Fiscal policy

Policy costings: a case study

Michael Reddell Fiscal policy, National Party

I’ve written a few posts here over the years about the idea – which apparently Labour, National, and the Greens are now keen on – of a state established and funded policy costings unit. The most recent two were a month ago, here and here. I’m a longstanding sceptic of the case for such a unit, seeing it is just a way to get more state funding for political parties, and not dealing with any of the common arguments made for such units.

It is election season now and some of the arguments have, in effect, been put to the test. This week National released its tax and spending plan, producing numbers suggesting that what they planned to spend was fully funded by other cuts and new taxes. I wrote here about the macro issues and implications of/around the plan, largely taking as given the specific numbers the party supplied.

I’m not close enough to any of the line by line numbers to know whether each of them is solidly costed. Their economic consultants say they have been, and (assuming there were no silly mistakes made by accident) National does have a pretty strong incentive to ensure the numbers are each reasonably robust. So, for now, I’ll assume they are (with a few possible caveats about the foreign buyers tax, see below).

[and, later, on that tax]

…As for the revenue estimates ($750 million a year), they seem quite high, and the tax rate seems high by most international standards (Singapore is a lot higher). Only time will tell how many people not living here so want a New Zealand house they will pay a 15 per cent tax to do so.

Individual costings really weren’t and, as macroeconomic commentator, still aren’t my focus. In the grand scheme of things, the overall package involves adjustments of less than 1 per cent of GDP per annum, most costings don’t seem to have been contested, and in an age of MMP even a big party’s plans are likely to be implemented a bit differently than the pre-election promises. The foreign property buyers tax itself is expected to raise revenue equal to 0.2 per cent of annual GDP (and the gambling tax about 0.05 per cent of annual GDP).

But both as a potential voter and as someone interested in institutional proposals, notably that for policy costings offices, the subsequent debate has been interesting. I don’t really understand the issues around the online gambling costings (and the amounts involved are much smaller) so I’m going to focus on the foreign buyer tax. On that score there seem to be two quite separable concerns raised:

  • first, how consistent is the proposed tax with various tax and trade treaties New Zealand has signed? and
  • second, even if the tax were able to be put into effect as National tells us it envisages it (excluding buyers from Australia and Singapore, as with the current outright ban), just how much revenue would the tax be likely to raise year in year out?

Of course, the more there are issues under the first leg, the more questions could legitimately be raised about the revenue estimates.

Based on what they have told us, in the lead up to the announcement National did what one might have expected from a party seeking to win the right to lead the government after the election.  It hired a firm of advisers (Castalia) and asked them to review the draft numbers.   From what National has said (and I recall one media outlet being shown Castalia’s comments), National went with numbers that were generally at the conservative and cautious end of the spectrum.   Castalia apparently also cast a fresh eye over the numbers in light of the government’s fiscal announcements last Monday (although this is unlikely to have meant much since how much baseline spending can be saved – by either party –  isn’t really something a consultant can tell you, since it is mostly about the resolve of the politicians’ themselves once in office). 

In addition to having consultants review modelling numbers, the National document told us they’d sought legal advice

National has sought legal advice on whether the replacement of the foreign buyer ban with a foreign buyer tax is consistent with New Zealand’s existing free trade agreements – that advice confirms such a replacement would be consistent with those agreements. However, this policy assumes Australian and Singaporean citizens will not be affected by the tax as they are not currently affected by the foreign buyer ban.

and a Newshub article yesterday reported that National had sought both legal and tax advice on these issues.

Image

So far and mostly so good.  We don’t just have National’s word for the numbers, but an established firm –  yes, paid for by National, but with an ongoing reputation to guard – is reported as telling us they thought the numbers overall had been cautious and conservative.

But then the questions arose. First, around the legality of imposing such a tax on various countries.  Some of the points were from Labour Party spokespeople (eg this press statement).   They are the political opposition so we might have no more particular reason to take their claims on trust than to take National’s on trust, but they do make some specific points, which to a lay voter seem like questions deserving an answer.  In fact, there might be both legal questions and questions about whether the proposed tax is within the spirit of agreements that New Zealand governments have voluntarily entered into (and which National is not on record as having opposed, or is now proposing to withdraw from).   (Non-specialists among us might also wonder why if absolute bans –  the ultimate in discrimination – mostly are legally okay (we now have one), a tax which would be less onerous would not.)   As National notes, some other jurisdictions have such taxes, but the issues here isn’t one of merits, but what specific New Zealand agreements do and don’t allow (and noting that New South Wales appears to have recently withdrawn its version of such a tax because of federal tax treaty issues).

And then questions arose around the modelling (ie even if the law could be done as National had suggested whether it would raise $750 million or so year in year out).   Various economists and property analysts (people without apparent strong party loyalties that might make their perspectives suspect) raised doubts.  On the property experts side this article from today’s Post seems representative.

tax doubts

There are, of course, some enthusiastic real estate agents.  I read an article reporting one agent saying he’d had US billionaire clients on the phone within hours.  I don’t doubt there would be interest: the question is how much, and how much beyond the first wave (a quick Google suggests there only 2700 billionaires in the world).

Without seeing National’s modelling, it isn’t really possible to reach a confident view on their numbers.  But what makes me cautious is that I’ve seen no one –  neutral expert or even National surrogate arguing that the numbers are really on the cautious side and a more realistic assessment might be higher again.  It seems hard to find revenue estimates for other countries’ foreign buyer taxes –  often they are designed to deter purchases rather than to raise revenue – although I found a reference yesterday suggesting that a similar tax in Toronto (a metropolitan area with more people than New Zealand) was raising only about $200m per annum.

So wouldn’t this have been a clear case for a policy costings office?   I don’t think so.

National has used its (scarce) resources to pay for analysis and advice and has told as much as it seems to want to tell us.  Debate and scrutiny has ensued.   As a geeky analyst and undecided potential voter I’d really like them to release their modelling and any Castalia comments on it, and either the advice or a fairly full summary of the advice from the “legal and tax experts”.   It would be good even if they had some known National-sympathising experts who they could wheel out to make the case for (a) the legal problems not being what some suggest they might be, and b) the robustness of the numbers  (I don’t really expect Willis or their Revenue spokesperson to spending lots of time in public debate in the middle of a campaign).

But here’s the thing. It is their choice what to release (or not), and our choice as voters to draw our own conclusions.    Elections are most unlikely to turn on a specific like this, which is ultimately fairly small in the scheme of things (eg against the backdrop of some of the largest primary fiscal deficits of any advanced country at present, 0.2 per cent of revenue isn’t nothing but it is almost lost in the rounding – and is less than the non-specific proposed bureaucracy savings).  For some people and at the margin, it may shake confidence.    Go back to that quote from my post earlier in the week:   my starting point was to think that National had strong incentives to make sure that their numbers were robust, so as a starting point I took them as given.  Now that questions (apparently serious questions) having been raised, they have chosen not to release anything more or to address the specific concerns.    It is a legitimate choice (they are free to make it), but I (and the handful of interested analysts and potential voters) can draw my own conclusions. For me, I’m less confident now that the numbers add up, and also less confident than I might have hoped in their commitment towards being an open and transparent party in government.  It reinforces my wider doubts about their overall fiscal stance.

And that seems to be the political market working.  Parties will make choices about what they think a sufficient number of voters care about, or even about what sufficiently vocal commentators might shape public thinking over.  It is very unlikely that details of this tax score highly on either count.   Is that a bad thing?   I don’t really think so.    Voters are making judgements about values, about competence, about desires (or lack of them) for change.   And frankly, if fiscal issues were to become an issue, such concerns should probably centre on things individually more important than details of this tax.   The merits of unprincipled tax policies (this foreign buyers’ tax, Labour’s proposed GST exemptions, or the distortionary new depreciation provisions both parties have individually proposed to foist on the business sector) for example should probably count for more.  Or the sheer size of deficits  – without precedent in New Zealand now for many decades on the eve of an election.  But in the end, voters and parties will make their own choices, and nothing this week suggests to me that we’d have been better with some state-funded tax and trade lawyers and economist adding to the mix.  Precise numbers almost certainly do, and in my view probably should, matter less than what we learn about parties and their spokespeople in how they handle issues like this.

