HYEFU bits and bobs

I don’t have too much to say about yesterday’s HYEFU, but two things caught my eye.

The first was a bit of attention on the $6 billion “operating allowance” the government has given itself to increase spending (or, I suppose, cut taxes) at next year’s Budget. It is a big number, but it doesn’t mean a great deal. In principle, the operating allowance covers things where the government has some discretion (whereas, by legislation, tax revenue tends to rise each year as nominal GDP does, and welfare benefits rise each year as inflation/wages do, and without new legislation the government of the day has no choice in the matter).

But governments tend to care about purchasing/delivering real goods and services, and they need actual people to work for them. And when there is inflation, the dollar cost of purchasing goods, services, and labour tends to rise. Governments don’t have to – and tend not to – compensate agencies/votes for inflation each and every year but when inflation is higher, over time more dollars need to be allocated for increased spending just to keep the real volume as the government intended. And since inflation – in principle – just blows up prices and incomes, making us as a whole neither richer nor poorer, they can do so with no particularly ill effects.

To illustrate, suppose the government spends $100 billion a year in an economy with nominal GDP of $330 billion (so roughly 30 per cent of GDP). Now assume that prices generally suddenly rise by 5 per cent, with nothing else changing. The things the government wants to purchase cost more, but its tax revenue also rises by more. In fact, it will now cost $5 billion more than otherwise to purchase the same volume of goods, services, labour (or real transfers). In practice, as noted above, quite a bit of government spending is indexed by legislation (roughly a third of core Crown spending is on welfare) and so not covered by the operating allowance. But in this scenario a 5 per cent lift in prices might require a $3.3 billion operating allowance, just to keep real government purchases unchanged.

I don’t have the time today or the patience to try to reconcile all the numbers, but to illustrate that inflation is a big part of the picture note that in this year’s Budget Treasury forecast that inflation for the year to June 2021 would be 2.4 per cent, for the year to June 2022 1.7 per cent, and for the year to June 2023 1.8 per cent. In the HYEFU, those numbers (2021 now known) are 3.3 per cent, 5.1 per cent, and 3.1 per cent. The total increase in the price level over those three years was expected to be 6.0 per cent, and is now expected to be 11.9 per cent. So of course the government needs to put more money (quite a lot more) in the operating allowance just to maintain real spending at the levels they intended only a few months ago. A lot of it is simply an inflation illusion. In the same way that a very small operating allowance would reveal nothing about the fiscal stance if inflation was to be unexpectedly low (as it was, say, a decade ago).

Don’t take it from me. Here are The Treasury’s forecasts of core Crown operating expenses as a per cent of GDP, including the government’s fiscal plans (those “big” operating allowances) as communicated to them and published yesterday.

core crown expenses hyefu 21

On these plans, core Crown spending as a share of GDP will be around the same share of the economy as it was going into John Key’s final term.

There is plenty to criticise about individual spending items under this government – take $51 million wasted on the aborted, always ludicrous, Auckland walking bridge, let alone $5 billion in Reserve Bank losses – but the bottom line at this stage is one in which total spending ends up much where it was as a share of GDP. One might, of course, worry more about timing. With an overheated economy (on Treasury and Reserve Bank numbers), with high and rising inflation, and with a high terms of trade, the government really should be running a surplus next year (headline surplus consistent with cyclically-adjusted balance. But, in fairness, the forecast deficit for 2022/23 is small.

As noted, there has been – and is expected to be – quite a bit more inflation. Like the Reserve Bank, Treasury now seems to think that even core inflation will move outside the top of the target band the government set for inflation. They expect 3.1 per cent inflation in the year to June 2023 – ages away, and fully within the control of monetary policy now – and won’t be forecasting the sorts of one-off price shocks that often distort near-term headline inflation forecasts.

But, on the Treasury’s numbers it doesn’t seem like anything to worry about because by the end of the forecast period (June 2025) inflation is back to 2.2 per cent, basically the midpoint of the target range.

But how is this being achieved? Sure, they expect the Reserve Bank to raise the OCR, to a peak of 3.2 per cent by June 2023. But raising the OCR above neutral – as the Governor told us they expect to – usually dampens (core) inflation mostly by generating some temporary excess capacity in the economy.

But here is The Treasury’s view on the output gap.

Tsy output gap

They reckon it was deeply negative a decade ago, when core inflation was low and falling (reaching a trough around the end of 2014), but now they reckon it will be positive – quite materially so for the next couple of years – throughout the forecast horizon. All else equal, that should normally be consistent with core inflation rising further.

What about the labour market? The Treasury doesn’t publish an “unemployment gap” number, but comparing their unemployment rate forecasts, and the medium-term trend assumptions they use in their Fiscal Strategy Model makes very clear that they expect the unemployment rate to be below sustainable levels over the next few years.

U gap Tsy

So how is it that they expect (core) inflation to come down?

I can think of two possibilities, neither very convincing. The first is that they are still treating all the current (and forecast over the next 18 months) surge in the inflation rate – including on the core measures – as really just transitory and having nothing to do with excess demand. If so, as (eg) supply chain disruptions dissipate, what now looks like core inflation vanishes like the morning mist. But that certainly doesn’t seem to be the Reserve Bank’s view, just doesn’t square with (eg) forecast positive output gaps, and isn’t really consistent with expecting fairly rapid increases in the OCR.

The second possible story might involve inflation expectations. Perhaps they too stay firmly rooted at 2 per cent and inflation just vanishes, despite the headline pressures, despite the (on Treasury’s own estimates) overheated economy. But it doesn’t make a lot of sense, and isn’t consistent with any of the other swings or slumps we’ve seen in core inflation over the decades.

I don’t know what Treasury thinks the story is. In the end, perhaps it doesn’t matter that much. The Reserve Bank will – we presume – eventually do what needs doing and adjust the OCR to get core inflation credibly heading for the midpoint. But if there is enough inflationary pressure built up that the OCR really needs to be raised more than 200 basis points more from here, it is a little hard to believe that would be consistent with an economy still generating a positive output gap and such low unemployment rates. Medium-term forecasting is a mug’s game – no one is any good at it – so my interest is more in the logic of their model than in what the economic outturns a couple of years hence might be. But if the OCR has to be raised a lot more over the next 18 months, you might normally expect the biggest adverse economic effects (normally needed to get core inflation back down) might well be showing themselves in the second half of 2023. Which might be awkward timing for the government.

But who knows how many shocks – positive, negative, Covid and other – will be along before then.

Debt and deficits

The OECD’s latest Economic Outlook came out a few days ago. As always with the OECD, the value is rarely in the analysis or policy prescriptions, but mostly in the vast collection of more-or-less comparable tables, collating data for a wide range of advanced economies (and a few diversity hires).

Take public debt as an example. Next week our Treasury will be out with their HYEFU and more-detailed New Zealand numbers for central government. But there is no easy way of comparing Treasury’s New Zealand numbers with those for other countries. And so I tend to focus most often on the OECD series of “net general government financial liabilities”, which includes all layers of government, and doesn’t exclude things that particular national governments find it convenient to exclude (in New Zealand’s case, all the assets in the Crown’s hedge fund, the NZSF).

The OECD’s forecasts only a couple of years ahead, but that is probably about the most that is useful anyway, Here are their recent forecasts for net general government liabilities as a per cent of GDP (for the 30 countries they do these numbers for).

debt 2023

For New Zealand, the 2023 number is 14.82 per cent of GDP and on these forecasts we’d be 7th lowest of (these) OECD countries. There isn’t a forecast for Norway for 2023, but they have net financial assets of about 350 per cent of GDP, so call it 8th.

Going into the pandemic, our net general government liabilities as a per cent of GDP in 2019 was 0.8 per cent. (Including Norway) we were 8th lowest of these OECD countries.

That is a not-insignificant increase in net debt as a per cent of GDP. Between 2007 and 2012 – serious recession and the earthquakes – net general government financial liabilities were increased by about 12 percentage points of GDP. But, and on the other hand, in five good-times years (from 2002 to 2007) net general government liabilities as a share of GDP dropped by 23 percentage points of GDP.

Here is the cross-country comparison over time

gen govt liabs

I’m not suggesting we should be totally comfortable about that picture, but our net public debt is forecast to remain (a) low, and (b) much lower than the typical advanced country.

What if we break out the countries. Some argue (I’m not really convinced) that big countries, at least those with a history of reasonable government etc, can comfortably ran higher ratios of public debt than smaller countries. And, on the other hand, perhaps the countries most like New Zealand are the fairly-small places with their own central bank and floating exchange rate. Here are the relevant comparisions over time (medians in both cases).

gen govt small and big

The big countries – Germany excepted – really have been on a rising debt path. I’m not one who believes crisis and/or default is looming (generally – Italy remains a wild card) but were I a voter in one of those countries I’d be seriously uneasy. Were I involved in an opposition political party, I hope the high and rising debt would be made a salient political issue.

But – and generally – the small advanced countries have done pretty well (true on this sample of countries, or if one uses all the small countries – including those in the euro – in the database), and there has been (and is) nothing startling or particularly impressive about the New Zealand performance. If anything, one might note the widening gap at the end of the period.

Of course, none of this includes the fiscal challenges imposed by the rising NZS fiscal burden from maintaining the age of eligibility at 65 (although it is now a decade since baby boomers started turning 65) and the expected trend increase in public health expenditure….but I really can’t see public debt itself being a particularly salient issue in 2023.

But what about deficits? No one argues the government should have been running a balanced budget last year, and perhaps not even this year (given the renewed lockdowns and big output losses the government left itself open to), but why not 2023? These are the OECD’s projections – the primary balance excludes financing costs, and a common rule of thumb is that even a small primary surplus is consistent with keeping debt in check. “Underlying” captures cyclical-adjustment.

primary defs

In 2023, with the economy projected to be fully-employed (a reasonably significantly positive output gap), with a strong terms of trade, and (as ever) with some of the highest real interest rates anywhere in the advanced world, the OECD estimates that the government’s fiscal policy will see us in 2023 with a large primary deficit, a bit worse than the median OECD country. (Norway’s primary deficit is much larger, but remember that they have big net earnings (finance receipts) on the government’s huge net asset position.

