Two charts

….on unrelated matters.

One of the objections sometimes raised to my advocacy of a deeply negative OCR is along the lines of “it will only lift asset prices”, with the implication –  and sometimes directly stated –  that that is what has happened in the last decade or so, even as policy rates in most of the advanced world fell from materially positive numbers to somewhere near zero.   In 2007, policy rates in the US and the UK had been over 5 per cent, in the euro-area 4 per cent, and in New Zealand and Australia higher than all those rates.   Only Japan was then in the extreme low interest rate club.

The asset price that tends to attract most attention in New Zealand is house prices (really house+ land).  The Bank for International Settlements maintain a nice quarterly database of real house prices for a large group of advanced and emerging economies.

Here is what has happened to real house prices for the largest advanced economies, and for the advanced economies as a whole, over the 12 years from the end of 2007 to the end of last year.

house prices to end 2019

Very little change at all.

The aggregate advanced economy measure only starts in December 2007, and for quite a lot of countries the data starts getting thin for earlier periods.   But for the UK, the euro-area, and the US, I had a look at the previous decade –  over which period policy interest rates hadn’t changed much at all (ups and downs of course during the period) – and in each case real house prices increases were much more rapid in that period than in the more recent (extremely low interest rate) one.   The US had experienced a 53 per cent increase in house prices –  and they had already fallen back from peak by the end of 2007 –  and the euro-area a 40 per cent increase.  In Japan –  very low interest rates throughout –  real house prices had fallen substantially over the 1997 to 2007 period.

Of course, within these aggregates for the last decade or so there is a lot of cross-country variation.  We all know real house prices in New Zealand and Australia have risen a lot.   In some other countries, they’ve fallen a lot.    But even in New Zealand, Australia and Canada, the rate of increase has been less in the last (low interest rate) 12 years than it was in the previous decade.

That shouldn’t really be a surprise.  After all, in principle, houses are reproducible assets (some labour, some timber, some concrete, some fittings) and in few countries is very much of land built on.   Moreover, interest rates aren’t where they’ve been as the result of some toss of a coin, or a draw from a random number generator; they reflect underlying changes in savings/investment imbalances, which central banks adjust policy rates to more or less reflect.

When a wide range of countries have had fairly similar interest rate experiences (and inflation outcomes; the check on whether monetary policy is out of step), and yet have had very different house price experiences, it probably suggests that some non-interest rate factors have been at work.   Of course, in some cases, that might just mean working off past crises –  although if you want to cite the US there (a) recall that by the end of 2007 real house prices had already fallen by 15 per cent from peak, and (b) that in the boom years nationwide real house prices in the US never rose as much as they did in, for example, Australia and New Zealand.

A more plausible story is that some combination and land-use restrictions and population pressures continue to explain a lot about differential house prices performance in the years since 2007.   In New Zealand and Australia, for example, we have had tight planning restrictions and rapid population growth.    I don’t know much about planning rules in central and eastern Europe, but there isn’t much population growth (deliberate understatement here) in countries with strong economic growth such as Bulgaria, Romania, Slovenia, Slovakia and the Baltics.   It isn’t a simple one-for-one story, but taken across the advanced economies as a whole it just doesn’t look as though low interest rates are a credible part of the house price story –  house prices, in aggregate, not having done much at all.

Of course, had central banks completely ignored the market signals re savings/investment pressures and simply held policy rates up then no doubt house prices would have been lower.  Then again, we’d also have had persistent deflation and (more importantly) unemployment rates that stayed much higher for longer and more persistent losses of output.

On a completely different topic, I found myself yesterday on an email exchange with some fiscal hawks, very worried about the future level of public debt.

I’ve noted previously that on the Treasury budget numbers our ratio of net debt to GDP in 2023/24 would still be sufficiently modest by international standards that if we had had that high a debt ratio last year, we’d still have been (narrowly) in the less-indebted half of the OECD.

Another way of looking at things is to take the government at their word and assume that by the end of the forecast period the Budget is more or less back to balance, such that the nominal level of debt stabilises at the level forecast for the end of 2023/24.

If that were to happen that what happens to the debt ratio depends on how much growth in nominal GDP the economy manages in the years ahead.   If we assume that the terms of trade is stable (or that the only safe prediction is that we don’t know, so assume no change), then there are three components to the rate of growth of nominal GDP.    As an illustrative experiment I jotted down a range of possible average outcomes for each.

Average annual growth
Low High Average
Population 0 1 0.5
Productivity 0 1.5 0.75
Inflation 1 2 1.5
2.75

So I’d assume growth in nominal GDP averaging 2.75 per cent over the decades beyond 2024.  Of course, there will be booms and recessions in that time, but this is just an average.   And then I’ve taken two alternative scenarios –  one in which nominal GDP growth averages 2.25 per cent, and one in which it averages 3.25 per cent.   Those aren’t extremes, and one could envisage even higher or lower numbers.

But this is what a net debt chart looks like out to 2064.

net debt scenarios

Even on the worst of these scenarios this (exaggerated, because it excludes NZSF assets) net debt measure is back to 30 per cent of GDP by 2050.   That doesn’t seem too bad to me for a one in a hundred year shock (as the government likes to claim) or –  less pardonably –  a one in 160 year shock as the Reserve Bank Governor was talking up the other day.

Of course, fiscal hawks will say, “but what if another really nasty shocks happens in the meantime?”.  Well, of course we would have to face that if it comes –  and it could –  but, as I noted, our net debt at peak is not high by pre-crisis international standards, and isn’t even high by our own longer-term historical standards.

Governments might choose to lower the debt faster, although if real servicing costs remain low it is difficult to see why one would, since faster consolidation involves either higher taxes than otherwise (with real deadweight costs) or less spending than otherwise (and while each bit of spending has its own antagonists, there is a case to be made for most of it).   There is precisely no evidence that anything important would suffer if our net public debt took a trajectory something like the central scenario in that graph.

(Of course, it is a purely illustrative scenario, and the composition of nominal GDP growth does matter to the budgetary implications –  eg faster population growth means more infrastructure demand, faster inflation might mean some unanticipated inflation tax, faster productivity is more like pure gain –  but there is no reason to suppose that if governments can get back to balance (as they repeatedly have now for decades) that we will need anything much beyond that.  Getting back to balance will require discipline and focus –  and a strong credible recovery would help –  but since most of the fiscal measures to date have been avowedly temporary, doing so should not be beyond our political system, whichever group of parties happens to be governing by then.

Financing the government

In normal circumstances governments finance themselves primarily with visible legislated taxes, with a bit of additional debt on the side.

In New Zealand, over the last complete 10 years, core Crown revenue was $715 billion (mostly taxes) and debt contributed between $10 and $40 billion –  depending which gross or net measure you prefer.    That borrowing was almost all from the private sector, again as one would expect.  The Reserve Bank’s holdings of government bonds. for example, hardly changed at all (nor did bank settlement cash balances at the Reserve Bank).   And the government mostly had credit balances in its account at the Reserve Bank.

In the last couple of months, everything has been thrown up in the air.   On the Budget numbers I mentioned in Friday’s post, almost a quarter of government spending over the five years (including 2019/20) is expected to be financed by increased debt.   And on the Reserve Bank’s own numbers we could easily see at least half of that increase in debt take the form of Reserve Bank lending to the Crown (the forecast rise in net debt is $134 billion, and the Governor has talked of the possibility of raising further the current $60 billion limit on the LSAP programme).

That the Bank is buying those bonds on the secondary market, rather than getting some or all direct from the government (as some advanced country secondary banks are now doing to an extent), is a second or third order issue, making little or no macroeconomic difference.   The important point at present is that (a) the Bank is buying the bonds, and (b) the Bank is sterilising the liquidity effect on those purchases by paying an at-or-above market rate on the resulting settlement cash balances.

Oh, and the most important points of all were that the decision to buy bonds at all is (a) wholly a decision for the Monetary Policy Committee, and (b) working with an unchanged (from pre-crisis) mandate: delivering inflation near 2 per cent and, as much as it can consistent with that, supporting employment.  The government has given the Bank an indemnity, which makes the Bank feel more comfortable taking the associated interest rate risk, but if the government had not done so, it need not have stopped the Bank making the purchases if the MPC felt that was what the monetary policy mandate required.

I wrote about all this a month ago when there was first a flurry of concern about reported comments suggesting that at some point the Bank might buy bonds direct from the Crown, in a post intended to be basically supportive of the Bank.