National’s tax and spending plan

Michael Reddell Fiscal policy, National Party

National announced its tax and spending plans this morning. You can read the full 29 page document.

In the way of all parties and bureaucratic agencies these days, everything gets quoted as a four year figure: $14.7 billion sounds like a lot but it about $3.7 billion a year, which is about 0.8 per cent of annual GDP. Cost things over 10 years and you could if you wanted call it a $35 billion plan, with no more or less meaning (and, to be clear, all parties and agencies engage in this headline-inflating exercise).

Today’s plan is sold as being fully separable from National’s fiscal plan, which we will apparently get to see after they’ve had time to digest the PREFU numbers (coming on 12 September). It is a clever wheeze – it seemed to work – in allowing Willis and Luxon to deflect all and any questions this morning regarding the deficit and the possible/eventual/one day return to budget operating balance or surplus. They sold this line on the basis that today’s package was itself fully-funded from new initiatives of one form or another, so that in principle the net impact on what fiscal numbers The Treasury comes up with this package could just be slotted in with no net fiscal effect.

I’m not close enough to any of the line by line numbers to know whether each of them is solidly costed. Their economic consultants say they have been, and (assuming there were no silly mistakes made by accident) National does have a pretty strong incentive to ensure the numbers are each reasonably robust. So, for now, I’ll assume they are (with a few possible caveats about the foreign buyers tax, see below).

But the overall argument – “this isn’t our fiscal plan, come back next month for that” – doesn’t really wash. It might if the budget now was pretty near balance, or even in surplus. No one would, or perhaps should, be very worried about modest changes in a comfortable fiscal position.

But we don’t have a comfortable fiscal position.

These were the fiscal numbers the International Monetary Fund put out yesterday in their annual New Zealand review

The blue numbers are more or less solid (actual fiscals are, but the cyclical adjustments could still change a bit), while the red numbers – calendar 2023 and 2024 – are going to be heavily influenced by choices and decisions the government has already made. The best advice from the IMF is that no progress has been made in reducing the deficits first run up in the Covid disruption years, even though actual Covid spending is no longer a thing. The Fund includes projections for the further-out years in which the operating balance goes back to respectable surplus for calendar 2027 and 2028, but those are really just assumptions, and don’t rely on specific identifiable tax or spending decisions that would bring about such an adjustment. I should stress that these are cyclically-adjusted numbers, so the ebbs and flows of the economic cycle don’t provide either the problem or the solution. These sorts of numbers led to the IMF recommending – in really quite pointed language for a diplomatic agency talking of a country that has been among the star fiscal performers for decades – “frontloaded fiscal consolidation” and steps to ease the fiscal pressure on monetary policy.

(The government’s control of the timing of the release of the IMF report, kicked to after Monday’s modest fiscal announcement, means these sorts of lines have had almost no media coverage. And of course no one seems to have gone and asked the Governor “what is this fiscal pressure on monetary policy/inflation the IMF talks about; you have claimed in the last two MPSs that there was none?”)

Last week I ran a post here using the OECD’s fiscal numbers. Those numbers will have been finalised a bit earlier than the IMF’s but are available on a consistent cross-country basis. Using that data you can see how large our (cyclically-adjusted) general government deficits now are relative to other OECD countries (and to our own past). The picture of recent years is a little different, but the final year deficit is also large.

Or here (not cyclically-adjusted)

We have a primary deficit that is large in absolute terms, and among the largest in the OECD.

These international comparisons aren’t done on the New Zealand operating balance definition. On that metric, the cyclically-adjusted operating deficit will be a smaller percentage of GDP, but there is little case for a cyclically-adjusted operating deficit (paying for the groceries etc) at all.

These structural deficits do not heal themselves. And while fiscal drag has been a bit of a help in limiting the deterioration in recent years, the forecast return to lower inflation means not even much of that support will be on offer.

Both Labour and National profess allegiance to the idea of an operating surplus…….but seem to have not the remotest interest in telling us what choices they are going to make to get us there. Discretionary choices/adjustments of perhaps 3 per cent of annual GDP might be required.

Today, however, is National’s day. This was their big tax and spending plan. Willis told reporters this morning that “your tax cuts are coming no matter how much Labour proves to have wrecked the joint”. So the tax cuts are iron-clad, and having bitten the bullet – after railing at Labour’s new taxes for years – and put several new tax increases on the table, it is hard to see they are suddenly going to pull a whole bunch more tax increases from their hat a couple of weeks hence to close the deficit.

It is always possible, they could announce some big new expenditure cut – killing off a few big wasteful specific programmes – but it doesn’t really seem in character, and would completely blunt the message from today that “tax cuts are coming”.

It is much more likely that – having announced their big tax and spending plan today – that is largely it. It may be fiscally neutral in its own right, which is better than the alternative of adding to the deficit, but they aren’t going to do anything much about the deficit at all. No doubt Labour won’t either – it will just handwave around whatever the PREFU shows, having cut (with no accountability whatever re eg likely cost pressures) future operating allowances on Monday. It will be a case of “trust us”, without even any credible evidence from either that ‘we know what we are doing” or really care one way or the other. We are at risk of sliding towards the normalisation of operating deficits, of borrowing to pay the grocery bill. The sort of really poor fiscal management you see in places like the United States federal government.

If asked, perhaps National will talk up cutting public sector bloat. I’m sure there is a fair amount to go round (and no one has mentioned the big increase in Reserve Bank spending that the government snuck out last week), but (a) in this morning’s announcement they ruled out a whole bunch of agencies, both because of Labour’s own vapourware announcements on Monday, and because they want any savings redirected to frontline services those agencies provide. That latter might be laudable but it doesn’t represent fiscal savings.

And, in any case, today’s package already relies on unspecific cuts in public sector bloat.

That is $4bn of the $14.6 billion cost of the overall package (30 per cent). I’m not disputing that there are (substantial) savings to be made, but savings made to finance tax cuts (as in this morning’s package) can’t then be used to also close the deficit. Both Labour and National talk of cutting consultant spend. That is cheap talk, unless (a) it amounts to a reduction in total spend, not just taking people onto the permanent staff (shifting the line item, but not changing the total, and b) identifying what work future governments don’t want done.

To the extent there is genuine bloat, the tax cuts package will have grabbed it. To cut further – cut the deficit – they would need to cut deeper and that would mean harder choices, which so far they’ve shown no inclination to be willing to make (nor Labour, but this is National’s day). And all this assumes that cost pressures are adequately captured in current baselines (which I doubt – citing for example the real wage cut forced on teachers despite apparently very real recruitment and retention challenges).

Finally a few thoughts on specific items. Childcare subsidies aren’t really my thing (better to collapse house prices), but both parties seem to like them. I like them cutting back the brightline test tax (less good than abolishing it, but…) and the restoration of interest deductibility for residential rental property owners (like any normal business). On the other hand, there is no commitment to inflation indexing income tax brackets even going forward (if they’d committed they’d have to have costed it).

But what got my goat were the first two of the new taxes.

Is it marginally better to have no ban on foreign buyers buying very expensive houses but having to pay a high tax to do so than to have an absolute ban? I might grudging acknowledge that, but any gain is marginal at best, and it is a policy that David Parker might have dreamed up in a moderate moment. It is an unprincipled revenue grab, which is wildly inconsistent with the party’s rhetoric (mostly good rhetoric) that freeing up the responsiveness of housing supply is what matters, and that we should be encouraging and facilitating more foreign investment generally. And from a party which claims to be – and historically has been – keen on immigration, it just seems weird (conflicting messages) again to not be allowing anyone who moves here, even on a work visa for several years, to buy a house. They are all over the place with barely a hint of philosophical consistency. It is all made more weird by this line from their document in which they seem to argue that their foreign buyer tax policy will itself somehow dampen property price growth.

