insights Briefing they are required to produce next year. In any case, Rennie – creature of the 80s/90s Treasury – claims to be keen on more means-testing. Views will differ of course, but it has its own problems (especially once done across multiple programmes) and the last attempt to apply it to retirement income provisions did not end well.

He also touched on tax. There is some ambiguity about that second para, but I take it that he is advocating taxing capital income at a lower rate than labour income. If so, he’d have my full support, but championing it in public is going to buy quite a fight – even with a notionally centre-right government that has just increased business taxation and shows no inclination at all to do anything about one of the highest company tax rates in the OECD.

But the real reason for this post – and the reason why I phrased the title of this post as I did – is Rennie’s apparent complacency on fiscal policy: it could have been channelling Willis. There is, we are told, no hurry to close the structural fiscal deficit

“That’s why I’ve been very clear that fiscal consolidation will need to happen over a number of years.”

We didn’t get into a structural deficit “over a number of years” (but quickly), we’ve now been running one for more than a few years, nothing done this year reduced the deficit, and on the government’s own projections any return to fiscal balance is still several years away. And this is in a country that was running surpluses less than five years ago (the first – and mostly necessary – Covid splurge was March 2020). Core Crown operational spending this year (24/25) is almost six percentage points of GDP higher than it was in the last full pre-Covid year (18/19).

Now, it is certainly true that not all reforms can be done overnight, but that doesn’t mean that fiscal adjustment couldn’t – and shouldn’t – be done a great deal faster than either Robertson or Willis have been willing to contemplate. And there is not a sign of recognition from Rennie that the date for the return to fiscal balance has been pushed out again and again – it isn’t as if successive governments are making steady progress on a well-understood and stable forward track.

There seems to much the same sort of elite resignation around productivity issues and failures. He seems willing to acknowledge that it is a significant issue, but with no sense of urgency, and no sense of just how deep-rooted the problems have become – weak productivity growth isn’t just some phenomenon of the last few years, but something that now dates back 70+ years in New Zealand, with no sustained period since when New Zealand has made any progress in closing the gaps.

Rennie’s final comments are about comparisons with 1990/91

Again, it feels more as though he is channelling his Minister, who desperately does not want to be compared with Ruth Richardson.

A fair amount of the debate around 1990/91 is more about mythology than hard facts. Reasonable people might differ about the pros and cons of welfare benefit cuts then (as they might about the ill-judged increases in real benefit rates under the last Labour government), but….

Here is total Crown primary (ie ex interest) spending in the fiscal years through that period

Government spending was not slashed and burned.

And what of that story of 15 years of failed fiscal adjustment. Here, from Treasury’s own data, is the primary balance from that era

Very considerable progress had in fact been made in the previous few years, with large primary surpluses having been achieved (nominal interest rates at the time were very high, but much of those interest rates were simply compensation for inflation, not an additional real burden). Now, it is certainly true that in the dying days of the 1984-90 government fiscal discipline weakened – primary surpluses were smaller – but there were primary surpluses throughout.

It is also true that at the end of 1990, there had been the second (and more severe) BNZ failure/bailout, unemployment was rising, and another recession was almost upon us. There were genuine fiscal surprises for the incoming government – and the ratings agencies – but the basic position, while well short of ideal, was not dire. And if net debt – at about 50 per cent of GDP – was higher than it should have been (and higher than today), it was pretty moderate by the standards of indebted OECD countries today. And, since Rennie rightly notes ageing population pressures on spending now and in the years to come, back in 1990, not only had the outgoing Labour government already put in place a plan to raise (very gradually) the eligibility age for the state pension, but the demographics going into the next 10-15 years were particularly favourable, since the birth rates 60 or so years earlier had been so temporarily low.

Instead now we have deficits well into the future, no serious evidence (yet) of a government with a willingness to make hard adjustments, and demographic pressures that are already on us and will only intensify. It is, therefore, more than a bit disconcerting to hear such complacent noises from the Secretary to the Treasury, as if to pat us all on the head and say “don’t worry, we’ll get things sorted out eventually”. No doubt it will make for holiday reading for the public that the Minister of Finance will smile favourably upon. But one can only hope that when Rennie is alone with the Minister he is rather more urgent in his advice. If not, perhaps he really is the Secretary Willis wanted…..but the only sense in which he might then be a “change agent” is in somehow acting to help accustom us to a new grim reality in which neither main party is any longer that worried about returning to fiscal balance.

Rennie’s final line was that one about there allegedly being “confidence” our “fiscal institutions” will respond and consolidate successfully. I’m not sure who has this confidence – perhaps a few members of the government party caucuses – or what foundation any such confidence might rest on. It feels more like wishful thinking, or just spin.

Fiscal failure and indifference

Michael Reddell Fiscal policy

I was away in Papua New Guinea last week when the HYEFU came out, and have only just gotten round to looking at the numbers. Quite possibly, what is in this post will be repeating ground others have covered, and if so the post will end up being mostly for my records (good to be able to look back and see what one said at the time).

It was this tweet from a non-partisan analyst that really caught my eye

Three sets of spending forecasts: those for Labour’s final Budget last year, those from last year’s PREFU (and available to political parties finalising their fiscal promises), and those from last week’s HYEFU. They run out only to the year to June 2027, because that is as far as the forecasts done in 2023 went.

Spending on core Crown expenses is as higher or a little higher than in Labour’s last Budget.

It isn’t because interest rates are higher (out of the government’s control); in fact, primary spending is also a touch higher over four years than was planned in last year’s Budget.

It isn’t because of the state of the business cycle: the output gap forecast now for 26/27 is almost identical to that forecast for 26/27 in last year’s Budget.

Overall, core Crown expenses are forecast to be 32.2 per cent of GDP in 26/27, up from 31.5% for 26/27 in last year’s Budget.

And net debt (excluding the – quite variable – NZSF assets) is forecast to be $42 billion higher in 26/27 than was forecast just 18 months ago.

Of course, defenders of the government will note that revenue forecasts are a lot lower. That is partly a matter of pure political choice – tax cuts – and partly a changed view on the potential rate of growth of GDP (not about the business cycle). But when the family’s income estimate are revised quite a bit lower over the medium term it would be usual to adjust future spending plans. But not, it appears, this government.

For all the pre-election rhetoric, the current coalition government seems to be keeping right on with the path adopted by the previous Labour government, which had more or less abandoned (for practical purposes) any serious interest in running budgets in which the revenue raised paid for the groceries. National wasn’t very ambitious in its election campaign fiscal plans, but its numbers now represent deep underperformance even relative to those modest electoral ambitions. Will we see a balanced budget ever under Luxon/Willis. Unless something positive just happens to turn up it seems very unlikely – and with each passing year the ageing population fiscal pressures just keep mounting. If the failure is first and foremost the responsibility of the Minister of Finance, no Prime Minister can ever escape shared responsibility for this kick-the-can down the road approach to fiscal management.

As a reminder of the broader fiscal position, here is Treasury’s chart showing the estimated cyclically-adjusted and structural deficits.

Not only is no progress at all being made at present, but the imbalances are a bit larger than those Treasury was estimating at the time of the 2023 Budget. People rightly criticised Labour’s fiscal excess, and the structural deficits they chose to incur. The coalition’s structural deficits are also pure choice – bad ones. And we can’t have much confidence in the eventual sluggish return towards balance after the next election – as for any government, forward operating allowances are no more than lines on a graph at this point, and the government has shown little inclination or ability to make and sell sustained hard fiscal choices consistent with those operating allowances.