Now, as you know, I don’t think the LSAP is making much difference at all now to anything that matters much to macroecononomic outcomes.  It is slightly perverse in that it involves shifting the duration of the Crown’s effective debt portfolio much shorter –  swapping long-dated government bonds for on-demand instantly repriceable settlement cash liabilities –  but if you believe interest rates are going to be low for quite some time, you might even downplay that.  Other than that, it probably does little harm –  and adds to our database of monetary experiments for future analysis – if little good.

But in the last couple of weeks there have been a number of comments from the Governor that suggest that something much more troubling is afoot.

The first hint I heard of it was when the Bank turned up to Parliament’s Finance and Expenditure Committee on the day after the Monetary Policy Statement.  This is an extract from the post I wrote then.

Goldsmith asked the Governor about those comments a few weeks ago that the Bank could consider buying government bonds directly from the Crown, rather than (as at present) in the secondary market.  He seemed to just be wanting to close off the issue, but the Governor opened it up all over again, in a way that seems to have attracted no attention.

The expected answer would probably have been along the lines that there were no plans at present, the secondary market was working well, but if there ever were dysfunction there was really no macro difference in the Bank buying direct, so long as the decision rested with the Bank, consistent with the inflation target.   In backing the Governor on this point previously, that is what I have said.

Instead, the Governor launched into a discussion noting that while the Bank did not rule out lending direct to the Crown, that was really fiscal policy not monetary policy, that the central bank can always lend as much as fiscal policy requires, but that that would be a matter for the government to decide, not the Bank.

Goldsmith then challenged him on that, asking whether he was really saying that the Minister could decide whether the Bank would lend direct.  Orr reiterated the possibility of market dysfunction, while noting that at present markets were functioning well, but then repeated that what he called “pure monetary financing” would be a matter for the Minister of Finance to decide.

At this point, the Governor invited the Deputy Governor Geoff Bascand –  usually the safe pair of hands in that senior management cohort –  to comment.  He indicated that it would be a matter of ministerial direction, but which would involve a substantial process including looking at whether what the minister might be directing would still be consistent with the existing price stability etc target.  And then he tried to close things down by suggesting that this was all just an “esoteric discussion”.

Reasonably enough ACT’s David Seymour reacted to that, suggesting that if the Bank was seriously saying the Minister of Finance could direct them to lend to the government, in any amount he chose, it was “anything but esoteric”.

I went on to articulate the (possibly) relevant provisions of the Act as I saw them, concluding

But……there is no hint in this provision [section 12 override powers], or anywhere else in the Act, suggesting that the Minister of Finance can direct the Bank to lend to the government.  Perhaps the Bank and its lawyers think/worry that “lend to the government at zero interest up to $…billion” is an alternative “economic objective” within the meaning of section 12 of the Act.   But, at very least, it would be a stretch –  it isn’t an “economic objective”, but an instrument,  and favouring one specific party in the economy.    And note that if a government did attempt to impose such an “economic objective” there would still be nothing to stop the Bank setting interest rates for the rest of the economy at a sufficiently high level to counter the inflationary effects of this coerced lending.

I’m at a loss to know what the Governor and Deputy Governor mean.   I’m tempted to lodge an OIA request, but am not sure I’ll bother, as they would find myriad ways to refuse to release anything.  But journalists could directly ask the Bank what the Governor/Deputy Governor were on about?   MPs could use parliamentary questions to ask the Minister of Finance whether (a) he has received any advice as regard his direction powers over the Reserve Bank, and (b) whether he or Treasury believe he has the statutory power to compel the Bank to lend to the Crown.  Most everyone I’m aware of has always assumed they can’t –  and took great reassurance in that –  so if the powers that be now believe differently we deserve to know?    (Of course, if the government just wants more inflation, it can always raise the inflation target, but that is a rather different issue).

And there I left it, a bit puzzled, none the wiser, and even wondering whether Orr had perhaps confused some details and there really wasn’t anything to worry about.

At least until over this last weekend.  Then I happened to listen to a post-MPS presentation Orr had given to clients of Jardens (on 15 May), in which he touched on the issue and noted that (paraphrasing from my notes) “if we were to take a direction from the government to finance it directly – as distinct from what monetary policy needs might imply – we would have to have different legislation”

I then read an interesting interest.co.nz article reporting comments the Governor had given to their journalist Jenee Tibshraeny late last week in which this topic was addressed at some length.

Orr said it was up to government to decide if it wanted to go further and give the RBNZ the mandate to buy bonds for fiscal policy purposes, rather than monetary policy purposes – IE buy bonds to help pay for government spending initiatives rather than to keep inflation and employment in check.

“There’s no right or wrong,” Orr said.

“It’s just that it is different and you would need legislative and/or institutional instructions, because when I last looked at my job description, I’m not allowed to go off and buy whatever I feel like because I’ve got the ATM…

“That would take some significant transparency as well as operational structures to ensure everyone knew who was doing what, why, how, where, when.”

Asked whether he would be hesitant to go down this path if Robertson asked him to, Orr responded: “Yes, I mean, it really depends to what purpose… and under what conditions is this managed.

“Because you could take it to the extreme immediately and you’ve gone back in time 30, 40 years and the central bank is being used as the ATM for a government and it’s unclear whether we can control inflation anymore, and it’s back in the hands of the elected officials…

“It’s not for me to choose the policy. I would implement the policy, but I would be extremely cautious about making sure the risks are understood, managed and mitigated wherever they could be.

“And I imagine I would be surrounded by many many people with free and often unsolicited advice around whether it did or didn’t work… which is good…

“People are very passionate about the structures that have been built and you don’t muck around with them lightly.

“These things are achievable; they’re just different.”

On the one hand, it is good to know that the Governor seems to think that under current law he can’t just go and buy anything he likes (he probably can, but it has to be consistent with the Bank’s statutory functions, including the monetary policy Remit the Minister has given him, which in turn is subordinate to the Act).   But then note those Bascand comments earlier suggesting the Bank thinks it could be directed under existing legislation, even if that might involve overriding or changing the Remit.

The Bank has clearly been giving such radical options quite a bit of thought, not just as extreme contingency plans (Parliament, being sovereign, can empower almost anything) but as something they are quite openly talking about.    That suggests something that they are either keen on themselves, or which the Minister and/or Treasury has raised fairly seriously as a possibility.

Given the Governor’s longstanding belief in a bigger government and a more aggresssive use of fiscal policy, it wouldn’t be entirely surprising if this were something he was championing (indeed, it would be the best explanation for why (a) he is the only one talking about it, and (b) doing so in a non-negative sort of way).

Going down such a path would, however, be a seriously retrograde step. Perhaps it might lift inflation expectations a bit –  governments acting to direct the central bank to lend to them will create some concern – but in a quite undesirable sort of way (even if Social Credit and the more rabid MMT enthusiasts might be salivating at the prospect).

For a start, there is no obvious need for such a mandate.  The New Zealand government is a highly creditworthy borrower which, on current government plans, will remain one of the least-indebted of all the advanced countries.   One can never rule out a new extreme global crisis that might seize up markets for a few days, but the prospects of the New Zealand government not being able to issue on market the quantity of debt believes it requires is slim indeed.   And the Crown already has an overdraft facility at the Reserve Bank that it can draw on to smooths ups and downs.

More disconcertingly, although technically the Reserve Bank could be required to lend to the government –  beyond anything consistent with the Remit –  and that wouldn’t immediately tip us into serious inflationary problems, it would be a highly distortionary policy.  In principle, the Bank could lend lots of money to the Crown at zero interest, and the government then further increases its spending beyond what would normally be consistent with the inflation target. If that happened, you would expect the MPC to start raising the OCR, to keep overall demand in check.  And then we’d be in the bizarre throwback world in which the government was borrowing for zero and the rest of the economy faced really quite high interest rates, squeezing out private sector activity to favour the government.