As for the revenue estimates ($750 million a year), they seem quite high, and the tax rate seems high by most international standards (Singapore is a lot higher). Only time will tell how many people not living here so want a New Zealand house they will pay a 15 per cent tax to do so.

And then there was the other unprincipled revenue grab, the removal of tax depreciation for non-residential buildings. This measure – which increases the tax rate on businesses – was first introduced by National in 2010 to help fund that tax switch package, with no credible or rigorous underpinnings at all. Buildings depreciate (land doesn’t). In 2020 Labour restored this depreciation provision, and was supported in doing so by their own Tax Working Group. And now both Labour and National are campaigning on getting rid of it again, with no more rationale than that they need revenue (and no doubt tax depreciation provisions won’t show up in the focus groups). The intellectual bankruptcy behind this is evident in National’s document

No rationale at all beyond claiming it was a “tax break”. They rightly pushed back when Labour called interest-deductibility a tax break – it wasn’t, business operating expenses are generally deductible – and depreciation is no different. (Arguably, simply calling it a tax break is no worse than Labour pretending the 2020 change as a temporary Covid stimulus measure when they were quite clear at the time it was permanent, but…..it is a close call. Our political parties………)

Finally just a fairly small technical point. Willis claimed this morning that the National package would not add to inflation pressures. The justification for this claim is that the package is fiscally neutral. That isn’t necessarily sufficient for there to be no net demand impact. For example, the tax cuts etc are skewed towards people who probably have a very high marginal propensity to consume, and the revenue sources probably less so. Perhaps more important, and as someone pointed out over lunch, 20 per cent of the revenue is coming from the foreign buyers tax. Since the higher end, most lucrative, foreign buyers – some billionaire wanting a luxury mansion – mostly won’t be paying the tax out of New Zealand income that additional tax revenue may not represent any diminution of demand in New Zealand. These are small points – the whole (funded) package is less than 1 per cent of GDP – but all else equal I would expect it to be slightly stimulatory. Those compiling Treasury’s fiscal impulse measure might think the same.

The IMF probably wouldn’t think it was a step in the right direction. Perhaps the same will be able to be said for Labour’s plans as they unfold?

UPDATE: On the fiscal impulse issue, the removal of the regional petrol tax in Auckland has the potential to be net stimulatory, at least for a time, as the Auckland local authorities had to wind down projects or identify alternative revenue sources. Re the foreign buyers tax, there may be an incidence question (purchasers of mansions may be able to push the tax incidence back onto vendors, but probably not purchasers of $2.1 million houses in Roseneath or Epsom (where there would normally be more potential domestic purchasers)). In any case, I think most estimates of spending from capital gains – by fairly well-off vendors- probably assume a lower MPC than spending from income.

Fiscals and elections

Michael Reddell Fiscal policy

In his (paywalled) newsletter this morning Richard Harman compares the current fiscal situation, with yesterday’s last minute fiscal announcements, to the 1972 Budget and election campaign, when Robert Muldoon, then Minister of Finance, was reputed to have said that he’d spent it all and there wasn’t anything much left for the Opposition. Surpluses and deficits were measured differently in those days (cash-based and including capex but not depreciation) but the Treasury long-term fiscal tables tell us in 1972/73 the government accounts ended up with a (very) modest surplus, 0.1 per cent of GDP.

The outgoing Labour government’s fiscal policy around its 2008 Budget is also often heavily criticised. And there is plenty to criticise it for, but as I’ve documented here in several posts (here and here) at the time The Treasury was producing forecasts showing that the operating balance would remain in surplus over the entire forecast period (tiny surplus by the end of the period, but still). It wasn’t Treasury’s finest hour, but you can’t blame Cullen and Clark for Treasury’s forecasting problems. Now, by the time of the PREFU that year things had deteriorated quite a bit – the recession was recognised to be underway – and there were no longer surpluses in prospect. But even then for the fiscal year they were actually in – 2008/09 – the best Treasury projection was a balance of 0.0 per cent GDP. A couple of years beyond that date, a deficit of 1.5 per cent of GDP was projected.

In this year’s Budget the operating balance for 2023/24 – the year we are in, the one where the government makes actual specific tax and spending decisions – the operating deficit was forecast at 1.8 per cent of GDP. There is no good case for running operating deficits at all in an economy that is more or less fully employed (Treasury’s 2023 Budget forecasts for the unemployment rate were 3.7 per cent for June 2023 and 5 per cent for June 2024, suggesting an average roughly equal to many NAIRU estimates).

Fiscal numbers for years beyond the immediately current year are substantially vapourware, but never more so than just prior to an election. The Secretary to the Treasury is required to take as given what the Minister of Finance tells her is government policy. If the Minister of Finance decides to cut future operating allowances those new lower allowances will be what is used, regardless of how plausible the numbers are (it isn’t for Treasury to inquire into that in doing the PREFU numbers). But statements of future intentions don’t bind anyone – and this is true of any Minister of Finance, of any political stripe – and need have no regard to actual budgetary pressures. The vapourware character is perhaps especially so when the plausible political allies for the incumbent party, were it to form the next government, tend to be even less keen on fiscal/spending discipline. Something like the PREFU is a good idea in principle, but there are severe limitations to what it is useful for (a few years ago I posed some suggestions that might make it more useful and might come back to those another day).

It is also easy to forget that it was only 15 months ago – last year’s Budget – that the Minister of Finance was touting his new “fiscal rules“, that were to – he claimed – “ensure New Zealand continues to maintain a world-leading Government financial position”. Among them was this

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

Just a shame there were, and are, no surpluses. St Augustine’s famous prayer (“Lord, give me chastity and continence, but not yet!”) has a certain resonance for current New Zealand fiscal discipline (or lack of it).

The focus of yesterday’s announcement – months after the expansionary Budget, weeks before the election- was on spending cuts. So I took a look at how this government’s spending plans for this year have evolved over the course of this electoral cycle.

Here is (nominal) core Crown expenses projections for 2023/24 for every EFU starting with the 2020 PREFU. The 2020 PREFU forecasts were done in August 2020, after the first and worst lockdown, but at a time when economic projections generally were pretty bleak (back then, for example, they thought the unemployment rate now would still be around 6 per cent).

The last observation takes account of yesterday’s announcement which may have knocked $1 billion or so off this year’s spending.

Even now the plan seems to be to spend $20 billion more this year than they said they intended at the end of 2020.

Now, no doubt the government would respond “ah, but inflation”. That is a pretty shaky argument, to say the least, when (a) you are the government and the central bank is one of your agencies, and (b) there has never been uttered, not once, by the PM or Minister of Finance, any sort of critical word about the central bank’s stewardship, and you went on to reappoint all the central bank decisionmakers when their terms expired, even (in the case of the Governor) when the main Opposition parties explicitly objected when (as the newly-passed law required) they were consulted. Inflation has been savage. (But of course, just the other day Robertson allowed the Bank a huge increase in its own spending with, as yet, no published rationale or justification.)

But set inflation to one side, and focus instead on projections as a share of GDP (again allowing for $1 billion off this year’s spending, per yesterday, but no reduction since this year’s Budget in expected nominal GDP)

In the first EFU of the majority Labour government (December 2020), they said that they planned to spend 30.1 per cent of GDP in 2023/24. In fact, their latest revised plans would involve spending about 32.75 per cent of GDP this year, and even with lots of fiscal drag to help them, still substantial operating deficits. Note that even after yesterday’s announcement, operational spending this year as a share of GDP is still likely to be a bit larger than they told us they’d planned even in the HYEFU late last year, a mere 9 months ago. (In HYEFU 2021 – less than two years ago now – they expected to spend just over 30 per cent of GDP this year and record a small operating surplus. Now, not so much.