Were one confident that spending initiatives were being ruthlessly scrutinised to keep waste to an absolute minimum, perhaps one might be a little less worried – although small structural surpluses, where spending is funded by taxes remains a good rule of thumb – but does anyone suppose that describes current New Zealand approaches to public spending.

I don’t suppose Ardern and Robertson are likely to let things get really out of hand. They seem oriented enough towards broad macro stability – in the traditions of all New Zealand governments of recent decades – even as they too watch our real economic performance decline, but at present the structural deficit picture (as the OECD interprets our data and policies) isn’t looking that good.

primary def nz

There should be considerable scrutiny on the government’s plans in the forthcoming Budget Policy Statement, and the Treasury’s HYEFU projections.

Health spending

Over the last few days I’ve noticed a few political partisans on Twitter squabbling about health spending under various governments. I’m not exactly sure what triggered it, although perhaps it had something to do with John Key’s op-ed at the weekend.

Not being a political partisan myself – let alone a recent supporter of either National or Labour – I decided to have a quick look at the data myself. The Treasury publishes a quite useful long-term set of annual fiscal data, including a breakdown of spending. It is all in nominal dollars, but they also show those numbers as a percentage of nominal GDP. Here is how health spending has changed, as a per cent of GDP, since 1972 (bearing in mind that the years shifted from March to June years about 30 years ago). The data for the year to June 2021 should be out shortly (one would hope).

The trend over time is upwards. That shouldn’t surprise anyone. There is a lot more medical technology can now do for us, expectations are higher, and a larger proportion of the population is now relatively old. Oh, and as far as we can tell productivity growth in the government health sector has been pretty unimpressive.

And if the trend is upwards, there are quite material fluctuations around the trend. But note that they won’t always tell you much about health policy. After all, the ratio has a numerator (health spending) and a denominator (GDP), and nominal GDP growth can be quite variable, even in the low inflation era of the last 30 years.

The state of the economy influences what can be spent on health (and other things) but you wouldn’t expect this year’s health spend to be affected much (if at all) if the terms of trade happened to fall sharply this year, perhaps after the Budget was set.

And thus, to revert to the first chart, you may already have noticed the two big increases in health spending as a share of GDP – neither of which were sustained – happened in the 1970s (when our economy badly underperformed after 1973 for several years), and over the first few years of the last National government, when we went through a severe recession (not caused by that government) that took quite a few years to recover from. Note that part (but not all) of the reason health spending rose as a percentage of GDP in the year to June 2020 is that GDP plummeted in the first half of 2020.

Now, of course, recessions should be expected to slow the growth of health spending – even if not necessarily the volume of health services delivered. After all, a big chunk of the health budget, directly and indirectly, is salaries, and real wage inflation tends to slow (often quite sharply) in significant economic slowdowns. But it isn’t a mechanical or immediate connection, especially as much of the health workforce is unionised and sometimes on multi-year collective contracts. Equally, of course, in relatively good times, the government may be willing to settle more generously with the health workforce, boosting spending (if not necessarily the volume of health services delivered).

Comparisons across governments aren’t just affected by denominator issues. There is also the facts that (a) government fiscal years don’t line up with the dates of changes of governments, and (b) even if they were, it is hard to change spending immediately (at least if purchasing more/less health services is the aim). But, for what it is worth, here is my best effort – using annual data only – at average health spending as a percentage of GDP for each government since 1972

To be clear, it is not some gotcha effort at the current government. You can see from the first chart that health spending as a share of GDP has been rising under this government from the levels they inherited, although are still below – for good or ill, for whatever reason – the percentages run during the previous recession and immediate aftermath.

That chart involved multi-year averages and (at least for the three nine-year governments the numbers aren’t so sensitive to the choice of first or last years). The same can’t be said for crude changes from the beginning to the end of the government. But for what they are worth:

Labour 72-75: Fiscal years were March, governments changed in December. In the March 1973 year, health spending was 4.2 per cent of GDP, and in the March 1976 year it was 5.3 per cent.

National 75-84: March years. National took office in Dec, and left office in July (hot having delivered a Budget). In the March 1976 year, health spending was 5.3 per cent, and in the March 1984 year it was 4.8 per cent.

Labour 84-90: Data change to June years in 1990. Labour left office in November 1990. Health spending was 4.8 per cent of GDP in the March 1984 year, and 5.0% in the June 1990 year and 5.2% on the June 1991 year.

from here on June fiscal years, and government changes in the Dec quarter. I assume outgoing government is responsible for health spending in the June year it leaves office (Budget having been passed etc)

National 90-99: 5.2% in June 1991 year and 5.4% in the June 2000 year.

Labour 99-08: 5.4% June 2000 year, 6.5% for June 2009 year

National 08 to 17: 6.5% for June 2009 year, 5.9 per cent for June 2018 year

Labour 17 to present: 5.9 per cent for June 2018 year, 6.5 per cent for June 202 year

Here is one more chart, this time showing health spending by the government as a percentage of total primary (ie non-interest) spending.

The two big trends seem to be about welfare spending. Up to the early 1990s not only were numbers unemployed rising (latterly sharply) but NZS eligibility at age 60 was becoming a heavier fiscal burden. Both trends were reversed from the early 1990s. The sharp drop in the 2020 year is, of course, mostly a reflection of the huge wage subsidy spending in the first half of last year. For those wanting to play gotcha about the previous government, health spending increased as a share of total (primary) government spending over the entire course of that government.

What do I take from all this? Not a great deal. Economic fluctuations happen, and there are limits to what governments can do about them quickly. Productivity slowdowns occur, and if there is more governments can do about them, they make it harder to manage health demands. And raw spending on its own doesn’t necessarily mean a great deal anyway, at least in terms of the health outcomes the wider public probably care about – and that is especially so if the changes in spending substantially reflect (say) a few years of being stingy or generous with the public sector health workforce.

Still on health, this post might be a good opportunity to introduce a couple of cross-country charts I showed on Twitter a couple of weeks ago. The OECD gathers data on total health spending (public and private) as a percentage of GDP, mostly for OECD countries.

This was the OECD’s chart, useful because it shows the splits across countries between government (or compulsory private) and voluntary private spending on health. I was interested in it partly because there seems to be much more difference across countries in the public/compulsory spend (per cent of GDP) than there does in the voluntary spend, and there is no sign (for example) that countries with a high government/compulsory spend (per cent of GDP) spend less voluntarily.

You’ll notice it is labelled “2020 or latest available”. Usually that might be fine, but of course 2020 not only saw big increases in health spending in many countries, but also saw significant drops in GDP in many, so comparisons that involve 2020 for some of the countries and 2019 for others aren’t going to be reliable.

Here is total health spending for 2019 for the OECD countries from the earlier chart.

The US is, of course, something of an outlier. But, focusing on New Zealand, mostly the countries that spend more on health (public and private) as a percentage of GDP are richer and more productive than we are (Chile is the exception), and countries that spend less of health (percentage of GDP) are similar productivity/income to us, or poorer (Luxembourg is the exception, but much of Luxembourg’s GDP is generated by people who work there but live in neighbouring countries). We look to spend about as much of health – public and private – as you might expect if you knew our productivity/income performance.

FInally in that group of charts, I lined up total (public and private) spending on health with total primary government spending (both as a percentage of GDP) for the OECD countries (most) that have data for both series. I’ve marked New Zealand in red. You can see that government spending as a share of GDP is well towards the lower end of the range for these OECD countries (as people on the left often bemoan) but also that there is no cross-country relationship between the two series. Countries – all in Europe – in which the government spends a great deal more of GDP (15-20 percentage points more than New Zealand) don’t spend greatly more (public and private) on health as a percentage of GDP. To the extent they do, it appears to be mostly because they are richer and more productive than New Zealand, and richer and more productive countries choose (public and private) to devote a larger share of that higher income to health.

I’m much more interested in productivity (under)performance than health spending per se. As far as I can see, we devote about what one might expect to health in a country of our productivity/income. A much better productivity performance – something that seems to seriously interest neither side of politics – would open up lots more opportunities (public and private), including the likelihood that we would choose to devote a larger share of our higher incomes to health.

Economic underperformance – over many decades now – has real consequences.

Long-term spending and revenue

The Public Finance Act requires that every four years The Treasury publishes a “statement on the long-term fiscal position” looking “at least” 40 years ahead. Parliament allowed them to defer the report due last year, but yesterday they published a draft – for consultation – of the report they will formally publish later this year. Quite why they have chosen to go through this additional step, of consulting formally on the draft of a report that is likely to have next to no impact even when finalised, is a little beyond me.

These long-term fiscal reports are fashionable around the world. As I’ve noted previously I was once quite keen on the idea, but have become much more sceptical. They take a lot of work/resource – which should be scarce, and thus comes at a cost of other analysis/advice The Treasury might work on – and really do little more than state the obvious. As I noted when the last long-term fiscal report was published.

I was once a fan, but I’ve become progressively more sceptical about their value.  There is a requirement to focus at least 40 years ahead, which sounds very prudent and responsible.    But, in fact, it doesn’t take much analysis to realise that (a) permanently increasing the share of government expenditure without increasing commensurately government revenue will, over time, run government finances into trouble, and (b) that offering a flat universal pension payment to an ever-increasing share of the population is a good example of a policy that increases the share of government expenditure in GDP.  We all know that.  Even politicians know that.  And although Treasury often produces an interesting range of background analysis, there really isn’t much more to it than that.  Changes in productivity growth rate assumptions don’t matter much (long-term fiscally) and nor do changes in immigration assumptions.  What matters is permanent (well, long-term) spending and revenue choices. 

And I’m old enough to remember people lamenting the potential fiscal implications of an ageing population – at least conditional on government choices – well before long-term fiscal reports were a thing.

What’s more, lots of countries have these sorts of reports, and of them some have very high and rising levels of government debt, and others don’t. It isn’t obvious that access to these sorts of long-term reports really makes any difference at all (see, for example, the US, with a rich array of private and public sector analysis – although do note that the US is well ahead of us in raising the eligibility age for Social Security retirement benefits).