I’m not going to allow myself to be drawn into an inconsistency here.  At present, if anything, the presenting issue is that the Reserve Bank is not doing its core monetary policy job sufficiently well that either the market, survey respondents, or the Bank itself believe that inflation will be consistent with the target set for them.  If they persist in that stance, amid a really savage recession, I believe the Minister of Finance should act, using existing powers either to replace the key individuals (to ensure the current Remit is being followed) or to explicitly direct the Bank to adopt an easier monetary policy (consistent with the current Remit over the medium term).  Those powers are in the Act for a reason, to protect citizens.   There is no such power to direct the Bank to lend to the government and there has long been an international consensus that it would be quite unwise to provide for such a power.  It would be to step away from any sense that monetary policy operates in a neutral way, not setting out to favour or disadvantage any particular party or sector (private or public), and into a world where governments could regard control of the “printing press” as an acceptable way for them to finance their spending (or reluctance to tax) preferences.  With reasonable people, it isn’t some immediate path to hyperinflation, but it would be undesirable on numerous counts and further increase the politicisation of the Reserve Bank.

One can make an argument against central bank operational autonomy –  I sometimes come and go and whether there are real advantages that justify the costs and lack of accountability (part of the reason why I keep on about enhancing real central bank transparency) – but giving the government reason to think control of the printing press is a legitimate tool has nothing going for it at all.

We need some answers as to just what is going on.   When I tweeted about this on Saturday, Tibshraeny responded

That is encouraging, and I will look forward to her story.  But if Robertson –  who always seem conservative and risk averse (sometimes beyond what is warranted) – is not interested, then what cause is Orr championing, to what end, and why?

If he thinks more macroeconomic stimulus is required, try conventional monetary policy (would have helped, of course, if he’d sorted out those alleged “operational issues” some banks are claimed to have, but even those obstacles exist they can be overcome).  If the governments thinks it needs to spend more, the conventional options are still open to them –  higher taxes (probably not a great idea at present) or tapping the global market for public debt.  Maintaining that borrowing capability was, as you’ll recall, one of the main reasons why successive governments kept net debt low and stable.  (Of course. it also has a $40 billion fund –  which it insists on putting more money into, even as its new borrowings are large, to speculate on world markets –  much of which could be quite readily liquidated.)

 

 

Losing $128 billion

I don’t usually pay much attention to forecasts of nominal GDP.  Not many people in New Zealand really seem to.  But The Treasury takes nominal GDP forecasts more seriously than most, since nominal GDP (in aggregate) is, more or less, the tax base.

Out of little more than idle curiosity I dug out the numbers from last December’s HYEFU forecasts –  the last before the coronavirus –  and compared them to the numbers published in last week’s BEFU, accompanying the Budget.  And this was what I found.

Nominal GDP ($bn)
HYEFU BEFU Difference
2019/20 319.8 294.2 -25.6
2020/21 336.4 294.2 -42.2
2021/22 354.1 328.3 -25.8
2022/23 371.5 352.3 -19.2
2023/24 389.2 374.3 -14.9
Total 1771 1643.3 -127.7

Over the full five years, New Zealand’s nominal GDP is projected to be $128 billion less than The Treasury thought only a few months ago.

Recall that changes in nominal GDP can be broken down into three broad components:

  • the change in real GDP  (the volume of stuff produced here),
  • the change in the general price level (inflation), and
  • the terms of trade

On this occasion, changes in the terms of trade make only a tiny difference over the five years taken together.

General (CPI) inflation is expected to be lower than previously thought.    On average over the five years, the price level in the BEFU forecasts is about 1.8 per cent lower than in the HYEFU forecasts.  That accounts for about $33 billion in lost nominal GDP.

The balance –  the overwhelming bulk of the loss –  is real GDP.

I haven’t written anything much about The Treasury’s forecasts, which were done quite a while ago, and could not fully incorporate the final fiscal decisions the government made.  But for what it is worth, I reckon Treasury’s numbers were on the optimistic side –  quite possibly on all three components of nominal GDP.  On inflation, for example, they are more optimistic than the Reserve Bank (which finished its forecasts later), even as they assume tighter monetary conditions than the Bank does.

But the point I really wanted to make was that these forecast GDP losses will never be made back (in the sense that some future year will be higher to compensate –  resources not used this year mostly represents a permanent loss of wealth).  And that these losses occur despite all the fiscal support (and rather limited monetary support).   And fiscal here includes both the effects of the automatic stabilisers (mainly lower tax revenue as the economy shrinks) and the discretionary policy initiatives (temporary and permanent).

How large are those fiscal numbers?  Well, here is core Crown revenue (more than 90 per cent of which is tax)

Core Crown revenue ($bn)
HYEFU BEFU Difference
2019/20 95.8 89.5 -6.3
2020/21 101.6 87 -14.6
2021/22 106.5 94.6 -11.9
2022/23 112.7 104 -8.7
2023/24 117.7 109.9 -7.8
534.3 485 -49.3

Almost $50 billion the Crown was expecting but which it won’t now receive.  Some of that will be the result of discretionary initiatives –  the corporate tax clawback scheme, much of which will result in permanent losses, and the business tax changes announced in the 17 March package –  but the bulk of the loss will be the automatic stabilisers at work.

And on the expenditure side?

Core Crown expenses ($bn)
HYEFU BEFU Difference
2019/20 93.8 114 20.2
2020/21 98.8 113.5 14.7
2021/22 102 119.8 17.8
2022/23 106.3 118.6 12.3
2023/24 109.2 113 3.8
Total 510.1 578.9 68.8

Almost $70 billion of current spending the Crown didn’t expect to make only a few months ago.  A small amount of this will be the automatic stabilisers at work (the unemployment benefit), but The Treasury is pretty optimistic about unemployment.  Most of the change is discretionary policy initiatives (announced or provided for).

And here is the change in net debt

Net core Crown debt (incl NZSF) as at year end  ($bn)
HYEFU BEFU
2018/19 14.1 14.1
2019/20 14.6 47.6
2020/21 17.6 82.8
2021/22 17.1 111.7
2022/23 12.3 131.7
2023/24 3.9 138.2 134.3

That will be almost $135 billion higher than expected.

As I’ve noted in earlier posts, I don’t have too much problem with the extent of overall fiscal support (although I would have structured it differently and made it more frontloaded –  consistent with the “pandemic insurance” model).

But even on this scale, fiscal policy is nowhere near enough to stop the losses.  Some of those losses are now unavoidable.  It is only five weeks until the end of 2019/2020, so we can treat $26 billion of nominal GDP losses (see first table) as water under the bridge now.   As it happens, fiscal policy looks to have more than fully “replaced” the income loss in aggregate (whether $27 billion from operating revenue and expenses in combination, or the $33 billion increase in net debt) –  not as windfall, but as borrowing (narrowing future choices).   (UPDATE: Even in quote marks “replaced” isn’t really quite right there, as without the fiscal initiatives it is near-certain that actual nominal GDP would have been at least a bit lower than The Treasury now forecasts, even for 19/20.)

But there is a great deal of lost income/output ahead of us, even on these (relatively optimistic) Treasury numbers.

Which is really where monetary policy should be coming in.   The Treasury assumes that monetary policy does almost nothing: there is no further fall in the 90 day rate (the variable they forecast), and as they will recognise as well as anyone inflation expectations have fallen, so real rates are little changed from where they were at the start of the year.  And although the exchange rate is lower throughout than they assumed in the HYEFU, the difference is less than 5 per cent –  better than nothing of course, but tiny by comparison with exchange rate adjustments that have been part of previous recoveries.  It isn’t entirely clear how The Treasury has allowed for the LSAP bond purchase programme, but whatever effect they are assuming…….there is still a great deal of lost output.

The Governor has often been heard calling for banks –  private businesses – to be “courageous”.  It is never quite clear what he means, but he apparently wants to risk other peoples’ money.  But the central bank is ours –  a public institution.   A courageous central bank, that had really grasped the likely severity of this slump, could have begun to make a real difference.  If they’d cut the OCR back in February, and taken steps to ensure that large amounts of deposits couldn’t be converted to physical cash, and then cut the OCR to deeply negative levels (perhaps – 5 per cent) as the full horror dawned, we’d be in a much better position now looking ahead.     Wholesale lending and deposit rates would be substantially negative at the short end, and even real rates on longer-term assets might be as low as they now, without much need for bond purchases.   Retail rates might also in many case be modestly negative –  perhaps for small depositors achieved through fees.   And, almost certainly, the exchange rate would have fallen a long way, assisting in the stabilisation and recovery goal.  There are winners and losers from such steps –  as there are from any interventions, or from choices just to sit to the sidelines –  but it is really just conventional macroeconomics: in a time of serious excess capacity and falling inflation expectations, act to seek to bring domestic demand forward, and net demand towards New Zealand producers.    Working hand in hand with the substantial fiscal support (see above), we’d be hugely better positioned to minimise those large future nominal GDP losses –  losses that at present, we risk never making back.