It will be interesting to see the PREFU numbers (at least for this year) on 12 September, but it seems almost certain whereas in 1972 Muldoon actually delivered a tiny surplus in his final year, and whereas in 2008 Clark/Cullen went into PREFU thinking that at least the operating balance for their final year (2008/09) would be literally in balance, this year – and notwithstanding yesterday’s announcement – we will again see forecasts of a material operating deficit for 2023/24. That is all on Hipkins and Robertson.

(It will, of course, also be interesting to see National’s plan and numbers. I’m pretty sceptical based on what we’ve heard so far, but we’ll see. But when the operating balance is in material deficit, it is quite depressing to see both major parties competing on who has the best giveaways – be it GST carveouts, extra subsidies for this or that, and whatever tax plans National has – rather than on restoring promptly a record of fiscal balance. There is no good economic reason for running operating deficits this year – it is like a family overspending its income on consumption items in a year when it has been fully employed – but politics seems to say otherwise. Similarly, there isn’t a really good reason for cutting spending because of a cyclical slowdown – there are Keynesian bones in me – when the real point is that a substantial operating deficit shouldn’t have been budgeted this year in the first place.)

Finally, I remind you of last week’s post, in which the OECD numbers revealed that New Zealand has recently had one of the stimulatory of fiscal policies and now has among the largest general government (primary) deficits of any advanced country.

Prescriptions

Michael Reddell Fiscal policy, Monetary policy, New Zealand Initiative

It is the time of the cycle when plenty of groups are keen to have their policy ideas and prescriptions be heard. After all, parties may still be finalising policies and there seems to be a reasonable chance of a new government and different set of ministers before long.

Many are just self-interested (no doubt the authors mostly believe there might be wider benefits, but the fact remains that they are championing policies to help their firm/industry/sector). As an example I found a link in my email this morning to one called a “Blueprint for Growth”. It was this from the covering press release that made me rashly open the handful of slides:

“Today’s announcement is just the beginning, as we know that good, evidence-based, bipartisan policy leads to better outcomes for all New Zealanders. This is part of the key to unlocking the future prosperity and productivity in New Zealand. 

Instead it was a bunch of suggestions from the Financial Services Council, some probably worthy, others purely self-interested, that were primarily going to be good for member firms of the Financial Services Council and which, whatever their merits, were going to do nothing at all for productivity,

Yesterday the New Zealand Initiative released a rather more substantive effort, an 86 page collection of proposals and recommendations across a wide range of areas of government policy (nothing on foreign policy for example, and no references to China at all, except perhaps by allusion when discussing the proposed foreign investment regulatory regime, and no mention at all of company tax). (I wrote about their Manifesto 2017 here.)

In some parts of the left, the New Zealand Initiative is looked on as some sort of lobby group for big business, and anything they say is, accordingly, to be dismissed without further examination. The Initiative would sometimes have you believe that it was the opposite: simply public-spirited disinterested people, focused only the well-being of all New Zealanders, who put up their money (in some cases, although mostly their shareholders’ money) only to produce research and analysis without fear, favour, or predisposition. The truth is probably in the middle, but it really shouldn’t matter because the Initiative is transparent about (a) who their members are, (b) their staff and the views of those staff, and (c) their analysis and research. Their stuff should be taken on its merits, and critically scrutinised in the same way as any other contributions to debates. Topics chosen will presumably reflect, to some extent, members’ interests (in both senses of that word) but that is a different matter than what is said on those topics.

I probably agreed with half the proposals in the latest Prescription. I often find myself agreeing with them on second order issues, while profoundly disagreeing with them on the diagnosis and prescription for New Zealand’s long-running productivity failure. But it is a fairly serious collection of ideas and I was a bit surprised not to have seen any media coverage.

In this post I wanted to comment only on their fiscal and monetary policy recommendations, summarised here (and discussed in a bit more depth on page 20-22 of the PDF.

Take fiscal first.

While I generally agree with the first recommendation (no new or higher taxes) – since there is plenty of room to close the (large) deficit by cutting out low-value spending over several years – some of the arguments adduced in support don’t stand much scrutiny. Take, for example, this paragraph

It is certainly true that Singapore and Taiwan have markedly lower rates of tax to GDP than New Zealand (or other advanced countries). On the other hand, OECD data for taxes and social security contributions as a share of GDP show that these days both Japan and Korea have about the same or higher tax shares than New Zealand does. Switzerland, Australia and the US are certainly lower than New Zealand, but then Canada is higher. And “Europe aside” does tend to rather overlook the fact that most of the world’s advanced economies are in Europe. (The Ireland line was fairly disreputable, it being well-understood that Ireland’s GDP numbers are seriously distorted by international tax factors. Using as a denominator the one the Irish authorities recommend (modified GNI), Ireland’s tax share is much the same as New Zealand’s).

I largely agree with their proposals around retirement income, and was surprised to realise that Kiwisaver subsidies now cost about $1 billion per annum. The text suggests that they envisage a pretty slow increase in the age of NZS eligibility, which does fit with what National is promising but should not be necessary in a first-best set of recommendations. Lift the age of eligibility by one quarter a year and it would be at 67 in eight years’ time.

There is quite a difference between suspending contributions to the New Zealand Superannuation Fund (the headline recommendation) and the alternative they moot in the fuller text of simply winding up the Fund. Do the former and Labour is likely to simply resume contributions again. There is no natural place for the government taking your money and mine (or, worse, borrowing it) to punt in international markets at our risk. The NZSF was initially designed for two things: to keep Michael Cullen’s colleagues’ spending sticky fingers off his early large surpluses, and to help buttress an NZS age of 65. We’ve not now had regular surpluses for a long time, and there is no good reason – with improvements in life expectancy – why the eligibility age for the universal state pension should be the same now as it was set at, for the then means-tested age pension, in 1898. NZSF should be wound up and the government’s gross debt substantially reduced.

The third bullet – comprehensive expenditure review – is fine, even admirable. But specifics, and willingness to actually cut, will matter. I like the idea of getting rid of interest-free student loans (my kids look at me reproachfully) but…..what hope?

I have long favoured a (small) Fiscal Council, or perhaps a slightly wider Macroeconomic Policy Council. This is a quite different thing than the policy costings office National, Labour and the Greens are all keen on (as a public subsidy to political parties). That said, if one were serious about austerity in the next term of government – and for my money the NZI doesn’t give sufficient weight to the scale of the fiscal challenge – I’m not sure I’d be treating new nice-to-have agencies (even very small ones) as any sort of priority. I’d rather focus on replacing the Secretary to the Treasury (whose term is up next year) and revitalising the analytical and advisory capabilities of The Treasury.

What of the monetary policy and Reserve Bank proposals. In several places, they overlap with ideas I’ve pushed here over the years.

I was in favour of something like the change to the statutory monetary policy mandate to the Reserve Bank, and am actually on record (in my submission to FEC in 2018) as having favoured going further. The change to the way the mandate was expressed was never envisaged as materially altering how monetary policy was run (from Robertson’s perspective it mostly seemed to be political product differentiation), and I don’t think there is any evidence it has actually done so. The Reserve Bank has made big mistakes in recent years but they have been analytical and forecasting mistakes, not things that can be sheeted home to the change in the way the mandate was expressed (here I imagine the Governor and I would be at one, although of course he’d be reluctant to get anywhere near the world “mistake”). All that said, since making the change made no substantive difference and was mostly about product differentiation, so would undoing it. We need real change at the Bank (and in how it is held to account) so I won’t argue strongly about symbolic change, a least if it markets/headlines real underlying change.

On the other hand, I have long favoured splitting up the Bank, and leaving a monetary policy and broader macro stability focused central bank, and then a New Zealand Prudential Regulatory Agency (probably comprising the regulatory functions of the Bank and much of the FMA’s responsibilities). That such a model would parallel the Australian system is not a conclusive argument on its own, but it is a real benefit when the biggest banking and insurance players in New Zealand are Australian-based. The Initiative argues that

Separating the functions into two organisations would improve governance and reduce the risk of political interference in the RBNZ’s core mission of price stability.