New Zealand, to the credit of politicians in both main parties, has been one of the (not so small) other group of countries where government debt as a share of GDP has been kept fairly low and fairly stable. We’ve had recessions and earthquakes, and governments with big spending ambitions but if you reckon – as I do – that low and fairly stable government debt is generally a “good thing”, New Zealand has been a success story. We even ramped up the NZS eligibility age from 60 to 65 (back to the 1898 eligibility age) in fairly short order. For good or ill – and no doubt there is an argument to be had – government health spending as a share of GDP was not much higher last year than it was 40 years ago (recall, 40 years is the statutory timeframe for long-term fiscal statements).

health 2021

At the start of last year I’d probably have put myself in the camp of those saying “we’ve done okay on fiscal management and there is no obvious reason to suppose we won’t adjust as required in future”. Among other things, there is a certain absurdity in paying out a universal state welfare benefit to everyone at 65 as an ever-increasing share of those 65+ are still in the workforce, so change was likely to happen – it had in other countries, it had here previously and actually Labour in 2014 and National in 2017 and 2020 had campaigned on beginning to raise the age of eligibility (to which you might respond that none of those parties then got elected, but National still won 44.4 per cent of the vote in 2017).

I’m no longer so sure.

One chart that didn’t feature in the draft long-term fiscal report was this one from the Budget.

mcl 2

On their own numbers and estimates, the cyclically-adjusted primary deficit for the current (2021/22) financial year is projected to be really large (in excess of 5 per cent of GDP), at a time when – again on their own numbers – the economy is more or less back to full employment, with an output gap estimate close to zero. Note (again) that this is not a dispute about appropriate policy in the June quarter of last year when most of us were ordered to stay home and many were unable to work. It is about now.

In their text, Treasury is at pains to play down the current fiscal situation. They don’t mention these cyclically-adjusted estimates, but they claim that the situation is temporary, the spending is temporary, and will go away quite quickly. Of course, they have lines on a graph that show such an outcome, but that isn’t the same thing as hard fiscal choices over a succession of years. No doubt there are still some temporary programmes – the subsidies for Air New Zealand and exporters, MIQ costs, and vaccine costs – but a cyclically-adjusted primary deficit in excess of 5 per cent of GDP is getting on for a gap of $20 billion per annum. And every instinct of this government appears to be to spend more.

Here is the chart from the draft report

LTFS 2021

The primary deficit for 2060 on this scenario actually isn’t much larger than the primary deficit The Treasury smiles benignly on this year (assuming it will all go away quite easily). There are long-term issues that need addressing, but perhaps a less complacent approach to the current situation – and the poor quality of a lot of the new spending decisions – might be a better place to start.

Ah, but of course we heard from The Treasury a couple of weeks ago – the Secretary no less – that they are now keener on more government debt and a more active use of fiscal policy. Which probably isn’t the best backdrop against which to make the case for adjustment.

More generally, one of the things that has shifted over the last couple of years – and certainly since the 2016 LTFS – is some sense, especially on the left, that lots more public debt is something to embraced or welcomed, coming at little or no cost (so it is claimed). The focus is always on interest rates (low) and never on opportunity cost (when the coercive power of the state is at work in the spending choices). It makes it a bit harder to mount fiscal arguments about NZS if – as is probably the case – New Zealand could have government debt of 177 per cent of GDP without being cut out of funding markets (although note that, in the nature of such scenarios, the debt ratios mechanically explode beyond that 40 year horizon). And that is another reason why I’m sceptical of the benefits of reports like this: The Treasury really can’t offer any useful insights on the appropriate level of public debt, even if they can offer useful technical advice on the implications of various specific measures that might raise or lower the debt. The real debates to be had are political – both about the debt and the numerous progammes and even (to some extent) around the tax choices.

On NZS here were my thoughts from a post a couple of years ago (emphasis added)

As for NZS itself, personally I’m not overly interested in arguing the case for reform on fiscal grounds but on a rather more moral ground.    Even if we could afford it, even if there were no productive costs from the deadweight costs of the associated taxes, there just seems something wrong to me in providing a universal liveable income to every person aged 65 or over (subject only to undemanding residence requirements).    45 per cent of those 65-69 are now in the labour force –  suggesting they are physically able to work –  which is substantially greater than the 30 per cent of those aged 60-64 who were in the labour force 30 years ago when NZS eligibility was at age 60.

I don’t consider myself a welfare hardliner.  I think society should treat quite generously those genuinely unable to work, especially those who find themselves in that position unforeseeably.  Old age isn’t one of those (unforeseeable) conditions, but personally, I have no particular problem with something like the current flat rate of NZS, or even of indexing it to wage movements (which would be likely to happen over time anytime, whether it was the formal mechanism from year to year), from some age where we can generally agree a large proportion of the population might not be able to hold down much of a job.  I don’t have a problem with not being overly demanding in tests for those finding work increasingly physically difficult beyond, say, 60.   But what is right or fair about a universal flat rate paid – by the rest of the population – to a group where almost half are working anyway?  It is why I would favour raising the NZS age to, say, 68 now (in pretty short order) and then indexing the age in line with further improvements in life expectancy, and I’d favour that approach even if long-term fiscal forecasts showed large surpluses for decades to come.    At the margin, I’d reinforce that policy change with a provision that you have to have lived in New Zealand for 30 years after age 20 to be eligible for full NZS (a pro-rated payment for people with, say, between 10 and 30 years of actual residence).  Why?  Because in general you should only be expected to be supported by the people of New Zealand, unconditionally, in your old age, if most of your adult life was spent as part of this society.

Reasonable people can, of course, debate these suggestions.  But they are where I think the debate should be –  about what sort of society we should be, what sort of mix between self-reliance and public provision there should be, even about what mix of family support and public support there should be, or what (if any) stigma should attach to be funded by the taxpayer in old age –  not, mostly, about long-term fiscal forecasts.

And Treasury can’t help with very much of that. It is what we have politicians, think tanks, and citizens for.

I don’t think enough weight is given to the role that rules of thumb play in disciplining choices. If, in modern floating exchange rate open-capital account economy, many governments can take on almost any amount of debt as they want, and even the interest rate consequences of higher public debt are really quite small, what constrains government choices? No doubt there are a few zealots who think no constraints are necessary, but most people – left, right, or centre – don’t operate that way.

I favour running fiscal policy to two rules of thumb (not legal restrictions, but political covenants/commitments). First, aim to keep the (cyclically-adjusted) operating balance near zero, and second, aim to keep net public debt (all inclusive measures) near zero.

Note that (a) neither rule of thumb would be binding year by year (the state needs to cope with pandemics, earthquakes, or the like), they would be constant aiming points, the standard reference points towards which policy is oriented over several years, and (b) neither rule of thumb says anything about the appropriate size of government (if we conclude we want governments to do more (less) longer-term than adjust tax rates to pay for that. Adjusting tax rates – especially upwards – is a much higher hurdle (and appropriately so) than the Cabinet (commanding a majority in Parliament) simply deciding one morning to substantially alter spending.

There is probably less dispute about the operating balance rule of thumb than about the debt one. Smart people will mount arguments about (a) infrastructure, or (b) the potential capacity of the Crown to capture various high returns. A typical householder or company will, after all, have some debt. But (a) the disciplines on individuals and firms are much stronger, and more internalised, than they are for governments, and (b) much of government activity acts to reduce private savings. I’m not going to pretend there is any great difference between the narrow economics of a 20% debt target vs a -20% one, but zero has a resonance that no other number is ever likely to have. (And if you think this benchmark is demanding, on my preferred analytical measure – the OECD series on net general government financial liabilities – New Zealand has been between 10 per cent and -5 per cent of GDP continuously since about 2004.)

If you want the state to do more, make the case, have the debate for higher taxes – which takes the resources from specific identifiable types of people (tax incidence arguments aside), rather than by monetary policy squeezing out other private sector activity to make way for the government (in a fully-employed economy they are the only two options, there are no free lunches).

This has gotten rather rambly and I’m going to stop here, except to point you to this interesting table at the back of the Treasury report.

LTFS 2021 2

I noted:

  • the sharp drop in the long-term assumed birth rate (largely reflecting recent developments presumably)
  • the reduction in the assumed improvement in life expectancy
  • the significant reduction in assumed long-term productivity growth, and –  unlike the others, substantially a policy matter, 
  • the substantial increase in the assumed long-term annual rate of net inward migration

Fiscal policy in the wake of Covid

When the Reserve Bank and Treasury advertised a full-day workshop with the title “Fiscal and Monetary Policy in the wake of COVID”, I immediately signed up to attend. It sounded like a good idea for an event. After all, lots of tools were deployed, some new, some old, some deployed less than usual, some much more. And we’ve had a Budget, and projections from both agencies suggesting that the economy is now getting pretty close to operating at full capacity (albeit a capacity a little diminished by Covid restrictions).

It was just a shame about the execution. Notably, even though monetary policy has been the principal tool for macroeconomic cyclical stabilisation for decades – and not just since 1989 – here and abroad, there was not a single paper looking at the role of monetary policy, past, present or future. The Governor didn’t attend – which is fine – but nothing of substance was heard from any senior Bank figure. Orr’s deputy for macro policy, Christian (“The Future is Maori”) Hawkesby contented himself with opening remarks that had just some bonhomie and his recitation of a Treasury prayer (which, to add to the strangeness, seemed to appreciate “skilled workers” but not the rest of the public), but not a word of substance. There were a couple of technical papers from Reserve Bank researchers in the afternoon session, but one was little more than an early-stage in a research agenda on the distributional aspects of monetary policy (the paper itself couldn’t shed much light when the only asset in the model was bonds), and the other – on dual mandates – didn’t seem to offer any fresh insight.

So the stage was largely left to The Treasury, and particularly a series of three papers (complemented by a presentation from a US academic) that seemed dead-set on making the case for a bigger and more expansive role for fiscal policy and government debt in the new post-Covid world. Bureaucrats making the case for a bigger and more powerful bureau.

First up – and clearly most important – was the Secretary to the Treasury. She spoke for 40 minutes, but then took no questions (and, in an amateur-hour effort, the text of her speech was then not available until more than a day later). The Secretary is still quite new to the country, to the job, and to national economic policy matters. Probably most non-government attendees (of whom there were many, in a well-attended event) had seen and heard little or nothing of her before. So it didn’t speak well of her that she wasn’t willing to engage, despite having made a barely-disguised (“I would stress that we are not making policy recommendations”) bid for quite an upending of the way macro management is done her, in ways that would just happen to favour her agency.