But neither the Governor nor, apparently, the Minister of Finance seem bothered.

Finally, if nominal GDP appears to be a slightly abstract thing, it is worth recalling that almost all debt is nominal and it is nominal incomes that support outstanding debt.  There is about $500 billion of (intermediated) Private Sector Credit at present (and some other private credit on top of that).  Most likely that stock won’t grow much over the next few years. But government debt will –  on Treasury’s numbers net debt rises by $134 billion.   Against those stocks, a cumulative loss of nominal GDP of $128 billion over five years is no small loss.  As noted earlier, amid all the uncertainties, the precise numbers are only illustrative, but the broad magnitude of the likely losses (on current policies) are what –  and that magnitude is large, if anything perhaps understated on The Treasury’s numbers.

 

Insufficient macro policy action

Before getting into the substance of this post, let me note that for a Budget allegedly ‘all about jobs’ our official data are so grossly inadequate that our next official employment/participation/unemployment data won’t be available until early August and then it will be only quarterly.  By contrast, the US and Canada released their April (monthly) data last week.  Here, Statistics New Zealand has shown no sign of being willing to release on an experimental basis –  for the duration of the crisis – the results of each monthly set of interviews they do (of which there are thousands) and sent out a note a couple of weeks ago suggesting that even the full quarterly labour market data may be less than ideal.  It is at times like these that the gaps in New Zealand’s official macroeconomic data are most glaring –  and yet there was no sign (I heard/saw) of anything in yesterday’s Budget to remedy these failings, the combined outcome of neglect by successive governments (mainly) and by SNZ itself.   Analysts are left looking to the data for other countries, and attempting to interpret them in light of the (typically smaller) falls in GDP expected in those countries.   Looking at those Canadian and US numbers suggests pretty severe labour market excess capacity here (no matter how many people are twiddling their thumbs but not technically unemployed or out of the workforce, under the cover of the wage subsidy scheme).

What of the Budget itself?

I’m really not bothered by the fiscal bottom lines.    If one takes the government/Treasury numbers at their word then in the year to June 2024, core Crown expenses will be about the same (share of GDP) as they were in the year to June 2014, while core Crown tax revenue will be about the same share as in the year to June 2015.    I’m not entirely convinced nominal GDP by then will be as high as Treasury supposes, but the critical point here is that most what the government is spending as a response to the crisis isn’t a permanent worsening in the structural primary balance.  If so, then as the economy recovers –  and future governments restrain themselves – we get back to balance, and then debt/GDP ratios drop away steadily, even if future potential nominal GDP growth were to be as low as 2-3 per cent.   When I saw those tax/spending comparisons, it reminded me of the fairly far-left commentator I saw yesterday suggesting that the Budget might have been the sort of thing Bill English might have brought down in the circumstances (not, of course, intended as a compliment to anyone, Labour or National).   In the detail, that probably isn’t quite right, but National threw money at Kiwirail too, and did all sorts of other spending people on the right didn’t much approve of.

What of the debt itself?  I try never to pay any attention to the government’s preferred net debt measure, and to at least focus on the measure that includes all the money in the New Zealand Superannuation Fund.  For some reason, not known to me, the government is going to put lots more money in the NZSF over the next few years –  beyond what the statutory formula provides for –  as if having a flutter on the world markets, at your risk and mine, was an important part of a recovery programme.  On that measure, net debt as per cent of GDP peaks in the year to March 2023 at 37.4 per cent (up from 4.6 per cent in June 2019).  On the then Crown net debt measure, the recent peak was about 48 per cent in 1990 –  at a time when real interest rates (servicing costs) were almost breathtakingly high.   And although there is a lot of folk memory about the pressures then, they were political more than economic, and it is worth remembering that in 1990, our overall net (negative) international investment position was quite a bit larger than it is now.   As I noted in a post a couple of weeks ago, a hundred years ago we had much more government debt again (per cent of GDP).

And international context isn’t irrelevant.   For international comparisons, I reckon the best measure is the OECD’s measure of net general government financial liabilities as a share of GDP.  In 2019 the OECD estimate that New Zealand (all layers of government) had net financial assets of 3 per cent of GDP.   Add, say 36 percentage points of GDP to that – the 32.8 from core Crown and a bit more from local authorities and other total Crown entities – and we’d have net financial liabilities of 33 per cent of GDP at peak.     Round it up to 35 per cent and if we’d have that much debt last year we’d still –  then – have had about the 14th lowest net debt ratio among the OECD countries.

Do I have instinctive bias toward net government debt being close to zero?  Yes, I do, but (a) disasters and good times will alternate, and (b) even though I often make the point that interest rates are low for a reason (and can’t just be assumed to be a windfall) the drop in real interest rates is larger than the slowdown in the underlying rate of growth in the economy.  It is quite rational to be more relaxed about higher debt ratios now than we might have been 30 years ago.

None of which is to say the a cavalier approach should be taken to the spending/tax choices that get us to the higher debt level.  All such choices have opportunity costs –  the possibility that the money could, perhaps should, have been used for better initiatives, perhaps with long-term payoffs for the economy or wider society.

I’m not entirely persuaded by the particular ways the government has gone about distributing money.   The wage subsidy scheme was initially conceived in a climate in which it might, almost reasonably, have been assumed that the old pattern of the economy would be back again very soon –  as soon as the PRC got on top of the virus.  As it is, the largest of those initally-affected sector (tourism) may well be the very last to get back to anything like pre-crisis normal –  and, for now, as matter of policy we don’t even want it to (given we have travel bans in place). In a sense, yesterday’s extension of the policy only reinforces that bias –  the people who can claim 50 per cent reductions in monthly revenue (from the same period last year) by next month are likely to be mostly firms in the tourism and associated sector.  But it may be many years –  who knows how the virus will progress globally, let alone here –  before anything like the pre-crisis capacity is required from those firms, if (as individual firms) they have a place at all.    And so we will be in the weird position where firms that face reality soonest and close in the next few weeks will see their workers miss on the extended wage subsidy, while those who cling on – whether from over-optimism or just supporting their workers short-term –  will get the money.

There are other oddities.  The company tax clawback scheme –  allow companies making losses now to offset those against past income and get a refund of past tax paid now –  will act as a gift for the firms that fail (since there will never be profits again) but only a loan to those that succeed.   Given that many of the firms that do fail will be in the sectors that are likely to come back only slowly, there seems no compelling public policy interest for that approach.

Or, as I’ve pointed out previously this week, the weirdness that see the new “bank of the IRD” lending to smallish businesses at a zero interest rate, even as retail lending rates for businesses that can’t get debt funding elsewhere, while existing borrowers are stuck with real interest rates that may have made sense last year but which aren’t fit for this year.

It isn’t that I’m opposed to a pretty liberal approach.   Earlier in the crisis I argued for thinking of assistance in terms of a national pandemic insurance policy –  under which, perhaps, we might guarantee 80 per cent of last year’s income for this year (or, as some commenters suggested, even just for six months).  Part of the attraction of that model was that it wasn’t tied to trying to keep existing firms in place –  it provided a buffer, and time, but left it up to individual firms’ owners to decide about what was best for the future, and treated equally those who had no work –  whether or not they still had a formal tie to a previous firm.   People suggested that the likely cost was too high, but actually I reckon total debt would have been no higher than what the government is now proposing, and the framework for the distribution of upfront assistance would have made more coherence.

But even though the pandemic insurance approach might have helped, at the margin, in securing a recovery, recovery itself was never the prime focus –  it was always primarily about income support, and buying time.  Recovery was always going to rest more on (a) the passage of time, (b) a recovery globally, and (c) domestic monetary policy.

I suspect that, even on the government’s fiscal plans yesterday, that is still the case, but unfortunately with almost nothing from monetary policy.

The one chart that caught my eye in the BEFU document was this one of the fiscal impulse measure.

impulse measure

I’ve written previously about the impulse measure, which was first developed perhaps 20 years ago by The Treasury to help give the Reserve Bank a better sense of how much discretionary fiscal policy was adding to demand.  In my experience, it wasn’t always that good for the most recent few years –  there is quite a lot of unpicking goes on working out what is potential output etc –  but that for forecast periods it was a good indicator, and for periods well enough in the past generally quite useful too.