I agree (strongly) with the former. The current (reformed) Reserve Bank has a dogs’-breakfast of a governance model. I’m (much) less persuaded by the latter argument. I have seen no sign – in my time at the Bank or in recent years – of political interference in the operation of monetary policy. The mistakes have been Orr’s, and if there are valid criticisms of Robertson they are that he has showed little interest in doing anything about holding the Bank (and its key personnel) to account. Monetary policy and financial institution regulation are just two quite different functions, and need different skill-sets in CEOs. It isn’t impossible to make the current combined model work – though it would need big changes, including some legislative overhaul – but it simply isn’t the best model for New Zealand. (Such a reform would, done the right way, also render the Governor’s position redundant, with two new chief executive positions to fill.)

Should the Bank’s budget be cut? Yes, of course (and that comprehensive spending review shouldn’t overlook opportunities there), and since the NZI document was finalised we’ve seen an egregious increase in approved Bank spending without even the courtesy (or statutory obligation) to provide any documentation in support. But the budget is only one lever. As important will be finding expert people to lead the institution and monetary policy function who are really only interested, in their day job, in thinking about macroeconomics and doing and communicating monetary policy excellently, without fear, favour, or suspicion of either partisan allegiance or using a public role for private ideological purposes.

I have written here previously that I favour returning the inflation target to 0 to 2 per cent. That said, I don’t find the Initiative’s reasoning very persuasive

A lower target range would encourage the RBNZ to pursue more prudent monetary policies,
minimising the risk of excessive inflation and promoting sustainable economic growth.

But there is no evidence for these claims. Adrian Orr and his minions would have made more or less exactly the same forecasting mistakes in recent years with a target centred on 1 per cent as with the actual target centred on 2 per cent.

Perhaps more importantly, I don’t think the New Zealand Initiative team has ever taken sufficiently seriously the current (regulatorily-induced) effective lower bound on nominal interest rates. That constraint can and should be fixed but unless it is fixed it would be irresponsible to recommend lowering the inflation target.

On deposit insurance, I have long favoured deposit insurance, as a second-best way of reducing the scale and risk of government bailouts of banks (if no one is protected a failing big bank will almost certainly be bailed out, whereas with (retail) deposit insurance it is more credible to think that wholesale funders might be allowed to lose their money in a failure. That said, my argument was primarily about the big banks, and the deposit insurance regime will not cover only them. I do worry about heightened moral hazard risks around the small institutions. One could, I suppose, argue that capital ratios are now high enough there is very little risk of a large bank failing, to a point where it is credible that depositors could face material losses, but that argument cuts both ways in that with high capital ratios moral hazard risks are much smaller even in the present of deposit insurance.

The second to last item on the monetary policy list is a curious one. The Reserve Bank has run up losses of about $11 billion dollars through an LSAP conducted almost entirely in government bonds. So while I agree with limiting what NZ assets the Bank can buy, I don’t think it gets near the heart of the issue. New Zealand legislation is generally for too lax in allowing huge risks to be assumed with no parliamentary approval (whether the Minister of Finance issuing guarantees, for which there is no limit, or the Reserve Bank – which cannot default on its debts – buying risky assets. While there is a need for some crisis flexibility, the scale of the intervention undertaken (over more than a year) should not again be possible without parliamentary approval. That, incidentally, does not impair monetary policy operational autonomy both because the LSAP is a very weak (just risky) instrument and because (see above) the effective lower bound on the nominal OCR itself can and should be fixed.

I have no particular problem with something like the final item on the list, but as regards the LSAP expansion it would seem to be already there. The Bank’s holdings of government bonds are being slowly but steadily sold back to The Treasury (and others are maturing in RB hands). One can argue that the mix of sales might have been different or that the pace should have been (much) faster, but the domestic monetary policy bit of the balance sheet will shrink a lot. There are debates to be had about how much of an “abundant reserves” approach is taken in future – I’d probably favour not – and there are issues that should have had more scrutiny around increases in foreign reserves that the Minister has approved this year, but they are probably second order in nature.

With only 86 pages and lots of policy areas to get through, the NZI document was never going to cover all the significant issues in any subject area. I have quite a list of others, both as regards fiscal policy and around monetary and financial regulatory policy, but this post was about engaging the debate on the ideas NZI has proposed, not tackling all the ones they didn’t or didn’t have space for. Overall, I’m mostly sympathetic to the direction they suggest, but any incoming government actually interested in change should subject the specifics to some serious critical scrutiny.

Policy costings offices in Australia

Michael Reddell Fiscal policy

After my post yesterday I remembered that I had also written a post in 2019 based around the excellent talk Jenny Wilkinson, then the Australian federal Parliamentary Budget Officer had given at Treasury in 2019. I ended that post this way

….it was a very useful presentation (I hope Treasury makes her slides available) from a technocrat’s technocrat.  I’m left sceptical on two main counts:

  • first, whether elections ever much do, or really should, turn much on precise fiscal costings. Perhaps it appeals to inside-the-Beltway technocrats to conceive of that model, but I see elections as mostly about things like competing visions, competing personalities, competing diagnoses, and competing claims to competence.  If so, why spend so much on highly-detailed and expensive state-funded costings, that the parties themselves don’t think it worth spending their own money on?
  • second, we should think harder about the whole panoply of support and information etc we provide to political parties and the public, preferably without further reinforcing the favoured position of established large parties.  Thus, it is interesting to note that written parliamentary questions are much much less used in Australia, as a way of garnering information, than is the case in New Zealand. (“In the years 2008–2014 only about 8 questions in writing were being asked each sitting day, but this number increased to 19 in 2015, and was 14 in 2016.”).   What about better resourcing select committees (to me a better use of money)?  And if we threw in a free PBO service, should we reduce existing money parliamentary parties are funded with?  If not, why not?  And would resistance to that idea suggest the costings were some epicurean nice-to-have rather than a central element of a well-functioning democracy?  And then, of course, there is the OIA.  Mightn’t it be better to require agencies to release documented costings models themselves, in ways that would allow political parties and their consultancy firms to use them to the extent they judge appropriate (and not otherwise).

And if I had the analytical resource implied by 40-45 more staff and had to deploy it somewhere in the public sector, it is far from obvious that a policy costing operation (with supporting analysis and research as the PBO) would offer the highest benefit-cost ratio.

Rereading that got me thinking again about the resource requirements for such an agency in New Zealand, that both Grant Robertson and Nicola Willis now seem keen on (despite apparently straitened fiscal circumstances). As I noted in yesterday’s post, no small advanced economy I’m aware of runs one of these costings offices (Australia, you will recall, has five times our population and rather more than that multiple of real GDP, the real resources used for this luxury product). And policy issues aren’t really less complex or less numerous just because your country is smaller (Australia has some federal/state interaction issues, but they aren’t likely to material affect the potential demand for policy costing work).

As far I can see there are three such costing offices in Australia. I will focus on the federal and Victorian versions, but the first such entity was the New South Wales one.

The NSW entity is a bit of an odd beast, and I don’t think anyone has championed anything like it in New Zealand. It is set up only for the 9 months prior to each state election (not sure if snap elections are allowed in NSW), and can be used only by the leaders of the two main parties, who in turn are required to submit all their policies to the PBO 10 days before the election, and the PBO is required to publish costings for them at least 5 days before the election. It seems to be staffed largely by temporary secondees from existing public service departments, overseen by an academic. From the report on the 2019 election, it seems to have had about 20 staff at peak

In practice, it seems that parties work with the PBO behind the scenes in advance getting their policies costed, and either modifying or dumping ones that come in too expensive etc, with only the final policies and the costings of them seeing the light of public day.

If you believe in these sorts of things, I guess one can see the logic of the NSW approach, as it tries to put the main Opposition party on something like the same footing as the governing party. It isn’t a small financial or resource commitment (about the total staff numbers of, say, our Productivity Commission), for what is after all only a state government, but it is only for 9 months every three years.