But what of the substance? It was a workmanlike effort (NB with a minor mistake in footnote 2) but hardly persuasive to anyone not already champing at the bit for fiscal policy to do well. For example, there was no serious discussion about the effectiveness of monetary policy. The Governor has previously told us he thinks monetary policy has been as effective as ever. The Secretary seems to disagree, but we can’t be sure – perhaps she just thinks fiscal policy is even better, but she doesn’t make that case either. Much in her case seems to rest on the effective lower bound on nominal interest rates but (a) as the next Treasury speaker acknowledged that is not some immoveable barrier, and (b) she offers no thoughts on the effectiveness or otherwise of things like the LSAP programme. Surely one starting point for thinking about the future might involve some careful diagnostic work reaching a thoughtful view on what roles the various elements of fiscal and monetary policy played in economic outcomes over the last 15 months. But neither she, nor anyone else on the day, attempted anything of that sort. Remarkably no one – from the Bank or Treasury – looked at the options and merits for removing – or greatly easing – the ELB so that at least ministers have effective choices in future severe downturns,

Quite a bit of Treasury’s thinking – or at least their marketing – seems to have been shaped by the success of the wage subsidy scheme. And it was a success – getting money out the door quickly, at a time when the government had just done the unprecedented and (a) shut the borders, and (b) simply compelled most people not to go to work, or do anything much else. It provided immediate income support, and probably had some beneficial effects beyond that (some smart person might attempt to model what difference it has made to outcomes not just last March/April but now). But it isn’t exactly a conventional event of the sort we can expect to see every cycle. And the primary consideration wasn’t really macroeconomic stabilisation at all – the whole point of the lockdowns was to aggressively (but temporarily) reduce activity, including economic activity – but income relief/support (as unemployment benefits have an incidental automatic stabiliser benefit, but aren’t primarily about macroeconomics). There are always going to be one-off events when the the government’s spending capabilities need to come into play – one can think of earthquakes (where fiscal measures and monetary policy will often tend to work in opposite directions, since earthquakes cause real disruptions and significant wealth losses, and but also generate a lot of fresh (reconstruction demand), plagues, wars, and so on. But it is seems like a category error to use such episodes as the basis for some sort of generalised play for more routine use of discretionary fiscal policy with cyclical stabilisation in view, when most recessions are quite different in character.

And even just thinking about the last 15 months or so, neither the Secretary nor her colleagues seemed to make any effort to unpick the effects of the wage subsidy scheme from the rest of the fiscal policy initiatives of the last year. One could easily imagine an alternative world in which the wage subsidy was used much as it was, but otherwise fiscal policy was kept much on the path it had been on at the start of last year, and at the same time the OCR was used more aggressively. How different would the outcomes for the economy have been, in aggregate and sectorally? The fiscal option involves the coercive use of state power, and politicians making discretionary choices playing favourites, while monetary policy adjusts relative prices and then let individuals make choices about how they (personally and individually) are placed to respond. And one thing that was striking about both the Secretary’s speech and the more technical discussion that followed from her colleague Oscar Parkyn is that in all their new enthusiasm for using fiscal policy more aggressively in downturns (and monetary policy less so) is that neither mentioned, even once, the exchange rate – typically a significant element in the adjustment mechanism in New Zealand recessions. New Zealand recessions often see sharp falls in international commodity prices (fortunately not this time) and the lower exchange rate acts as a buffer. But a much heavier routine reliance on fiscal policy will tend, all else equal, to hold up the exchange rate relatively more in downturns. It isn’t obvious – without a lot more analysis – that that would be a good thing.

The Secretary included this chart in her speech

It was apparently designed to show that fiscal policy in New Zealand has generally done sensible things. That might be generally true (although if so why change?), even setting aside the huge pressure loosening fiscal policy put on monetary conditions over 2005-2008, but it conveniently ignores where we are right now. This chart, which I’ve shown before, is from the recent Budget documents.

So with the output gap almost closed, the cyclically-adjusted primary balance (deficit) in 2021/22 year is expected to be almost as large as it was in 2019/20 (when the – sensible – big wage subsidy spending was concentrated. Extraordinarily, in a speech bidding for a more active role for fiscal policy in cyclical stabilisation she never mentioned this situation once – let alone engaged with why, from a macro policy perspective, such big deficits make sense now. As sceptic might suggest that this is the real world outcome when the Secretary’s textbook ideas get given some rope.

One could go on. The Treasury is clearly tantalised by the lower interest rates – although not now lower than pre-Covid – and the “appeal” of taking on more debt. But never once did we hear any serious examination of the typical real-world quality of the marginal additional public spending they had in mind (it wasn’t until the panel discussion late in the day that I heard a Treasury official – a temporary one, so perhaps not well-socialised – refer to the Auckland cycleway bridge). There was a paper reporting some model results suggesting, sensibly enough, that fiscal consolidation is most costly to GDP if done via taxes on capital income, but (symmetrically) there wasn’t a sense in the rest of the day that (say) Treasury was champing at the bit to lower company taxes. Rather they seem keen on public infrastructure – which often sounds good on paper, until we get to the concrete ideas. As it was, a discussant cast considerable doubt on one Treasury paper suggesting high payoffs to more government infrastructure spending.

We also never really heard any serious political economy discussion, or even a discussion of how we should think of the government balance sheet – is it a plaything for politicians or should it be best thought of as operating on behalf of citizens, each of whom have to make their own spending and borrowing choices. There wasn’t much about using coercion and compulsion rather than the indirect instruments of monetary policy. And, on the other hand, it was a little surprising that there wasn’t even a mention of MMT – so that in a floating exchange rate, the level of government debt isn’t really likely to be materially constrained by the market, which doesn’t mean that just any level of government debt is a socially good thing.

It was all a bit unsatisfactory really. Perhaps one could say it was just exploratory, and they are wanting to open the issues but (a) the speech was from the Secretary herself and (b) was making a case more than deeply and thoughtfully exploring the issues. We will have to see what more is in the papers they plan to release next week (a draft long-term fiscal statement and a draft insights briefing) but if the energy is with The Treasury at present, it isn’t really clear that they yet have the depth of analysis and engagement to support their enthusiasm.

And just finally, they arranged for an American professor, Eric Leeper, to speak, via Zoom, on monetary and fiscal issues. Leeper is pretty highly-regarded and has visited New Zealand previously. He is also very keen on a much greater use of fiscal policy and, it would appear, more debt (for various reasons including, he said. “the rise of the right” which didn’t seem quite relevant to New Zealand, let alone a good basis for official advice). Anyway, after the geeky bits of the presentation, he tried to make his case by reference to the Great Depression. He is clearly a big fan of Franklin Roosevelt, and was talking up the fiscal aspects of Roosevelt’s approach (while barely really mentioning the substantial monetary bits). But it was odd. Here he was talking to a New Zealand audience, championing the use of fiscal policy in the US Great Depression, but seemed quite oblivious to the fact that the US was one of the very last countries to get back to pre-Depression levels of output and unemployment. Here is the experience of the Anglo countries.

Those aren’t small differences. And as anyone who knows New Zealand economic history – or have read my past posts on it – New Zealand’s recovery from the Depression (back to pre-Depression levels by the time Labour took office) was barely at all about fiscal policy. The excellent quote from Keynes that our Minister of Finance of the time recorded in his diary, along the lines of: “if I were you I would no doubt seek to borrow, but if were your bankers I should be very reluctant to lend to you”.

When a half-baked loaf is finished cooking it can be a fine thing, but this loaf seems to need a lot more work before New Zealanders should be rushing to embrace a much more active role for fiscal policy or a lot more public debt. That includes a lot more work on what we reasonably can, and can’t, do with monetary policy.

UPDATE: A former RB colleague, now a lecturer at Sydney University, sent me a link to a paper he and a Reserve Bank researcher have written attempting to evaluate the impact of the New Zealand wage subsidy scheme. I haven’t yet read it, but it looks very interesting. Here is the end of their abstract

We then study the impact of a large-scale wage subsidy scheme implemented during the lockdown. The policy prevents job losses equivalent to 6.8% of steady state employment. Moreover, we find significant heterogeneity in its impact. The subsidy saves 17% of jobs for workers under the age of 30, but just 3% of jobs for those over 50. Nevertheless, our welfare analysis of fiscal alternatives shows that the young prefer increases in unemployment transfers as this enables greater consumption smoothing across employment states

(a) real interest rates, and (b) NZers’ migration

No, I’m not getting back into some routine of daily posts, and on this occasion the two topics don’t even have anything to do with each other, but are just a couple of a leftovers from things I was looking at over the last couple of days.

In my fiscal posts this week I’ve noted that the government is consciously and deliberately choosing to run cyclically-adjusted primary fiscal deficits in the coming year larger (probably much larger) than we’ve seen at any time since the end of World War Two. I noted in passing that although people are conscious of stories of large fiscal deficits under Robert Muldoon’s stewardship, in fact a large chunk of those deficits was interest payments, and this in an era when inflation was high, sometimes very high. When nominal interest rates are high just to reflect high inflation, the resulting “interest payment” is really more akin to a principal repayment. Back in the day, various people – especially at the Reserve Bank – did some nice work inflation-adjusting various macro statistics.

But just to check my point I put together this graph

real NZ bond yield since 70

What have I done here?

  • got the OECD’s series for long-term nominal bond rates that goes back to 1970 (this will mostly be 10 year bonds or thereabouts, although for a time in the late 80s we were not issuing bonds that long),
  • for the period since 1993, subtracted the Reserve Bank’s sectoral factor model measure of core inflation,
  • for the period up to 1993, subtracted a three-year centred moving average of the CPI inflation rate.

So for almost entire period prior to 1984 real New Zealand government bond yields were negative.

This is, of course, not testimony to different patterns of desired savings and investment, but (mostly) to financial repression. Until 1983 government bond yields were administratively set and – much more importantly – most financial institutions were simply compelled by law to buy and hold government securities (often 25 per cent of more of total deposits). The costs were borne by depositors.