In this chart, there are two periods of a substantial positive fiscal impulse –  around the time of the last recession, and now.  For the previous episode the positive fiscal impulse over the two years is equal to just over 4 per cent of GDP.    OECD estimates, done independently, suggest something of that magnitude or perhaps a bit higher.  There was a lot of fiscal support in the works –  not from crisis-response measures, but from the big easing in the fiscal policy the government had put in place before it realised a serious recession was upon us.

And what does Treasury think is happening now?    The total fiscal impulse across the two June years (2020 and 2021) is around 8 per cent of GDP, most of which is happening in the year just about to end.  Beyond that –  as really must happen if the fiscal situation is to be kept in check – the fiscal impulse, on current government policy, is really quite materially negative (perhaps almost implausibly so later in the period).

The fiscal impulse is reasonably materially larger –  optimistically, perhaps double –  than it was at the time of the last recession.  Then again, the adverse economic shock is much larger –  even if one were able to look through this quarter and next.

And, to be boring and repeating a point (that nonetheless seems to keep being made):

  • there was huge amounts of effective monetary support in the last recession (substantially lower real retail and wholesale interest rates, and a sharply lower exchange rate), for which there is no parallel at all this time (notwithstanding the big and expanded bond purchase programme), even if the Bank is inching ever so reluctantly towards a possible negative OCR next year, and
  • even though the unemployment rate rose only by just over 3 percentage points at peak, it still took 10 years after 2007 to get unemployment back to a level that some –  notably the Reserve Bank –  plausibly might consider a normal (NAIRU) sustainably level.

And in the years after 2008/09 we had the fruits of a strong terms of trade and a big boost to effective demand from the Christchurch repair and rebuild process.

It simply doesn’t seem credible that there is anything like enough policy stimulus in the works now, and (perhaps especially) looking just a few months ahead (the more so when we bear in mind that there is no certainty all the big fiscal numbers will be carried through, including because the election is close).   In a sense, as I noted in yesterday’s post, the Reserve Bank’s (more recent) forecasts tell that story, with inflation forecast to be below the bottom of the target range for the next two years, while the Bank sits on its hands.

It is also worth bearing in mind just how much of that fiscal assistance is heavily frontloaded.   Partly because of very restrictive government measures, economic activity in the last couple of months has been savaged.  Plausibly, nominal GDP in the first half the year will be $25 billion less than might normally have been expected.    That means an equivalent loss of national income.

Direct payouts from the government –  mainly the wage subsidy scheme but also the corporate tax clawback scheme –  has compensated many of the losers to a considerable extent.   Wage subsidy payments have already exceeded $10 billion and there is more to come in the next month or two.  If I recall the tables right, the tax clawback scheme has refunded something like $3 billion.

But there won’t be repeat of anything on that sort of scale.  Of course, the income/output losses in future quarters are unlikely to be as large either.    But my point really is that the output gap by later this year will still, almost certainly, be materially larger than anything we say in 2008/09, and already the biggest fiscal impulse will be in the past.

With no support from monetary policy – real retail rates are barely changed, and the exchange rate isn’t down much – everything rests on either domestic fiscal policy or some surprisingly strong global economic rebound.  Neither seems like a safe bet for getting us back to full employment any time soon.

This isn’t a plea for fiscal policy to do more, but for the government to wake up to the outlook and insist –  using formal statutory directive or appointment powers if necessary – that monetary policy start making a real difference.   I don’t suppose it will happen, especially not this side of the election: the government will prefer an “everything in hand, heroic saviours” narrative, even if the outlook is far from in hand.  I take them at their word when they say they care about full employment, invoking Peter Fraser and all that.  But the current set of policies simply is not likely to be consistent with achieving those sorts of outcomes in any reasonable timeframe.

(My other worry on front is that there are people who will criticise the government for doing too much on the fiscal side, but not many of them have credible alternative approaches to getting back to full employment rapidly – few, for example, embrace calls for more aggressive monetary policy.  It sometimes looks as if they don’t care.  There is that old maxim “it is better to have tried and failed than never to have tried at all”.  It isn’t an excuse for poor policy, but history would judge poorly any figures who were, in effect, indifferent to lingeringly high unemployment.)

Meanwhile, of course, there is also nothing that is at all likely to lift our longer-term economic performance – despite various bows in the direction of productivity in the Minister’s speech –  but sadly that doesn’t mark this Budget out from any of its predecessors this century.

 

The curate’s egg

It was a poor package.  On so many counts.  And my sense of that has only strengthened overnight.  Perhaps at best one might label it as a curate’s egg –  and rather more in the original meaning than the colloquial one.

It had the feel of a package that started as one thing, perhaps relatively small, two or three weeks ago when the government was still focused on the coronavirus as a China issue –  things that had happened, but which would now gradually if slowly sort themselves out – and on the small range of sectors materially directly affected by the China experience.  They were backward looking, and they refused to face up to what was clearly coming –  and it was as clear as day at least a week ago.  So then rushed changes were made to the package on the fly, including efforts to bulk it up to look enormous –  presumably solely for political reasons –  regardless of whether the components were relevant at all to the times or to the specific needs in responding to the situation that is upon us.   And at the same time, whether because they were caught by the momentum of their own process, or because they are still reluctant to front the severity of what awaits us, most of the really pressing issues were barely even addressed.

The government then has the gall to talk of a new round of measures in the Budget –  two months away –  allegedly to be focused on the recovery phase.  There is (a) absolutely no way they can wait until the Budget to do a lot more, and (b) the recovery phase is much more likely to be something to think about in next year’s Budget.  Remember the comments from Prof Michael Baker reported in the Herald a day or so ago: anyone who thinks this will be over by Christmas hasn’t thought hard enough.  Or, as he went on to rephrase, perhaps Christmas 2021.

I want to focus mostly on the economics, but the politicisation by the government was also unfortunate.   Crisis times, all in this together etc.  But there were the silly boasts that somehow this package was bigger than was done in 2008/09 –  which is true but irrelevant since (a) this is quite different sort of shock, (b) there was huge fiscal stimulus already put in place in the 2008 Budget, oblivious to what was just about to break, and (c) there was room for 575 basis points of interest rate cuts (and the exchange rate fell sharply).  There was, in fact, no discretionary fiscal stimulus in New Zealand during the recession itself: it wasn’t needed.   Then there were the attempts to wrap themselves in the cloak of Michael Joseph Savage –  Labour’s icon –  in “responding to the Great Depression”.  At least some of them are presumably historically literate enough to know that Savage didn’t take office until the worst of the Depression in New Zealand was long past and recovery was well underway.   Or the silly attempts to boast that their package was bigger than some others when (a) as we shall see, for coronavirus purposes a lot of their numbers were simply irrelevant, and (b) the scale of interventions globally is rising by the day (those other packages were last week’s news).      It isn’t exactly confidence-inspriring re the seriousness of the Prime Minister’s leadership in a crisis when she goes on TV to claim this would be the biggest package she announced, and then it becomes very evident that the numbers were simply cobbled together in a way that produces just barely that result – headline-grabbing rather than substantive policy.

What would have been much more welcome was evidence that the Minister and Prime Minister clearly understood what was going on, what the key issues were, what the relevant horizons were, and so on.  But there was little or none of that.

To get specific, this is the table summarising the package

package

We’ll get the easy bits out of the way first.  No one is going to argue with more resources going to health, although (a) some have asked why it wasn’t more (is that really all the sector can really use if we face 18 months of suppression strategies?), and (b) why this hadn’t been done at least six weeks ago.

And there probably isn’t much to quibble about (at least for now) re the sick leave and self-isolation support.

I didn’t see any details of the “redeployment package” although in his speech Robertson did make some comments, including mention of a package for Gisborne to be announced in the next few days. I guess the amounts are small, but mostly it seems to be a waste of time –  most likely before long hardly anyone (well apart from the health system and a few online retailers) will be taking on any new staff, and that could be the case for many months.  Face to face training doesn’t seem likely either.  It looks like just a legacy of where the package began weeks ago.

There is nothing to say about the “initial aviation support package” because they’ve said nothing about it, except that it apparently doesn’t include an Air New Zealand bailout.  Other than that, it isn’t entirely clear why this line item exists in the package, but I guess it bulked out the headline number.

And then we started getting to the big bucks.  Unfortunately, many of the big bucks are scheduled to be spent in several years time, and have nothing whatever to do with the coronavirus, whether stabilisation or recovery.   Because the thing that doesn’t get much attention in public consciousness is that the $12.1 billion number is total additional spending over four fiscal years.    That is an approach that makes sense in normal times (recognises the ongoing implications of new commitments) but it bears no relationship to the support provided for the coronavirus situation this year.