What of the federal Parliamentary Budget Office? There is quite a lot of material in that earlier post. One other extract that might be worth bringing forward is

…in answer to a question from me, Wilkinson observed that what the PBO can best do is cost programmes that represents small deviations from the status quo (they have good tools to estimate direct and immediate fiscal costs/gains) while wider economic second round effects, and the associated fiscal impacts, are likely to be small.  But, and using her own (deliberately extreme) example, if some party were to campaign on getting rid of the welfare state, her office could do the direct fiscal costs, but could offer little or nothing on the wider economic (or social) effects of such a policy, including the possibility that it might have large long-term indirect fiscal implications.    They will only offer qualitative statements about those wider effects.  Which left me thinking that the the PBO probably does very well on things that don’t matter that much, and can’t offer much on the bigger issues that elections probably should really be about (whether about the welfare state, climate change, productivity or whatever).   

They do a lot of costings

Another aspect of the presentation that surprised me was (a) the number of costings the PBO does, and (b) the extent to which demand is not concentrated just in the pre-election period.  In fairness, she noted that the latter had surprised them too.  In the most recent year (an election year) they’d done 2970 costings, while in the previous two non-election years they had averaged about 1700 costings. Only MPs can request costings, and there are 227 MPs (across House and Senate).     Those numbers don’t mean 2970 separate items of policy, as many of the costings will be, in effect, rework as members or parties iterate towards a policy that meets their ends and will be scored by the PBO as not costing too much.

but note (see above) how much less extensively written parliamentary questions are used in Australia.

At the time of that 2019 presentation, Wilkinson told us her office normally had about 45 staff, scaling up to around 55 at elections (and recall that this is a federal government, in a system where a lot of policies are state responsibilities). The table in the latest Annual Report suggests that is still about right

What of the Victorian state Parliamentary Budget Office? Here is what they say they do

All MPs have access (unlike in NSW).

This doesn’t come cheap. Their documents say that for last year’s election they peaked at 26 FTEs, and they appear to have a permanent staff of about 16.

For a system of unitary government it seems reasonable to think in terms of the combined Victoria plus federal offices (which thus cover all the policy areas that affect Victoria, whether via federal or state policy). That seems to involve a base level of 60 staff, scaling up to perhaps 80 in the run-up to elections.

Now, of course, Australia is a fairly big country. But as already noted, neither the number of policy issues nor the design complexity of those policies is really scalable with the size of the country. And it seems most unlikely that one could do a worthwhile job – across the multiplicity of areas of policy – with 12-16 staff in New Zealand. In fact, I find it difficult to see how it could be done well – and there is really no point if it is not done well – with fewer than perhaps 30-40 staff.

That would be bigger (much bigger) than either the Productivity Commission or the Parliamentary Commissioner for the Environment (21 staff). Would it be a priority use of scarce resources for taxpayers to be putting this additional financial assistance towards political parties and MPs? I continue to think that better-resourcing select committees would have a much larger payoff for citizens and good governance. There is likely to be a good reason why no other small advanced countries run state-funded policy costing offices (while parties themselves are of course free to use economics and other consultancy firms to the extent they find useful – in a political market).

Issues of scale are very real for small countries’ central government policy functions. I’ve already mentioned that the Productivity Commission has 15-20 people in total. To the extent there was an inspiration behind our Commission (as distinct from a bauble for the Key government to throw ACT’s way), it was the Australian Productivity Commission, which has over the years produced a lot of useful reports. The latest Annual Report suggests that Commission has 165 staff and 12 commissioners. The sorts of issues facing Australia are not likely to be any less numerous or complex than those facing New Zealand, and even if the staff of our Commission walked on water they simply could not match the value that could be added by the Australian Productivity Commission.

I would have thought there was no credible way we would devote 180 people to the Productivity Commission – nor do I think we should – but I guess if the Ministry for the Environment now has more than 1000 staff really who knows anymore. But with 15-20 people it was always going to be vulnerable to going the way it has, and was always going to struggle to maintain depth and critical mass.

The pool of really able people is small, and fiscal resources are limited (in a smallish underperforming economy). It just doesn’t make a lot of sense to be thinking of putting dozens of people into helping political parties cost their specific policies. On the track record of their performance, nor does having 15-20 people in a Productivity Commission that now seems, in practice, to perform a more general role in support of political parties of the left. A new government should rebuild Treasury, and if there is resource it would be better spent strengthening select committees to scrutinise actual legislation and actual government agencies, rather than (further) funding the bids of the parties competing for the keys to the Beehive.

Policy costing

Michael Reddell Fiscal policy

Yesterday one of the Labour’s surrogates – Craig Renney, economist at the CTU, but also former adviser to the Minister of Finance (and reputed to be interested in being a Labour MP himself) – came out with a short document attempting to put a fiscal frame around National’s election promises. (One might have thought that if you’d been a part of enabling an $11bn hole in the government finances – the LSAP losses – you might have been a bit more modest in your rhetorical tone, but I guess he was only a (very senior) adviser).

It is explicitly partisan political in nature, and heavy on rhetoric. The flavour is perhaps conveyed by the front cover

As anything other than partisan spin though, it was a strange document. I’m as keen as anyone to see National’s programme (with numbers), but then in a week when the PM has been going round distinguishing between Labour Party policy and government policy, the same could be said of Labour’s (as yet largely unannounced) programme.

Renney’s document is built around an attempt to show that what National has announced so far does not fit within the operating allowances for the next three Budgets set down by the Minister of Finance in this year’s Budget. I have no reason to doubt that his numbers are approximately right. But (not only is it not clear that National has yet announced all its policies) there is no obvious reason why National would regard itself as bound by the operating allowances the Labour Minister of Finance had put in his pre-election budget. After all, Labour hasn’t in the past, and is highly unlikely to do so next year were it to be re-elected. (The operating allowance framework is in any case quite badly flawed as any sort of future signal, but especially when inflation is jumping around.)

I’m not championing what we know of either side’s fiscal policy. From both sides, there seems to be a disconcerting falling away from a commitment to budget surpluses, except in that vague distant future sense of the early St Augustine (“Lord, give me continence and chastity, but not yet”).

But Labour’s own (official government) numbers already have about them a considerable air of unrealism. In this year’s Budget, the only hard numbers – those planned for 23/24 – showed a slight increase in core Crown primary spending (ie excluding finance costs) as a share of GDP, but then the vapourware numbers – the ones relying on those operating allowances – show a fall from 31.2 per cent of GDP this year to 29.7 per cent in 2026/27. Another way of looking at those same numbers is to calculate – all from Budget numbers – real per capita core Crown primary spending over those three years Renney focuses on. On Labour government numbers, real per capita expenditure is projected/planned to show no growth at all in the next three years. Does that seem like a prospect that would align with what we’ve seen of this government’s approach to spending in recent years (in an era of ageing populations, public sector wage pressures etc)? Not to me. And the last three years have seen a single party government, and on all the polls if Labour were to get back in it would be dependent on the even less fiscally disciplined, less inclined to expenditure restraint, Green and Maori parties. With a Labour leader who has already ruled out the wealth taxes those two parties favour to help pay for their fiscal ambitions.

There is also the small matter of scale. Renney’s claims are that there is a gap of $3.3-$5.2 billion over the three fiscal years in questions. Since core Crown primary spending over those years is estimated at in excess of $400 billion any such gap is 1 per cent spending (or about 0.3 per cent of GDP). Seems a slim basis for such florid headlines.

But it will be good to see National’s numbers. In a better world, they would be credibly showing a commitment to a structural fiscal surplus next year. But given that Labour’s vapourware tiny surplus the following year was looking shaky from day 1 (once Eric Crampton pointed out the tobacco excise tax losses they and Treasury had accidentally left out) I don’t suppose it is likely.

But no doubt Renney’s report achieved its political end and put National and Willis on the back foot for a news cycle. National’s response didn’t seem much better. It seemed to consist first of suggesting that the economist of the CTU shouldn’t be commenting in public, which was a bit odd to say the least. And then we had the attempt to reclaim the news cycle by suggesting that it all (what?) was down to Grant Robertson not having followed through on the earlier plan to set up a budget-costing unit. National had (rightly in my view, see below) opposed the idea of such a unit when Labour and the Greens were championing it, but apparently when Willis had become finance spokesperson she had written to Robertson to express National now being in favour. Nothing had happened in the intervening year or so.