It is also worth noting that pre-1984 the government was also borrowing, at times heavily, directly from the retail market, at times offering real interest rates well above those shown here. And the government was also borrowing, again at times quite heavily, from abroad. In some of those markets, inflation was a big chunk of the headline interest rate, but in none of the major borrowing markets were government borrowing rates by then as repressed as they were still in New Zealand.

Finally, note that in the chart I have compared a 10 year bond yield to a one year inflation rate. But at least since 1995 we have had a direct read on real government bond yields through trading in government inflation indexed bonds. As this chart shows, the pattern over that period is very similar,

IIB yields since 95

Developments in the last few months are interesting, but that is something for another day.

My second brief topic this morning was sparked by a strange quite-long article in the New York Times yesterday headed “New Zealanders are Flooding Home: Will the Old Problems Push Them Back Out”. A lot of work seemed to have gone into it, and some of the individual anecdotes were not uninteresting (and in the small world that is New Zealand, one of the recent returnees was even someone I’d once worked with) but…….no one (do they have factcheckers at the NYT?) seemed to have stopped and checked the numbers. It took about two minutes to produce this graph that I put on Twitter yesterday.

NZ citizen migration

Using the official SNZ estimates, the problem with the story was that arrivals of New Zealanders had not really changed much at all – a bit higher than usual in the March 2020 year, and then lower than usual in the most recent year. There has, of course, been a big change in the net flow of New Zealand citizens but……..that is mostly the very steep fall in the number of New Zealanders leaving. That reduction – over the March 2021 year – is, of course, not surprising in the slightest given (a) travel restrictions to Australia for much of the year, and (b) travel restrictions and/or bad Covid in much of the rest of the world.

But, on official estimates, there simply is no flood of New Zealanders returning home. None.

This morning I looked a little more closely, and dug out the quarterly (seasonally adjusted) version of the data.

nz citizen migration quarterly

It is, of course, much the same picture, but what surprised me a little was the upsurge in (estimated) arrivals back in late 2019, pre-Covid. Here it is worth remembering that until a couple of years ago our PLT migration data was based on reported intentions at the time of arrival, but the 12/16 approach now used looks at what actually happened. It looks as though some New Zealanders who had come to New Zealand in late 2019, probably not intending to stay, ended up doing so, voluntarily or otherwise, once Covid hit. So they are now recorded as migrant arrivals in late 2019 even though at the time they would not have thought of themselves as such.

But it does not change the picture: there is no flood, or even a little surge now, in returning New Zealanders. A problem with the 12/16 approach is that the most recent data is prone to quite significant revisions (and that is particularly a risk when the normal patterns the models use aren’t likely to be holding, but there is nothing to suggest there is a significant influx of returning New Zealanders happening.

There will be always be natives who’ve spent time abroad returning home. It happens even in rather poor and downtrodden countries, and it happens here – always has, probably always will. That adjustment isn’t always that easy, plenty of people often aren’t sure for a long time that they’ve made the right choice. Covid means a few different factors have influenced some of those choices for some people. But there is no “flood”, just a similar to usual (or perhaps now smaller than usual) number of returnees, coming back to a New Zealand of extraordinarily high house prices and productivity levels and incomes that increasingly lag behind a growing number of advanced economies. Those persistent failures – and the indifference of our main political parties – should be worth a story. But not the non-existent flood.

A bit more on fiscal policy

In yesterday’s post I outlined some of my concerns about the government’s Budget, from a macroeconomic perspective. Not only did it seem to be built on rather optimistic medium-term economic assumptions, but several years out – on current policy advised to it by the government – The Treasury still expects a fairly significant cyclically-adjusted primary deficit (which means, once finance costs are added in, a larger-still overall cyclically-adjusted deficit).

CAB primary

There was a good case for such deficits last year, and perhaps even in the year that ends next month. But there is no obvious macroeconomic reason for running larger deficits in this coming year, and still having cyclically-adjusted deficits four years hence (by which time The Treasury numbers project a non-trivial positive output gap). It is now simply a splurge – a government that, unnecessarily, is simply choosing to take on more debt to fund its new spending, rather than fund core operating spending with taxes. In a climate when risks abound.

And all this is an environment where fiscal policy now appears to be unanchored by any specific fiscal goals a government is committing itself too.

I’ve never been one of those who put huge weight on the Fiscal Responsibility Act 1994, now (as amended) incorporated as Part 2 of the Public Finance Act. There are some good aspects to the legislation but I was never really convinced that asking governments to set out their specific short and long-term fiscal objectives, or articulating in statute “principles of responsible fiscal management” would make much difference to anything that mattered about the conduct of fiscal policy. (Here is a post on the 30th anniversary of the Public Finance Act critiquing some rather over the top claims then made for the framework.) In my take, there was a shared commitment across the main parties to balanced budgets (in normal times) and low debt, and the legislation reflected that rather than driving it.

And I guess I take this year’s Budget as vindication of that stance. There was a shared commitment to such things, and now it appears there is not. And the legislation still sits on the books, lonely and overlooked. Check out the requirements of Part 2 of the Public Finance Act, and then compare it with this year’s Budget documents. In particular, have a look at the statutory principles for responsible fiscal management, and the requirements that a Fiscal Strategy Report brought down on Budget day has to contain outlining both short-term and long-term fiscal objectives.

And then go and check out the vestigial thing the Fiscal Strategy Report appears to have become. Here is the statement of the government’s fiscal intentions.

fiscal intentions 21

Take the long-term intentions first (if you can find them). For debt, the government offers no numbers at all – either as to the level they aim to first stabilise the debt at or the longer-term level they would aim to then reduce it to (not even whether that level is higher or lower than the current level). Not even anything conditional on, say, us avoiding future Covid outbreaks and new lockdowns.

And then what about the operating balance? Well, they assure us they will run an operating balance consistent with the long-term debt objective, but (a) isn’t that obvious?, and (b) it tells us nothing at all, since they give us no medium to long term debt objective. And all the rest of it is equally or more vacuous. Now, sure, the Act does not formally require the government to put numbers on their objectives in these areas, but I’m pretty sure the drafters of the Act – the Parliament that passed it – did not think that simply stating “we’ll do whatever we like to pursue our political objectives” (all that “productive, sustainable and inclusive economy” mantra) would meet the bill. The whole section of the Act is rendered empty and futile.

It is even worse when we get to the short-term intentions. The Act is somewhat more prescriptive there

short term fiscal

And there is simply none of that content at all.   No objectives, no serious discussion reconciling with the (non-existent) long-term objectives, and just this explanation for why the government is (for now anyway) abandoning the statutory principles for responsible fiscal management

Doing so in this case for the short-term operating balance intention is the right thing to do, given the unprecedented size of the global economic shock caused by COVID-19 and the need for the Government to provide a strong ongoing fiscal response to protect lives and livelihoods in New Zealand as we secure the economic recovery. 

But as I suggested yesterday, that argument probably made sense (at least the first half) at the time of last year’s Budget and FSR. It doesn’t today when New Zealand’s unemployment rate is under 5 per cent.

There is no rationale – grounded in the Act – no analysis, and no short or medium goals. Simply structural deficits for years to come (see first chart above) – discretionary deficits actively chosen by today’s government larger than any such cyclically-adjusted deficits run in New Zealand at any time since at least the end of World War Two. It hasn’t been the New Zealand way. But it appears to be so now.

As I noted yesterday, maybe it will all come right. Maybe Robertson and Ardern really are at heart a bit more responsible than this Budget suggests and future new spending splurges (which are, I guess, what one expects from a party whose MPs and leader have now taken to openly calling themselves “socialists”) will be funded by persuading the electorate to stump up with increased taxes.

But bad fiscal outcomes – high debt, and little obvious prospect of reversals – don’t arise overnight. And the sort of thing that concerns me is what has happened in some other advanced countries. Here are the cyclically-adjusted primary balances for the US, the UK, and Japan. Remember, a positive number should be a bare minimum for prudent fiscal management (higher the higher are your accumulated debts and the prevailing real interest rate).

uk and us balances

30 years each had relatively low levels of government debt (OECD data for net general government liabilities as per cent of GDP), the UK and Japan in particular. And now they are all among the OECD countries with the highest levels of (net) public debt.

It can happen here too. And if those on the left are celebrating this week their own government “breaking free” of the shackles, they need to remember that political fortunes come and go. The other parties will form governments again, and the precedent this government is setting may guide them in how constrained they feel about increasing spending or cutting taxes or whatever (see the US as an example). In a floating exchange rate economy the disciplines on fiscal policy are more political than market in nature. If your party believes in bigger government, that’s a choice but then insist that bigger government means higher taxes. If your party believes in much lower taxes, that too is a choice, but then insist that smaller revenue have to mean much lower spending. But don’t toss out the window a hard-won consensus around balanced budgets and low public debt – one of the few real achievements of the last 30 years – and substitute for it feel-good politics (whether from the left or right) that avoids confronting choices about who will pay.

I’m still reluctant to believe that Robertson is quite as reckless as this Budget suggests, but for now at least the evidence is tilting against my optimistic prior. And, disconcertingly, there isn’t much sign of the Opposition calling him out.

This, incidentally, is the sort of analysis and discussion that a Fiscal Council provides in many countries.

A questionable Budget

As far as I can see reaction to last week’s Budget seems to be split between those on the government side who thought it was great – in some cases just a start – and on the other side of politics those noting that there was no sign of any sort of plan or set of policies that might lift the economy’s productivity performance, and in turn lift the capacity – whether or individuals or governments – to spend on personal or collective priorities. Those critics are, of course, right.

But what I really wanted to focus on in this post is the size of the deficit the government is choosing to run.

Little more than four years ago the Labour and Green parties published the Budget Responsibility Rules that, they told us, would guide them should they take office (I wrote about them here). They were seeking to persuade us that in office they would prove to be responsible macroeconomic and fiscal managers.

The first of the rules they offered up was this one.

BRR1

Note especially that second sentence: they expected to be in surplus every year “unless there is a significant natural event or a major economic shock of crisis”. Pursuing other policy priorities wasn’t going to be an excuse either: if they thought they needed to spend more on this or that, they’d fund it by taxes.