Thus, the business tax reforms they announced seem generally sensible.  I’ve argued against the previous government’s abolition of depreciation on buildings ever since the National Party adopted the policy in 2010. It was daft and without any good economic foundation, so I’m really glad to see it being scrapped.  Probably this was planned for this year’s Budget anyway (I hope so).  But it has nothing whatever to do with coronavirus, with stabilisation, or even with recovery.  And the bulk of the spend will be in future years.  It is simply in here to (a) bulk up the numbers, and (b) as some sort of political counterpoint to the next item, welfare benefits.

Raising welfare benefits permanently also has nothing to do with coronavirus.  Again most of the spending (at least $1.8 billion of it) won’t even be in the March 2021 fiscal year, and of the remaining billion probably only $700 million will be paid out in the next six months (largely the “winter energy payment”).  Raising welfare benefits permanently has long been a cause of the Green Party and probably much of the Labour Party.  There is talk that this too was going to feature in the (election-year) Budget.    If so, it is just in this package to (again) bulk out the headline number.

But the increase in welfare benefits now is much more pernicious than that.  Life on a benefit isn’t easy (and before anyone scoffs about what do I know, that isn’t just rhetoric: I have a close family member living on a long term benefit).   But what beneficiaries at least had going for them this year was certainty of income: the government was not going to default or closedown, unlike many private sector employers (with the best will in the world on their part).  They and public servants were safe.  And yet the government chooses to lock-in a permanent boost to its spending commitments (a) to those with the least degree of income uncertainty now, and (b) when the country is in the process of becoming a lot poorer and scarce resources need to be used wisely.   Raising benefits might or might not have been a reasonable luxury in settled times.  It is simply irresponsible and evidence of fundamental unseriousness to do so now.  (And before anyone tells me about the high marginal propensity to consume that beneficiaries have, let me remind you that now is not the time for stimulus or encouraging people to spend more: instead we are entering a phase of deliberately choosing to shrink the economy to give us the best hope of fighting of the effects of the virus).  Oh, and the unemployment rate is going to rise a lot, and one of the big challenges after this is all over is going to be reconnecting people with the labour market, at a time when wage inflation will have been depressed anyway.  In that context, higher benefit replacement rates (relative to wages) is really the last thing that makes sense in getting the economy back on track.

All of which leaves us with the centrepiece of the strategy, the wage subsidy scheme.  It is probably reasonable enough as far as it goes, but “as far it goes” is no more than a very short-term holding action, not remotely enough to really address much at all (it runs til June, the crisis will not, banks (for example) and other creditors will know that. So, before long, will most households).

But again there is a strong suspicion of political vapourware in the numbers.   The scheme is estimated to pay out $5.1 billion in the next three months.  That is a lot of money.

It is paid out at a rate of $7029.60 per full-time employee.  That means they expect to pay out for about 725000 fulltime equivalent employees (there is a lower rate for part-time employees).   That sounds like a lot.

In the latest HLFS, there were 2.6 million employees in total (including the self-employed). Of them 2.1 million were fulltime.  Applying the same ratio the package does (part-time staff are paid for at 60 per cent of the fulltime rate) to the 519000 part-time staff produces a full-time equivalent number of employees of 2.44 million.  In other words, the headline budget figure is premised on paying out in respect of 30 per cent of all employees in the coming quarter.   And this is even though the payment is capped at $150000 per employer, equivalent to compensating for only up to 21 staff.  And you can only get the payment is your monthly revenue is down 30 per cent year on year

Now, sure, there are lots (and lots) of businesses with fewer than 21 staff.   But lots of employees (by number) work for big organisations, both in the public and private sectors.  All those universities who were moaning about foreign students a few weeks ago could only each get $150000 (if total revenue had even fallen 30 per cent) even though they employ thousands of people each.

I am not saying that the $5.1 billion total is impossible.  But it seems unlikely.  And in particular it seems inconsistent with (a) the political messaging about the severity of the economic shakeout (even yesterday the Minister still wouldn’t accept that a recession was a done deal), and (b) the preliminary Treasury forecast the Minister was happy to wave around suggesting that at worst we’d have only about a 3 per cent fall in GDP.

I reckon I have been consistently one of the most pessimistic commentators about the economic effects.  It isn’t that hard to envisage GDP falling 5 per cent in the June quarter alone (reality could be a lot worse than that if suppression really comes to New Zealand), but that isn’t the sort of message the government is giving New Zealanders.   Either they aren’t being honest with us, or they’ve just bulked up the headline numbers (it isn’t as if any underlying assumptions about any of the forecasts have been released).

So for all the talk of a 4 per cent of GDP package etc, it would probably be more realistic at this stage to think in terms of immediate additional outlays (next few months) of no more than half that (and not even all that will be helpful).  Those are still big numbers: 2 per cent of annual GDP is 5 per cent of four months’ GDP.    The Minister released a chart suggesting the package will boost annual GDP itself by 2 per cent over the next year, but that too seems optimistic (but hard to tell how much without Treasury releasing their assumptions/workings).

But for whatever immediate good some elements of the package might do, it still largely fails to address the real and pressing issues.   In particular, in typical recession debt service costs for borrowers (new and existing, at least for floating rate borrowers) drop sharply, and returns to depositors drop sharply.  That reallocation is a natural and normal part of the rebalancing and stabilisation process.  Despite the spin from central bankers (abroad as well as here), 75 points just does not cut it: 500 points has been more like it in recessions (over a period when none has been as bad as what we are facing now).   Between a central bank that refuses –  adamantly promises –  not to cut further, and a failure to ever deal with the lower bound issues, nothing is on the way.  That has to change.  The government could and should simply insist on it changing now.   (Related to this, what fall in the exchange rate we’ve seen –  also a natural part of shock absorption –  is tiny compared to the usual recessions.)

And even more pressingly, in this unique sort of shock, the package does nothing about stabilising income expectations for firms or households in a way that would support banks being willing to (a) maintain existing credit exposures, and (b) be willing to significantly extend credit to cover the gaping net revenue holes that will be opening up for many firms (and households).    That needs urgent action.   With the best will in the world, and much harassment from the Governor and the Minister, banks are businesses too and have shareholders to answer to (primarily) and their own future existence to protect.   They can read things like this week’s Imperial College paper arguing that suppression strategies may need to be kept in place for most of the next 18 months.  If so, with no income guarantees –  and not even any certainty about what subsequent emergence looks like – as a bank you would often be in breach of your duties to extend more debt in many cases.  And many people –  firms and households –  would be reluctant to borrow more.   Better to manage and minimise exposures early, to whatever extent one feasibly can.

Of course, governments could lend direct.  But that simply isn’t realistic on any sort of scale.  Much better to think hard about the sort of idea I advanced in a post on Monday where the government passes emergency legislation guaranteeing –  in legally enforceable form (perhaps it could even just be done under the guarantee powers of the Public Finance Act, but better to get parliamentary sanction) – that no firm or household/individual would have net income in 2020/2021 (and perhaps even the following year) less than 80 per cent of that for the last year (for firms, the guarantee would be scaled to the extent they retained staff).   Doing so would give a floor –  and thus remove much of the variance in expectations – for households, firms, and for actual/potential lenders.  It should help underpin a willingness to extend credit.  It should also serve as an underpinning if we find ourselves adopting shorter-term expedients –  as say France has done –  of temporarily suspending utlilities bills or mortgage payments:  utility companies could themselves get bridging finance if banks knew household would still have most of their income, and banks themselves wouldn’t face the need to record impaired assets etc.

I want to come back, in a further post, this afternoon to my overall proposed package, including answering some of the questions/objections.  I still believe it is the best and fairest approach to take, complementing some of the other shorter-term cash income support measures (which would be nested within the guarantee).  But whatever the precise form of what they do, the government simply must act very quickly to ensure that credit is available. (And on that score the Reserve Bank temporary suspension of the scheduled increase in capital requirements is of second order significance, not remotely the main game.