I wrote a lot about the idea of a policy costing unit here pre-Covid when the idea was being worked up by the government and The Treasury (there was a formal consultation process at one point). My most recent post on the issue was here. I ended that post with this thought

It won’t improve policymaking, it won’t change the character of elections, but it might –  at the margin –  create a few more jobs for economists.

I remain staunchly opposed. This was an extract from a submission to the Treasury consultation

Parties have adequate incentives already to make the case for their policies, in whatever level of detail the political (voter) market demands, and… already have access to the Parliamentary Library resources, parliamentary questions, and Official Information Act requests.  A policy costing office –  not found in any small OECD country –  would be, in effect, just a backdoor route to more state funding of parties (and not necessarily an efficient route – bulk funding would be preferable if state funded was to be more extensively adopted).  It also reflects a “inside the Beltway” conceit that specific costings are highly important, and that use of a single “model” or set of analysts somehow puts everyone on equal footing  (it doesn’t –  public service analysts having their own embedded assumptions about what is important, what behaviours are sensitive to what levers etc.)   With the possible exception of the Netherlands, I’m not aware of any country where a political costings office products plays any material or sustained role in election campaigns and outcomes.

Here was the list of other reasons from that 2019 post

I’ve listed most of my objections previously, but just quickly:

  • there isn’t an obvious gap in the market.   At present, political parties produce costings (sometimes reviewed by independent experts) to the extent they judge it to be in their own interests to do so.  Voters, in turn, can judge whether the presence or absence of any costings, or any debate around them, matters much.  Existing parliamentary parties have access to considerable taxpayer resources which they can draw on to develop and test policy proposals,
  • it isn’t obvious when, if ever, a New Zealand election in at least the last fifty years has turned on the presence, absence, quality (or otherwise) of election costings.  It is a technocratic conceit to suppose otherwise: people vote for parties for all sorts of reasons (values, mood affiliation, fear/hope, being sick of the incumbent, trust (or otherwise)) which have little or nothing to do with specific policy costings,
  • the relevance of specific policy costings (and indeed overall fiscal plans) is even less under MMP than it was in years gone by.  Party promises are now little more than opening bids, as coalitions of support are put together after the election to govern (and on almost every specific piece of legislation).  We simply aren’t in a world where a few dominant ministers dominate a Cabinet which in turn has a majority (or near so) in the government caucus, which in turn has an unchallenged majority in Parliament,
  • the “fiscal hole” argument (from the 2017 campaign) remains an utter straw man in this context.   First, when Steven Joyce made his claims in 2017 lots of people, including experienced ex-Treasury officials, weighed in voluntarily, and debate ensued about whether, and in what sense, Joyce was saying something important.  The system –  open scrutiny and debate –  worked.  And, secondly, a policy costings unit –  of the sort the government apparently envisages – would not have made any useful contribution to such a debate, which was about the overall implications of Labour’s fiscal plans, not about the costs of specific proposals Labour was putting forward.     Elections are messy things –  always were and probably always will be, and that isn’t even necessarily a bad thing.
  • some of the arguments made for a policy costings unit might have more traction if, somehow, every political party and candidate could be forced to use it (say, submit all campaign promises to the costings unit at least three months prior to an election, with the costings unit issuing a report on all of them say at least one month prior to an election).  But even if you thought that might be a good model, it isn’t going to happen (and there is no credible way that such a model could be enforced).  Instead, the proposed costings unit will be used when it suits parties, and not when it doesn’t, and will probably be most heavily used by parties that are (a) small, (b) cash-strapped, and (c) like to present themselves as policy-geeky.  The Greens, for example.  One might add that the unit would most likely be used by parties that believe their own mindset is most akin to that of those staffing the unit –  likely to be a bunch of active-government instinctively centre-left public servants.  Embedded assumptions can matter a lot –  The Treasury used to generate wildly over-optimistic revenue estimates for a capital gains tax, and it was probably no coincidence that as an agency they supported such a tax. 
  • the policy costings unit seems, in effect, to largely represent more state-funding for (established) political parties.  That might appeal to some, but even if you thought more state funding was a good idea (and I don’t) it isn’t obvious why this particular form of delivery is likely to be the best or the most efficient.  Money might be better spent on research and policy development (say) rather than “scoring” at the end of the process, for detailed plans that will almost inevitable change before they are ever legislated.  And if we want to spend more on policy scrutiny, I reckon a (much) stronger case could be made for better-resourcing parliamentary select committees.
  • the interim proposal for next year’s election would enable only parties already in Parliament to utilise the facility.  Again, this has the effect of further entrenching the advantage established parties have in our system (I hope it will be re-thought when the legislation itself is considered).
  • practicalities matter: there probably won’t be much demand on a policy costings unit in the year after an election, and could be quite a bit in the year prior to one.  How then will be unit be staffed and a critical mass of expertise maintained?  If people are seconded in from government agencies, would we really have an independence (including of mindset and model) at all?  And costings skills aren’t readily substitutable with bigger-picture fiscal policy (or macro policy) analysis skills.
  • the lack of transparency around the proposed institution should be deeply concerning.  As far as I’m aware there has not yet been any indication as to whether the policy costings unit would be subject to the OIA (as the Auditor-General and Ombudsman are not, and nor is Parliament more generally).   The Minister of Finance has indicated that any costings the unit did would only be released with the consent of the political party seeking the costings.  That should be a major red flag.  In my view, any new unit should be (a) explicitly under the OIA, and (b) the enabling legislation should require that any costings done for political parties should automatically be released 20 working days after being delivered to the relevant political party (or more quickly if the costing is delivered within 20 days of an election).  A policy costings unit should not be a research resource for political parties – the only possible basis for confidentiality – but a body that at the end of the process provides estimates based on the details the relevant party has submitted. (As I understand the system in Australia, costings provided during the immediate pre-election period are automatically released, but others are not.)

The fourth bullet there – re the 2017 “fiscal hole” debates – is germane to Willis’s claims in the last 24 hours. The sort of policy costings unit that has been proposed costs specific policy proposals, but does not provide reports on the coherence or otherwise of overall fiscal strategies. The presence of such a unit would have made no obvious difference to anything about the furore around the CTU report.

From a more narrowly political perspective, one might also note that if National is really championing this new source of employment opportunities for economists, and (which is what it is) additional state funding for political parties, it isn’t a great signal of the seriousness of their commitment to fiscal restraint. Renney might, after all, have the beginnings of a point.

Incidentally, in this rather silly political debate, Grant Robertson emerges no better than anyone else. He is reported as having said that National’s change of heart on a policy costings unit had meant it was too late to have done anything for the 2023 election. Except that he himself in 2019, announcing the new policy costings unit policy Cabinet had just agreed to about a year out from the 2020 election, explicitly announced a transitional non-statutory arrangement for the 2020 election, pending full establishment in 2021. If Willis’s change of heart was a year or more back, presumably the same could have been done this year. (I’m glad he didn’t of course.)

Finally, I have seen this morning at least one commentary suggesting that independent fiscal institutions are now the way of the world, the OECD champions them etc. A policy costing unit is not really what most countries – or international agencies – have in mind in advocating such institutions, which are typically more about independent monitoring and reporting on government fiscal strategy and policy (ie macro in focus). Very few countries have state-funded policy costings units, none of them small and (by advanced country standards) relatively poor.

Inflation, monetary policy, and central bank spin

Michael Reddell Fiscal policy, inflation, MPC

The CPI data out yesterday were not good news.

Annual headline inflation was, more or less as expected, down, but at around 6 per cent is miles from the 2 per cent target midpoint the Reserve Bank’s MPC has been required to focus on delivering. Much more importantly, core inflation measures show little or no sign of any reduction.