It sounded pretty good.

Even before Covid, if they were sticking to their own “rules” it is was a pretty close run thing. In the HYEFU for December 2019, for example, the total Crown OBEGAL measure in (very) slightly in deficit was for 2019/20 and exactly in balance in 2020/21. The same set of forecasts showed the economy running just a bit above potential in those two years. It wasn’t exactly the spirit of the Budget Responsibility Rules.

And then, of course, Covid came along. I don’t think anyone is going to dispute the idea that deficits (even large deficits) made sense for much of last calendar year, particularly to support the incomes of those unable to work because of lockdowns etc, Not many people are disputing the case for the wage subsidy, and of course when people couldn’t work and businesses couldn’t trade tax revenue was also going to be down. You’ll recall that the worst of all that was in the March and June quarters of last year (part of the fiscal year 2019/20). Consistent with that core Crown expenses in 2019/20 was 34.4 per cent GDP, compared with 28 per cent the year previously. Whichever deficit measure you prefer, the 2019/20 deficit was large. And few will quibble about much of that.

Right now we are coming to the end of the fiscal year 2020/21. Wage subsidies and similar measures have been used at very stages, especially early in year.

But as everyone also knows, the economy has bounced back more strongly that most (including me) had expected – notably, much faster than the official agencies had forecast. It is, of course, entirely right to note that the borders are still largely closed, global supply chains are disrupted, and prospects in parts of the wider world still look pretty shaky. On the other hand, the terms of trade are doing really well. In total, Treasury does the forecasts, and they reckon that when we finally get the nominal GDP data for the year to June 2021 it won’t be much different in total than they had thought back in late 2019 pre-Covid. The comparison is a little unfair, since there were some historical SNZ base revisions, but they also reckoned (when they did the forecasts in late March and early April) that the June quarter unemployment rate this year would be less than 1 percentage point higher than they’d been forecasting for that date back in late 2019.

That’s great, something to celebrate. But it doesn’t have the look or feel of a “major economic shock or crisis” – Labour’s 2017 words. There was one, especially in the first half of last year, but from a whole economy perspective it has an increasingly been a stretch to make such a case as 2020/21 drew on. And yet core Crown expenses in 2020/21 are expected to have been 33.1 per cent of GDP, not much lower than in the previous year, and more big deficits have been racked up.

But 2020/21 is really water under the bridge now. There is only five weeks of that year to go, and the Budget is about policy for 2021/22 (in particular) and beyond.

And in 2021/22 not only is the government planning to run large deficits but ones that even larger than those for 2020/21. The Budget documents this year were rather light on the analytical material that Treasury usually publishes, but they put in this year a chart of the cyclically-adjusted primary balance.

CAB primary

Cyclical-adjustment here involves Treasury adjusting for the state of the economic cycle (recessions dampen tax revenue quite a bit and raise spending a bit, as the automatic stabilisers play out). In this chart, the Treasury also exclude the EQC/Southern Response Canterbury earthquake costs. And the primary balance excludes finance costs – it is a standard measure used in fiscal analysis, with a common rule of thumb being that if your primary balance is positive, at least you aren’t borrowing simply to pay the interest on the accumulated debt. Labour’s 2017 commitment re surpluses would have implied running positive primary balances almost every year.

There were significant cyclically-adjusted primary deficits in the years following the 2008/09 recession – the twin consequence of the fiscal splurge at the end of the previous Labour government’s term and the unexpected (by Treasury, whose forecasts governments use) shortfall in potential output. But those cyclically-adjusted deficits over 2010-2012 look small by comparison with the deficit the current government plans to run in 2021/22 (and still smaller than what they are planning for next year).

Perhaps you might think the state of the economy in some sense warrants this, but (a) recall that these are cyclically-adjusted numbers, and (b) check out the state of the economy in the two periods. Over the coming year Treasury expects an average output gap of 1.7 per cent of GDP, coming back to zero in 2022/23. They expect the unemployment rate to be about 5 per cent next June, dropping to around (their view of the NAIRU) 4.4 per cent the following June. By contrast, Treasury now estimates that the output gaps in the 2012/13 and 2013/14 years were each around 1.5 per cent, and the unemployment rate in both years was also higher than they expect in the next two years.

What about some longer-term perspectives? I can’t see a Treasury version of this series going further back but (a) the OECD publishes estimates of the cyclically-adjusted primary balance at a general government level, and (b) the Treasury has primary balance (not cyclically adjusted) back to 1972. Neither series is fully comparable – the OECD numbers aren’t done on an accrual basis, and include local government (but it is small in New Zealand), and the older Treasury numbers aren’t cyclically adjusted. But together they can still create a useful picture.

Here is the OECD chart, back to 1989

CAB OECD

Cyclically-adjusted primary surpluses have been the New Zealand norm in modern times – even (a propaganda line Grant Robertson could have chosen to use, but preferred not to for obvious reasons) in 1990.

And here is the not cyclically-adjusted primary balance numbers back to the year to March 1972, using the data from the Treasury’s long-term fiscal time series.

Tsy primary balance

Note that although these numbers are not cyclically-adjusted, even in quite severe recessions the cyclical-adjustment procedure Treasury uses makes a difference of less than 2 percentage points of GDP.

So, one might reasonably note that over the next couple of years when, on Treasury’s numbers, the economy will be running increasingly close to full employment, the government is choosing – wholly as a matter of discretionary policy – to run a primary deficit bigger than any that have been run in the past 50 years, with the exception only of the accrual effect of the government’s EQC obligations post-Christchurch, obligations that were not discretionary or voluntary at that point. To be pointed, one might reasonably note that the primary deficits are (far) larger than any run under Robert Muldoon’s stewardship (the first two years on the chart, as well as 1976-84), and are in contrast to the primary surpluses run in every single year of the Lange/Palmer/Douglas and Clark/Cullen eras.

(What about those big Muldoon era deficits you keep reading about? Actually, a huge chunk of that was interest costs, and much of that was just inflation – real interest rates themselves were often quite low. Another way of looking at the issue is an inflation-adjustment to the deficits.)

It seems like pretty irresponsible opportunistic fiscal policy to me. It is certainly inconsistent with those mostly-admirable Budget Responsibility Rules Labour campaigned on – since not only are they running large deficits with no macroeconomic crisis, but debt is above their own targets.

Of course, from supporters of the government I expect there will be two responses.

The first might be to celebrate – Robertson and Ardern have thrown off the shackles, scrapping (as they formally have) any references to surpluses or balances budgets now or in the future. What is not to like, surpluses or balanced budgets being things for people like Clark, Cullen, Kirk, and Rowling, but not for our brave new leaders. After all, don’t we know that interest rates are low – even if long-term rates now are no lower than they were pre-Covid. If so, it is a dangerous path they are treading: their cyclically-adjusted primary balance outlook now looks a lot more like the sort of ill-disciplined approach to fiscal management we’ve seen in places like the UK, the US, and Japan over recent years. That was already underway with the various permanent fiscal measures the government put in place as early as last March (under the guise of a Covid package) and has continued since.

The second, more moderate, stance might be to acknowledge my point but to argue that (a) the economy is only doing as well as it is because of macroeconomic stimulus, and (b) better fiscal policy than monetary policy. I’m not going to dispute that policy stimulus is likely to have helped achieve the welcome economic rebound, and (more specifically) if the government had taken steps in this Budget to (say) cut the cyclically-adjusted primary deficit to 2 per cent of GDP in 2021/22, closing to zero the following year (while reserving the need for possible fresh intervention if Covid got loose here), the economic outlook would – all else equal – be worse than is portrayed in The Treasury’s forecasts.

But all is not equal. The primary tool for macroeconomic stabilisation is monetary policy. A tighter fiscal policy – getting back to balance quickly now that last year’s shock has passed – would naturally and normally be offset by monetary policy, doing its job. The Bank stuffed up going into Covid and wasn’t then able to take the OCR negative (or so it claimed), but even they tell us that is an issue no longer. For those who believe in the potency of the LSAP – and I think all the evidence is against it – there is that tool too. And the beauty of monetary policy is threefold:

  • it costs the taxpayer precisely nothing (relative price shift instead and those best placed to respond do),
  • it can be adjusted very quickly as the outlook and circumstances change, and
  • using monetary policy tends to lower the exchange rate while reliance on fiscal policy feeds an overvalued exchange rate, skewing the economy further inwards.

Monetary policy is, of course, no good at income relief. That is what fiscal policy did so well last year. But that was last year’s need not – as Treasury’s forecasts – the need now or for the next couple of years.

My unease about the Budget is not helped when I dug into some of the macroeconomic numbers.

For example, The Treasury’s forecasts for growth in the population of working age show expected growth in the five years to June 2024 exactly the same now as in the projections for the 2019 HYEFU. Perhaps, but it seems a bit of a stretch, when we know – from Customs data – that there has been a significant net outflow of people (migrants, tourists, New Zealanders, foreigners) over the last 17 months.

And then there are the Treasury’s productivity growth assumptions that seem heroic at best.

productivity growth budget 21

And this even though their text explicitly refers to some degree of permanent “scarring” as a result of Covid. Perhaps they could enlighten us as to what about the economic environment or economic policy framework is likely to generate such strong productivity growth (by New Zealand standards) in the next few years? Covid isn’t something the government can do much about, but nothing else in their policy programme now or in recent years seems likely to begin to reverse the lamentable New Zealand productivity performance. Without that productivity growth, future revenue growth would also be weaker than this Budget is built on.

It isn’t as if The Treasury expect business investment to soar. At best The Treasury seems to think we limp back to the rates of business investment seen in the previous half decade (when the Governor of the Reserve Bank was exhorting firms to invest more, as if he knew better than them where the profit opportunities lay).

bus investment 21

And then there is one of my favourite, but sad, charts

export import shares

Exports and import shares of GDP both rebound, of course, but only to settle at even lower levels than we’ve seen in New Zealand for decades. Successful economies tend to be ones that are exporting successfully lots of stuff to the rest of world and importing lots of stuff from the rest of the world. That isn’t New Zealand. But then we haven’t been a successful economy for a long time now.