Finally, I can only repeat a point I’ve made in various posts and numerous tweets over the last week: this is not the time for encouraging new private spending.  There will come a time for that, and it is likely that fiscal policy will have a significant role to play then.  But this is a time when we are deliberately scaling back the economy –  quite possibly savagely for months at a time – and discouraging spending in many areas.   We need to ensure have the income to live on, but for now much the most important economic priority is some set of guarantees –  supported by the strong Crown balance sheet – that means households are able to borrow, existing businesses are able and willing to borrow, and banks are genuinely willing to maintain and increase lending…..in the face of the most hostile and uncertain economic conditions of the lifetimes of almost all of us.

The government now needs to get serious and get down to real economic policy work.  It would be also good if they started authoritatively fronting with New Zealanders about just how tough things are going to get.    A lot of New Zealanders, who don’t obsessively follow the news or events abroad, really still have little no idea.

 

 

Thinking about fiscal policy

A few weeks ago the Minister of Finance announced that the government’s Budget would be delivered on 14 May.    That really isn’t far away now.  I noticed the Minister, on TVNZ’s Q&A yesterday, suggesting the timing was opportune in light of the coronavirus.     Perhaps, but contemplate some relevant dates.   Last year’s Budget was delivered on 30 May and according to the documents these were the relevant deadlines

budget 19

Assuming much the same sort of timetable holds this year, the economic forecasts the Budget draws on will have to be finalised in not much more than three weeks from now.  The tax and other fiscal forecasts are finalised later but they draw on the economic forecasts.  And who supposes that there will be any meaningfully greater certainty in three weeks time than there is now?  In truth, the Budget economic forecasts will be little more than (well, really less than given the long publication lags) one potentially useful scenario.     They simply aren’t going to be –  and can’t be –  any sort of useful guide for policy in the current climate, and I hope the Minister and the Treasury Secretary (the forecasts are Treasury’s and the Secretary has to sign off on them) start making that clear soon.    Consistent with that, in setting budgetary policy no one should be getting hung up on (for instance) whether the bottom line is a small surplus or small deficit.   Any such forecast number –  in a period of extreme uncertainty –  will be just meaningless.

In his interview yesterday the Minister of Finance seemed to be saying much the same sort thing as in his speech on Thursday.   Much of it was, at one level, sensible enough, but to me it fell a long way short in grappling with the likely severity of the issues, and the related uncertainty, and with the vulnerability of the world economy and the limitation of current macro policy.   Perhaps it was partly what he was (wasn’t) asked, but he is an experienced politician and knows how to get across the messages he wants to convey.    When community outbreak becomes a significant thing here, there is going to be a lot of economic disruption (even in the most optimistic cases abroad, eg Singapore, containment so far has appeared to rely on extensive social-distancing –  voluntary and compulsory –  none of which is conducive to holding up short-term GDP (or similar indicators).

But even pending that, what will be happening to tourism right now?  We know tourism from China collapsed a month ago –  first PRC restrictions and then our own –  but what about travel from other markets.  How many people are going to be keen on booking new trips, or even – if they have the option –  embarking on new trips now? I don’t know about you but I flicked through the travel sections of newspapers yesterday and today, wondering quite how many takers there would be.  Allowing for both direct and indirect effects, tourism is estimated to be about 10 per cent of the economy and about 55 per cent that is international tourism.  Even if international tourism only halves for the duration –  and it would be a lot lower than that if there is significant community outbreak here, that alone is equivalent to taking almost 3 per cent out of GDP.   Sure, there is scope for some switching –  more domestic tourism, as New Zealanders pull back on their foreign travel –  but a couple of nights in Picton is for most hardly a substitute for the trip to Disneyland.     And, of course, there are more and more reports of business travel –  typically higher-end – being cancelled.   And all of that is just one sector of the economy: that associated with foreign travel.   It takes no account of scenarios in which people are unable to work, whether because of illness, movement restrictions, school closures or whatever.

There is simply no way of knowing how long or how deep the economic effects will be, or (for example) what public psychology –  including eagerness to spend and to travel –  will be like as the world gets through the other side.  But with strongly asymmetric risks I reckon there is a pretty strong for an aggressive macro policy response.  And some part of that clearly has to be fiscal, especially given the failure of authorities –  here and abroad – to deal with lower bound constraints on monetary policy (covered in my post on Friday).  If you are sceptical that I’m over-egging the monetary policy limits point, I’m not nearly as pessimistic as the local ANZ economics team

Not as pessimistic only in that I think the OCR can usefully be cut further than they believe.  But if they are right and we really will be at the conventional limits of monetary policy by May (the day before the Budget in fact) people really should start worrying, because the ANZ economic scenario is not as bad as it could get.  And there are few additional buffers that people can really count on in planning and forming expectations (including of inflation).

There has been quite a bit of talk about how monetary policy (and aggregate fiscal policy for that matter) can’t solve immediate problems –  even bizarre articles from people who should know better suggesting there is some sort of either/or dimension between medical solutions and macro policy responses.  And that is true, of course.    Macro policy can never deal with the sectoral effects of sectoral-focused shocks.  Macro policy is about stabilising the wider economy.  Macro policy also can’t do a great deal in the very midst of a crisis –  financial or otherwise.  But what it can do in the midst of a crisis –  perhaps especially a disease one, where moral hazard concerns are less of a worry –  is better than nothing (easing servicing burdens, easing the exchange rate, signalling activity, leaning (a little) against collapses in confidence etc).  Perhaps more important is the value of such tools when either the immediate crisis passes and we are left with chronic weakness in demand (perhaps for a few quarters, perhaps longer) and during the recovery phase.   Macro policy tools work with a lag, and it is well to get adjustments in place pretty early (which is why monetary policy flexibility is so good to have: it is a very easy instrument to adjust, including to unwind when the need has clearly passed).

What sort of fiscal policy?   I’m not that interested in specific assistance packages to individual sectors.  In some cases, that sort of action might be justified, but much won’t really be –  and the announcement a couple of weeks ago of funding to promote non-Chinese tourism looks even sillier now.  Realistically, political considerations are likely to be more important than anything else in shaping those sorts of handouts, but (fortunately perhaps) such specific interventions/distortions/bailouts aren’t likely to be large enough to materially respond to wider weaknesses in aggregate demand.

And whatever you think of the case for more – even much more – government infrastructure spending, there are long lags to getting any such projects up and going.  The case for a second Mt Victoria tunnel in Wellington might be rock-solid –  and it is even in Grant Robertson’s constituency – but it is no sensible part of a response to a coronavirus-induced recession, even if (say) you worried about several waves of the virus over a couple of years.

Generalised tax cuts in income tax rates –  which might or might not make sense longer-term –  aren’t particularly effective because (a) the overwhelming bulk of any cut would go to higher-income households, (b) there is no particular incentive to spend (and some of the things higher income people might othewise spend on –  an extra overseas holiday –  aren’t likely to be so attractive in the next few months, and (c) as the Minister observed in his interview yesterday, such cuts tend to be permanent.

One could do, as Hong Kong announced last week, some sort of lump sum distribution –  perhaps $1500 payment to each adult.  It is much more concentrated ($ value) towards people likely to spend additional cash, but it is still less likely to be spent at the height of a crisis than in other circumstances, just because people will be (eg) staying away from shops.  But perhaps a more significant issue is precisely that it is one-off –  you might get a one-month lift to demand and activity, but the situation is reasonably likely to require longer-term support than that.

The point of this past was really to explore one other option I haven’t yet seen mentioned: an explicitly temporary reduction in the rate of GST.     The idea has been around for a while, it was tried by the United Kingdom as part of their macro policy response in 2009, and was discussed in some detail in a paper presented in New Zealand almost 15 years ago by the (then) academic economist Willem Buiter, who had also served as a member of the Bank of England Monetary Policy Committee.

Buiter was invited to New Zealand as part of a focus in the mid-2000s (including this work) looking at possible tools that might enable more downward pressure to be maintained on aggregate demand –  keeping inflation in check –  without the concomitant upward pressure on the real exchange rate; the latter having become something of a sore point with both the Governor and the Minister of Finance.    One element of that involved inviting four international experts to offer advice.  The resulting papers, and discussant comments, are here.  Buiter was invited to focus on fiscal policy issues and his specific paper is here.  One of the options he explored (from p51 at the link) was using a temporary change in the rate of GST.