Perhaps fiscal policy will come out okay in the end. But when the government isn’t expecting to be back in cyclically-adjusted primary surplus even by 2025, and when the medium-term economic projections seem to rest on some rather rosy assumptions (these and others), it is difficult to be optimistic. Thirty years of sound fiscal management – one of the few real successes New Zealand economic managers could claim – looks to be at risk. And yet the grim fiscal outlook seems to have had astonishingly little coverage, as if last year’s (appropriate) mega-deficit numbers have disoriented people so far that they’ve lost interest in the hard slog of delivering balanced (cyclically-adjusted) budgets. The appropriate size of government – perhaps even the appropriate degree of dependence on government – is rightly the stuff of political debate, but what is spent should be paid for, not simply grabbed from the population – reducing their future spending options – without the normal political conversations around what tax rates are tolerable and acceptable.

Central bank independence

Bernard Hickey – fluent and passionate left-wing journalist – had a piece out the other day headed thus

hickey rbnz

with a one sentence summary

TLDR: Put simply, the sort of true independence enjoyed by the Reserve Bank of New Zealand as it pioneered inflation targeting for the last 30 years is now over, and that’s a good thing.

I found it a strange piece on a number of counts, and I say that as someone who (a) does not think financial regulatory policy (as distinct from the implementation and enforcement of that policy) should be handed over to independent agency, and (b) is probably less compelled now than most macroeconomists by the case for operational independence for monetary policy. So I’m not responding to Hickey’s piece to mount a charger in defence of central bank independence. Mostly I want to push back against what seems to me quite a mis-characterisation of the effect of the Robertson Reserve Bank reforms – those already legislated, those before the House now, and those the government has announced as forthcoming. But also about the responsibility of central banks for the tale of woe Hickey sets out to describe.

It is worth remembering that, by international standards, the Reserve Bank’s monetary policy independence – de facto and de jure – was always quite limited by international standards. Under the 1989 Act the Minister and the Governor jointly agreed the target, but every Governor largely deferred to the Minister in setting – and repeatedly changing – the objective, even if details were haggled over. And with a fairly specific target, and explicit power for the Governor to be dismissed for inadequate performance relative to the target, it was a fairly constrained (operational) independence. The accountability proved to be weaker that those involved at the start had hoped, but it could have been used more.

The monetary policy parts of the Act were overhauled in 2018. There were some good dimensions to that, including making the Minister (alone) formally responsible for setting the monetary policy targets. The Minister got to directly appoint the chair of the Bank’s (monitoring) Board. And a committee was established by statute to be responsible for monetary policy operational decisions. But setting up the MPC didn’t change the Reserve Bank’s operational independence, and if it had been set up well could even have strengthened it de facto over time. The Minister did not take to himself the power – most of his peers abroad have – to directly appoint the Governor or any of the other MPC members. As it is, the reforms barely even reduced the power of the Governor – previously the exclusive holder of the monetary policy powers – who has huge influence on who gets appointed to the MPC (three others are his staff) and who got the Minister to agree that no one with any ongoing expertise in monetary policy and related matters should be appointed as a non-executive MPC members. Oh, and got the Minister to agree that the independent MPC members should be seen and heard just as little as absolutely possible (unlike, say, peers in the UK or the USA).

Hickey cites as an example of the reduced independence the Bank’s request for an indemnity from the Minister of Finance to cover any losses on the large scale asset purchase programme the Bank launched last March. I’d put it the other way round. The Bank did not need the government’s permission to launch the LSAP programme – indeed it is one of the concerns about the Reserve Bank Act that it empowers the Bank to do things (including fx intervention and bond buying) that could cost taxpayers very heavily with no checks or effective constraint. It seemed sensible and prudent of the Bank to have sought the indemnity, partly to recognise that any losses would ultimately fall to the Crown anyway. Operational independence never (should meant) operational license, especially when (unusually) the Bank is undertaking activities posing direct financial risk to the Crown. (And I say this as someone who thinks that the LSAP programme itself was largely pointless and macroeconomically ineffectual.)

What about the other reforms? I’ve written previously about the bill before the House at present, which is mostly about the governance of the Bank. It will make no difference at all to the Bank’s monetary policy operational independence (although increases the risk that poor quality people are appointed in future to monetary policy roles). That bill transfers most of the Governor’s remaining personal powers to the Board. The Minister will appoint the Board members directly (unlike the appointment of the Governor) but even then the Minister will first be required to consult the other political parties, so it is hardly any material loss of independence for the Bank. The Minister will, in future, be required to issue a Remit for the Bank’s uses of its regulatory powers – and we really don’t know what will be in such documents – but those provisions don’t even purport to diminish the Bank’s policy-setting autonomy (notably since it is much harder, probably not sensibly possible, to pre-specify a financial stability target akin to the inflation target).

Details of the next wave of reforms were announced last week. Of particular note is the provisions around the standards that the Bank will be able to issue setting out prudential restrictions on deposit-takers, including banks. I wrote about that announcement last week. Since then more papers, including the (long) Cabinet papers and an official sets of questions and answers has been released. We do have the draft legislation yet, so things might change, but as things stand it is clear that what the government is proposing will amount to no de facto reduction in the Bank’s policymaking autonomy, and only the very slightest de jure reduction.

Why do I say this? At present, the Bank regulates banks primarily by issuing Conditions of Registration (controls on non-bank deposit-takers, mostly small, are set by regulation, which the Minister has control over). Under the new legislation is proposed that Conditions of Registration will be replaced by Standards, which will be issued (solely) by the Bank, but will be subject to the disallowance provisions that are standard for regulations via theRegulations Review Committee. In between the Act (which will specify – loosely, inevitably – objectives and principles to guide the use of the statutory powers) and the Standards, the Minister will be given the power to make regulations specifying the types of activity the Bank can set standards for. Note, however, that empowering the Bank to set standards in particular areas does not compel the Bank to do so (in practice, it is likely to be a simultaneous process)

There was initially some uncertainty about how specific the Minister could get – the more specific, the more effective power the Minister would have. But the Cabinet paper removed most of the doubt.

standards 1

Backed up in the relevant text of the official questions and answers released on The Treasury’s website.

standards 2

That isn’t very much power for the Minister at all; in effect nothing at all in respect of housing lending (since once the new Act is in force the Minister will simply have to regulate to allow a Standard on residential mortgage lending, if only to give continuing underpinning to LVR restrictions). Perhaps what it would do is allow a liberalising Minister to prevent the Bank setting specific standards for specific types of lending but……that doesn’t seem like the Labour/Robertson approach. And once a Minister has allowed the Bank to set standards for residential lending, the Minister will have no further say at all: the Bank could ban lending entirely to particular classes of borrowers, ban entirely specific types of loans, impose LVRs, impose DTI limits, perhaps impose limits of lending on waterfront properties (we know the Governor’s climate change passion). For most practical purposes it is likely to strengthen the independence of the Bank to make policy in matters that directly affect firms and households, with few/no checks and balances, and little basis for any formal accountability. Based on this government’s programme, the age of central bank policy-setting independence is being put on more secure foundations (since the old Act never really envisaged discretionary use of regulatory policy, which crept in through the back door).

Hickey argues that the introduction of LVR controls in 2013 by then-Governor Graeme Wheeler required government consent. In law, it never did. If the law allowed LVR controls – a somewhat contested point – all the power rested with the Governor personally. It may have been politically prudent for the Governor to have agreed a Memorandum of Understanding with the Minister on such tools, but he did not (strictly) have to. At best, it was a second-best reassertion of some government influence of these intrusive regulatory tools.

Now perhaps some will argue that there might be something similar in future too: the Minister might have no formal powers, but any prudent central bank might still seek some non-binding agreement with the government. But I don’t believe that. If the government had wanted any say on whether, say, DTI limits were things it was comfortable with, or what sorts of borrowers they might apply to, the prudent and sensible approach would be to provide explicitly for that in legislation. The old legislation may have grown like topsy, but this will be brand new legislation. The Minister is actively choosing to opt out and given the Bank more policy-setting independence (including formally so for non-banks) on the sorts of matter simply unsuited to be delegated to an independent agency, that faces little effective accountability (see the table from Paul Tucker’s book in last week’s post).

Whether independence should be strengthened or not, the Ardern/Robertson government has announced plans that will do exactly that, while at the same time weakening the effective accountability of the Bank (since powers will be diffused through a large board, with no transparency about the contribution of individual members).

That was a slightly longwinded response to the suggestion that actual central bank independence (monetary policy or financial regulation) is being reduced, in practice or by this goverment’s reforms. I favour a reduction in the policymaking powers of the Bank around financial regulation (the Bank should be expert advisers, and implementers/enforcers without fear or favour, not policymakers – the job we elect people to do).

What about monetary policy. Hickey reckons not only (and incorrectly so far) that monetary policy operational independence has been reduced, but that it should be reduced.

As it happens, I’m now fairly openminded on the case for monetary policy operational independence. One can mount a reasonable argument – as Paul Tucker does – for delegation to an independent agency (since a target can be specified, there is reasonable agreement on that target, there is expertise to hold the agency to account etc). But it has to be acknowledged that much of the case that was popular 30 years ago – that politicians could not be trusted to keep inflation down and would simply mess things up on an ongoing basis – is a lot weaker after a decade in which inflation has consistently (in numerous countries) undershot the targets the politicians (untrustworthy by assumption) set for the noble, expert and public-spirited central bankers.

What I’m not persuaded by is any of Hickey’s case for taking away the operational autonomy. Five or six years ago, I recall him – like me – lamenting that New Zealand monetary policymakers were doing too little to get the unemployment back down towards a NAIRU-type rate (it lingered high for years after the recession) and core inflation back up to target. But now, when core inflation is still only just getting back to target, unemployment is above any estimate of the NAIRU (notably including the Bank’s) Hickey seems to have joined the “central banks are wreaking havoc, doing too much etc etc” club.

One can debate the impact of the Bank’s LSAP programme. Personally, I doubt it has any made material useful macroeconomic contribution over the last year (good or ill – I don’t think it has done anything much to asset prices generally, and not that much even to long bond prices), and as I’ve argued previously it has mostly been about appearing active, allowing the Governor to wave his hands and say “look at all we are doing”. But even if you believe the LSAP programme has been deeply detrimental in some respect or other – Hickey seems to be among those thinking it plays a material part in the latest house price surge (mechanism unclear) – why would anyone suppose that a Minister of Finance running monetary policy last year would have done anything materially different to what the Bank actually did. After all, as Hickey tells us the Minister did sign off on the LSAP programme anyway, and a decisionmaking Minister of Finance would have been advised primarily by…..the Reserve Bank and the Treasury (and recall that the Secretary to the Treasury sits as a non-voting member of the MPC, and there has been no hint that Treasury has had a materially different view).

I think the answer is that Hickey favours a much heavier reliance on fiscal policy – even though he laments, and presents graphs about, how much additional private saving has occurred in many advanced economies in the last year, the income that is being saved mostly have resulted from….fiscal policy. Again, I think the answer is that he wants the government to be much more active in purchasing real goods and services – not just redistributing incomes. I suppose it comes close to an MMT view of the world.

But again there is little sign of anyone much – not just in New Zealand but anywhere – adopting this approach, or even central bank independence being restricted in other countries (what there is plenty sign of is central bankers getting out of their lane and into all sorts of trendy personal agendas – be it climate change (non) financial stability risks, indigenous networks or whatever.

None of this agenda seems to add up when it comes to events like those of the last 15 months. We know that monetary policy instruments can be activated, adjusted, reversed almost immediately. We know that governments are quite technically good at flinging around income support very quickly. But governments – this one foremost among them – are terrible at, for example, wisely using money to quickly get real spending (eg infrastructure) going in short order, and such projects once launched are hard to stop or to adequately control. Monetary policy is simply much much better suited to the cyclical stabilisation role.

Hickey is a big-government guy, and there are reasonable political arguments to have about the appropriate size and scope of government, but they haven’t got anything much to do with stabilisation policy – and nor should they. One doesn’t want projects stopped or started simply for cyclical purposes – brings back memories of reading of how the Reserve Bank wasn’t able to build its building for a long time because the governments of the day judged the economy overheated.

The (unstated) final part of his story seems to relate to a view that perhaps monetary policy has reached its limits. It would be a curious argument, given that much of his case seems to rest of the damage monetary policy is doing (impotent instruments tend to be irrelevant, even if deployed). He repeat this, really nice, long-term Bank of England chart

hickey 2

The centuries-long trend has been downwards, and many advanced country rates are either side of zero. But interesting as the chart genuinely is, including for questions about the real neutral interest rate (something monetary policy has little or no impact on), it tells one nothing about (a) who should be the monetary policy decisionmaker, or (b) the relative roles of fiscal and monetary policy. After all, the only reason why nominal interest rates can’t usefully go much below zero yet is because of regulatory restrictions and rules established – in much different times – by governments and central banks. Scrap the unlimited convertibility at par of deposits for bank notes – not hard to do technically – and conventional monetary policy (the OCR) immediately regains lots more degrees of freedom, able to be used – easily and less controversially – for the stabilisation role for which is it the best tool.

To end, I wouldn’t be unduly disconcerted if the government were to legislate to return to a system in which the Bank advised and the Minister decided on monetary policy matters. It might just be an additional burden for a busy minister, but it would be unlikely to do significant sustained harm (and one of the lessons of the last 30+ years is that central bankers and ministers inhabit the same environment, have many of the same ideological preferences etc) in a place like New Zealand. But to junk monetary policy as the primary cyclical stabilisation tool really would be to toss out the baby as well as the bathwater, no matter how big or active you think government tax and spending should be.

PREFU thoughts

The debt numbers in yesterday’s PREFU are, to me, almost the least concerning aspects of the pages and pages of numbers/charts The Treasury published. My preferred debt measure – net core Crown debt, including the government financial assets held in the NZSF – is projected to peak at just under 40 per cent of GDP. As I’ve noted previously, numbers like that at the start of this year would have put us in the less-indebted half of the OECD countries then. By no obvious somewhat-objective metric is net debt at those sorts of levels particularly problematic, even if bond yields (and eventually, we assume, the OCR) do eventually head back in the direction of more-normal historical levels. And I hope neither main party – whether at this year’s election or that in 2023 – is going to make a fetish of specific timebound numerical targets for a particular debt measure (governments in few other countries do).

That said, the fiscal picture is not a rosy one. And it isn’t just because of Covid one-offs or because of the recession itself. Treasury produces estimates of the cyclically-adjusted balance, and this time gave us numbers that also stripped out those Covid measures. This is the resulting surplus/deficit chart.

CAB ex covid

Treasury estimated that there was a modest structural surplus over the second half of the 2010s, but now reckon the structural deficit will be around 1.5 per cent of GDP once we emerge from the immediate shadow of Covid. A three percentage point deterioration in the structural balance isn’t ruinous in and of itself – and is smaller than the moves in the previous decade – but it isn’t something to be entirely relaxed about either. It is the result of specific choices about permanent spending/tax choices. One would want to be comfortable that spending choices were of a particularly high quality.

I’m rather more bothered by the overall macroeconomic story, and the apparent complacency of The Treasury in these matters – not just as principal macro advisers to the government, but given that the Secretary to the Treasury is a non-voting member of the Reserve Bank Monetary Policy Committee. In four years time, the unemployment rate is forecast to still be materially above the NAIRU (and the output gap materially negative), and inflation is barely getting back to the target midpoint. A standard view of the monetary policy transmission mechanism is that monetary policy works with its fullest effects over perhaps an 18-24 month horizon. And yet on these projections not only has fiscal policy largely done its dash already, but there is hardly any further easing assumed in monetary policy (90 day bill rates drop to 0.1 per cent, but the OCR seems never to go negative). We have macroeconomic stabilisation policy to produce better cyclical outcomes than that. It has the feel of an approach that is just fine with people not likely to lose their jobs – Treasury and Reserve Bank officials – but shouldn’t be counted satisfactory to the rest of the population (and voters). Macro policy can’t solve structural failings, but it can address sustained cyclical weakness. A serious Opposition might make something of this, and reflect on the capabilities and priorities of our macro policy officials, and indeed on those (in the Beehive) who appoint/retain them.

One issue I’ve hammered on about here over the years is New Zealand’s rather woeful foreign trade performance. At the high tide of the latest wave of globalisation, we spent this century to date with the value of exports and imports shrinking as a share of GDP.

Treasury only produces volume forecasts for exports and imports in the PREFU. They aren’t pretty. Of course, (services) exports and imports are currently taking a large hit from closed borders, but Treasury assumes borders are reopened by the start of 2022.

Over the last economic cycle (2007/08 to the end of last year) the volume of New Zealand exports more or less kept pace with the growth rate in real GDP. But on Treasury’s forecasts over the full five years to 2023/2024, real GDP is projected to have risen by 8.4 per cent, while the volume of exports is projected to have risen by only 1.7 per cent. And whereas the volume of imports – things we consume, and use to produce – ran ahead of the growth in real GDP (quite significantly, as real import prices fell), even the latest forecast period to 2023/24 import volumes don’t even manage to keep pace with the subdued growth in real GDP.

As the prices of both exports and imports tend to grow more slowly than general prices (CPI, GDP deflator etc) and since Treasury projects the exchange rate goes nowhere over the next five years, these projections will be consistent with exports/imports falling to around a quarter of GDP. At the turn of the century they were around a third. And yet (growing) trade with the rest of the world is a key element in almost any country’s economic success – particularly for small countries.

The bottom line is perhaps expressed in lost GDP. We could do a simple comparison and look at nominal GDP for the years 2019/20 to 2023/24 from the Treasury’s HYEFU late last year and yesterday’s PREFU. Over those five years, Treasury now expects the value-added from all production in New Zealand will be $140 billion less than they thought just nine months ago. (For what it is worth, there is another $200 billion lost in the following five years, a period Treasury does not forecast in detail). These are really large losses, and on the Treasury numbers the associated wealth is never being made back. Nominal GDP matters for various reasons, including that most public and private debt is expressed in nominal terms.

But, of course, there is also plenty of focus on real GDP per capita. Over the last economic cycle (2007/08 to the end of last year), real GDP per capita. increased by about 1 per cent per annum. That was pretty underwhelming growth, reflecting the poor productivity performance and limited outward-oriented opportunities in turn reflected in weak business investment.

But here is rough comparison between the Treasury projections and a scenario in which we’d continued to stumble along at 1 per cent per annum growth in real per capita GDP.

scenario PREFU

On a rough estimate, the difference between the two lines is just over $100 billion – lost and never coming back. And although the two lines look as though they will eventually converge, my understanding of the Treasury projections beyond the official forecast period is that they don’t. Not only have we lost wealth upfront (that $100 billion) but our real annual income will always be a bit less than we previously thought.

None of these scenarios/numbers looks particularly unrealistically pessimistic to me. If anything, Treasury seems a bit more optimistic than I would be about the wider world economy – given how little has been done with monetary policy, the approaching political limits of fiscal policy, and the way that all societies look to be materially poorer than they would have thought just a few months ago, it is difficult to be very optimistic about the likely pace of sustained economic rebounds anywhere. And while Treasury assumes that we keep on in the medium-term with our modest productivity growht, it isn’t obvious even how that is going to be achieved – it is not as if either political party has any sort of serious economic plan. It doesn’t take aggressive fiscal consolidation here or abroad to think that private spending growth (consumption and investment) is likely to be really rather subdued for quite a long time to come.

Much of the political debate tends to turn on how much more debt governments have taken on, how much more public spending has been done. And there are important issues there, that deserve ongoing scrutiny, but at least as important is just how much poorer we now look likely to be than we thought just a few months ago. Fiscal policy redistributes among people in New Zealand, but even with all that fiscal support, as a country we are in aggregate so much poorer than we expected to be. And that will influence behaviour, choices, appetite for risk etc in the years ahead.

(Oh, and finally, I don’t have space to labour the point, but isn’t there something shameful when The Treasury reckons that – with no new fiscal or monetary stimulus – current structural features of the housing market (land use, immigration and whatever else) mean that they expect 7.4 per cent house price inflation in 2022/23 and a further 8.5 per cent the following year. That, not whether prices fall a bit this year as ,eg, unemployment rises, should be getting a lot more attention that it seems to be.)