As a stabilisation option, supplementary to whatever monetary policy can do, a variable GST rate has one very big advantage relative to most fiscal options that are often touted.  Not only does a temporary cut put more money in the pockets of households –  and do so in a moderately progressive way (whatever lifetime consumptions patterns, in any particular period low income people typically spend a larger proportion of that period’s income, and face tighter credit constraints) –  but it provides an active incentive to spend now because you know that prices will be more expensive later.   Take as an example, an announcement that the rate of GST would be lowered by 2.5 percentage points for a year.  For a person/household facing the choice between saving and spending now, at the start of the period, it is akin to a 250 basis point cut in interest rates.  As the year goes on, the (annualised) effect gets even stronger (as we’ve seen with past GST increases, spending is brought forward to just before the increase).

There are all sorts of drawbacks with this instrument in general, whether used for temporary increases or temporary cuts, including judging when it would be appropriate to deploy the instrument (relative to, say, using monetary policy). Buiter favoured an independent committee –  akin to an MPC –  having the power to adjust the rate (something which I’m old-fashioned enough –  only Parliament should change tax rates –  to find abhorent).    But this is an unusually stark situation (and may well be starker still by Budget day) –  as, in a different way, was the UK financial crisis in 2008/09.    It is not just a matter of slowly accumulating pressures (or lack of demand pressures) but a stark, truly exogenous (to the New Zealand economy) event.  Defining a trigger for action shouldn’t really be a problem.  And we are very close to the limits of conventional monetary policy, so the tradeoff-among-instruments questions also presents less starkly than Buiter would have imagined.

One of the other drawbacks –  which the UK ran into –  is defining an exit point.   The period of weak demand around the world lasted much longer than any authorities expected in 2008 when they were devising responses to the financial crisis/recession.    The extent of that weakness was hard, perhaps impossible, to foresee.  With a pandemic virus perhaps it is a little easier – these things tend to sweep through in perhaps 12-18 months (even in 1918) so –  for example – a cut in the GST rate announced/implemented in May, to end at end of 2021 might seem reasonable (while still providing a substitution effect signal).  And if, spare us, at the end of the next year severe problems still faced us, then realistically choices could still be made then about whether to proceed with raising the GST rate or not (to not do so should require new legislation) –  there shouldn’t be (but who can really imagine) the same debates about whose fault it was the banks had failed etc.

One other drawback in the risk to inflation expectations.   Cut the rate of GST by 2.5 percentage points and the level of the CPI will fall by perhaps 2.1 per cent –  and the reported annual rate of inflation will be that much lower than otherwise for a year.   With a heightened risk of inflation expectations sliding away, there is a risk that those headline effects could accentuate the problem, even though none of the core inflation measures –  the ones most analysts emphasise –  would fall.   There is no easy way to know how large this effect would be, and it would be quite circumstance-dependent.  If, for example, the New Zealand dollar fell sharply –  as it usually does in severe adverse global events –  the direct price effects of more expensive imported tradable goods would lean against the GST effect on headline inflation (the UK, for example, had a sharp fall in its exchange rate around 2008/09).  And if the temporary GST cut was part of an aggressive multi-faceted (monetary and fiscal) stabilisation package, the (helpful) demand effects might well outweigh any risks of adverse headline effects on expectations.

The other downside concern might be implementation lags.  When I was around these sorts of discussions, IRD used to emphasise that these sorts of changes couldn’t be done overnight.  Announce on Budget day a GST cut starting three months hence, and the risk is that you worsen things in that three month period.   But when I went back to check the UK experience, I found that the policy had been announced on 24 November 2008, to come into effect on 1 December 2008.    If a change can really be implemented that quickly –  and hard to see why New Zealand IRD should be less capable than HMRC – a one week disruption might be tolerable.

Finally, relative to using monetary policy more heavily, fiscal options will tend to hold up the exchange rate more than otherwise.  That might be less of concern in a scenario in which it has fallen a lot anyway and –  as importantly –  monetary policy options are approaching their limits.

I am not, repeat not, recommending that the rate of GST be temporarily cut, even on the assumption that the economic situations looks as bad or worse late next month when final Budget decisions have to be made.   But, in a highly policy-constrained world, it looks like an option that should be pulled out of mothballs and looked at fairly closely by the Minister’s advisers, including a closer review of the strengths and pitfalls of the UK experience.   In situations like the one we seem to find ourselves in –  with the world one shock away from exhausting normal macro policy capacity, and that shock now seeming to be upon us –  it is probably better to err on the side of doing more rather than less, and to consider taking risks with instruments that would not normally count as ideal (in which category I put the variable GST).

And whether or not the Minister of Finance thinks it an option worth exploring, I’d welcome comments here, including from those closer to the operational details of GST than I am.

 

 

HYEFU thoughts

I don’t have that much to say about the HYEFU and the Budget Policy Statement released yesterday.  If governments are going to keep on with the insane and destructive (to the economic wellbeing/prosperity of New Zealanders) policy of supercharging population growth then, sooner or later, they are going to need to spend more on increasing the associated public “infrastructure” (roads, schools, hospitals etc).  One can, of course, question the quality of some of that expenditure –  baseline or projected –  but more people pretty reliably means a need for more capital.

That said, if the population is growing rapidly you’d usually expect to see all sorts of investment growing quite strongly.    As I illustrated in a post last week both government and business investment have been really rather subdued in recent years.  The Treasury doesn’t give us forecasts that separate out government and business investment, but here is a chart of their forecasts for total non-housing investment (public and private) as a share of GDP.   The first observation is an actual, the rest are forecasts.

inv hyefu 19

Note the scale.  These are not huge moves, but they are falls.  Treasury expects that non-housing investment will be a smaller share of GDP in the coming years than it has been in the recent past.    Something doesn’t seem right about the economic policy settings, at least if the governments cares about lifting average material living standards of New Zealanders.  Treasury forecasts on the basis of policy as it is, and (fiscal) policy changes the government has told them it will be making.

The picture in the forecasts also doesn’t look very good if we concentrate on trade with the rest of the world.  Here is exports as a percentage of GDP.

exports hyefu 19.png

When it first took office, the government occasionally used to talk about a more export-oriented economy and all that.   No sign that the Treasury thinks that policy settings are consistent with delivering that.  I didn’t include imports on the chart, but the fall in imports as a share of GDP over the forecast period is slightly larger than the forecast fall in exports.     Taking on the world and winning, consuming more of the best the world has to offer, it isn’t.

And it isn’t as if The Treasury is forecasting doom and gloom: they expect overall GDP growth to pick up and be running at around 2.75 per cent per annum.

You’d hope that, faced with projections like these, the Minister of Finance would be demanding from the Secretary to the Treasury –  and that the Secretary would be proactive in offering –  robust advice on what might, after all these years, begin to reverse New Zealand’s woefully poor long-term economic performance.    It doesn’t seem very likely, but the Secretary is new.  Perhaps she is genuinely shocked at how poorly New Zealand does.  Perhaps she is demanding answers, analysis, and advice from her staff.

On page 2 of the HYEFU I noticed this claim

The Treasury is in a unique position to focus on improving the way our economy can raise New Zealand living standards. Along with delivering first-rate economic and financial advice,

Treasury certainly is in a unique position.  They have a lot of staff, have had their budget increased, and have (or should have, if they are doing their job) ready access to Ministers and input across all major areas of policy.   And yet, the actual performance has been poor, and there is little visible sign of that “first-rate economic and financial advice”.  It might be bad if governments were consistently rejecting such advice, but that is their prerogative.   But there isn’t much sign that The Treasury has been offering hard-headed searching advice on the failures of overall economic performance, whether or not successive governments had been inclined to give it heed.

All that said, one can’t argue too much with the fiscal performance.    Here is a chart of the best of the debt indicators Treasury publishes forecasts for.

net core crown debt

Modern New Zealand governments manage debt and the aggregate public finances in a pretty responsible way (I’m not one of those who thinks low interest rates mean governments should take on more debt: rates are low for a reason), and government debt levels near zero seem pretty prudent given the way other government policies remove some of the need for private savings.   And while Treasury thinks we have a small positive output gap, my own inclination –  and the balance of the other estimates they quote –  is that things are a bit weaker than that.  Commodity prices are pretty high to be sure, which always flatters the public finances a bit, but overall I’m pretty comfortable if the operating balance is somewhere just either side of zero.

Successive governments have done aggregate fiscal management pretty well.  It is just a shame they’ve haven’t shown the same degree of interest, passion, commitment etc to fixing the longrunning productivity failures.  Overall fiscal management matters, but in terms of the long-term material living standards of New Zealanders, it is a bit akin to keeping the garden pretty and the fences well tended even as the house itself slowly –  ever so slowly but surely –  rots.