Six months ago I had been intrigued by this chart

It looked as though a reasonable case could then be made that core inflation had peaked a year earlier and was now falling (albeit still far too high).

But jump forward to today and the chart now looks like this

If it still suggests a peak at the start of last year (at least on one of the measures), it is no longer a picture of (core) inflation falling now. (NB: You cannot put much weight on the absolute level of the numbers shown here because for some, unknown, reason SNZ persists in doing the calculations on not seasonally adjusted data, which can materially affect the level of quarterly estimates.)

If you look at a range of exclusion measures (CPI ex this, that or the other), the quarterly picture for Q2 looks a little more promising (but analytical measures such as those above are increasingly used for a reason).

On an annual basis, a whole bunch of measures centre on core inflation of perhaps just over 6 per cent.

Focusing on just two big individual price movements, the CPI ex petrol is up 7.1 per cent for the year, and the CPI ex international airfares is up 5.7 per cent.

The contrast between New Zealand

and Canada (where the central bank has the same target as ours) is striking

Rightly or wrongly, the Canadian central bank last week still judged it appropriate and necessary to raise its policy interest rate.

Over the period since the OCR was introduced, the New Zealand policy rate has typically been a lot higher than Canada’s (for the same inflation target since 2002): the median difference has been 1.5 percentage points. At present, the difference is unusually small even though our inflation numbers look quite a bit worse than Canada’s

If you think Canada is an obscure comparator, the story is, if anything, a bit more stark relative to the US where core inflation measures have also been falling.

And yet having chosen – and it is pure discretionary choice by the MPC – to review the OCR last week, just a few days BEFORE the infrequent New Zealand inflation data was released, the MPC then declared itself “confident” things were on track to get inflation back to target with policy rates at current levels.

Given how wrong they (and most other central banks) have been over the last three years, it is difficult to know how any bunch of monetary policymakers, with any self-knowledge and introspection at all, can declare themselves “confident” of anything about inflation outlooks. But what could possibly have led our lot to such a conclusion a week BEFORE the (quarterly only) inflation data? Once again, it isn’t looking great for them……and I guess it will be fingers crossed at the RB that the quarterly labour market data out early next month are much weaker. But the best official monthly data we have don’t seem that promising.

(As a reminder, it is not too late to apply to become a member of the Monetary Policy Committee although it is unclear that genuinely able people would be that keen to join a body led by underqualified uninterested people and where any genuine insight or challenge is unlikely, on the evidence to date, to be welcomed.)

I’ve always been reluctant to suggest that the MPC, or even Orr, were partisan. Mostly, they just seem not very good, something shown up more starkly in challenging times, and prone to questionable self-serving spin (even in front of Parliament). But since the May MPS I have started to wonder, and the nagging doubt was reinforced last week.

The Minister of Finance brought down the government’s annual Budget on Thursday 18 May. The Reserve Bank’s Monetary Policy Statement was a few days later, on Wednesday 24 May. I was travelling so most of my scattered comments were on Twitter.

On a current affairs show on 20 May, the Minister of Finance claimed that the Budget would not add to pressures on inflation or monetary policy.

This was utterly at odds with the material published by The Treasury. Treasury estimates and publishes a series for the “fiscal impulse”. This measure was designed specifically for the Reserve Bank to give a sense of how, particularly over the forecast period, fiscal policy choices were going to be affecting demand and inflation pressures.

All else equal a falling deficit or rising surplus act as a bit of a drag on inflation, and vice versa for rising deficits or falling surpluses.

This chart was from the Treasury HYEFU published last December and incorporating the government’s then fiscal plans, as formally advised to the Treasury. As you can see, for each of the forecast years, the estimated impulse was negative (the overall accounts were still expected to be in deficit for most of the period, but the projected deficit was shrinking). At the time, most monetary policy interest would have been on the (highlighted) 23/24 year – showing a moderate negative impulse – since it was the period that monetary policy choices would most affect (and anything beyond 23/24 was little more than vapourware anyway, with an election in the middle).

This is how the same chart looked in the May Budget documents (Treasury’s BEFU)

For the key year – the one for which this Budget directly related – the estimated fiscal impulse had shifted from something moderately negative to something reasonably materially positive. The difference is exactly 2.5 percentage points of GDP. That is a big shift in an important influence on the inflation outlook – which in turn should influence the monetary policy outlook – concentrated right in the policy window.

My point is not to debate the merits of the Budget (political parties will differ on that) but to highlight the macro implications of aggregate fiscal choices as estimated by The Treasury, and how utterly at odds with the Treasury’s analysis the Minister’s spin was.

Ministers – and perhaps campaigning ones – will say whatever suits them, whatever relationship (or otherwise) what suits bears to hard analysis and advice.

But one of the key reasons why societies have chosen to delegate the operation of monetary policy to autonomous central bankers is that the central bankers are thought more likely to operate without fear or favour, calling the data and events as they calmly and professionally see it. So, you’d have thought, with a Monetary Policy Statement a few days after the Budget one might have expected some serious detached analysis of the updated Budget fiscal numbers, as they affected demand and inflation. Either citing the Treasury’s estimates or perhaps presenting analysis explaining why the Bank thought the fiscal influence might be different than the Treasury did (the latter using a framework designed specifically for monetary policy purposes). After all, in their previous MPS, MPC minutes had explicitly noted that “members viewed the risks to inflation pressure from fiscal policy as skewed to the upside”.

Central bankers, including particularly at our Reserve Bank, have long avoided taking a stance on government spending and revenue choices. Mostly, they also avoid taking a stance of deficits and surpluses. Those are political choices, and particularly in modestly-indebted countries (like New Zealand) it doesn’t greatly matter to monetary policy whether the budget is in deficit or surplus. It matters way less whether one has a high spending and high taxing government or a low spending or low taxing government, and so it is rare – and appropriately so – for the Reserve Bank to be commenting on either spending or revenue choices. What matters (about fiscal policy) in updating the inflation outlook is changes in the discretionary component of the fiscal deficit/surplus (basically, what the fiscal impulse is trying to capture). This snippet (from a Bollard-years MPS) captures the general approach.

But how did the MPC treat things in the May 2023 MPS, coming just a few days after that very big increase in the expected fiscal impulse for the immediately approaching year, at a time when inflation (core and headline) was way outside the target range and the OCR had had to be raised aggressively?

The only uses of the terms “fiscal” or “fiscal policy” (“fiscal impulse” doesn’t appear at all) are in this paragraph from the minutes. Even here – even that final sentence – it is consistent minimisation.

But these are the only references. In the one page policy statement, there is no link drawn from fiscal choices to the inflation outlook, and only this rather odd (for a central bank) detached observation: “Broader government spending is anticipated to decline in inflation-adjusted terms and in proportion to GDP.” So what, one was left wondering…..unless the Governor and his colleagues had taken to playing politics, perhaps to help out a Minister and his colleagues who seem more disposed to the Governor’s way of doing/saying things than, say, the Opposition parties (who openly opposed his reappointment) might be.

Perhaps it wouldn’t even be worth highlighting if this were the only such reference. But it isn’t, by any means. Recall, there are no references in the body of the document to fiscal policy, fiscal impulses, fiscal deficits, OBEGAL, or changes in any of these. But there is a whole section devoted specifically to government spending, on top of the couple of references I’ve already quoted. And the focus there is not on the horizon relevant to May’s monetary policy choices, or the inflation outlook over the next 12-18 months but over the “medium term”, when who knows which government will be in charge and what their spending preferences and priorities will be.

It is quite right that their projections – which simply use Treasury numbers as a base – have real government consumption and investment spending (the bits they publish numbers for) flat for the next several years.

That might raise some interesting issues, including for supporters of the current government who favour lots of government spending (is it really consistent with your values that per capita spending is going to fall quite sharply?, would it prove politically sustainable? and so on).

But it is of almost no relevance to monetary policy. And omits really major bits of the fiscal story (on the spending side, all of transfers and finance costs, and all of the revenue side). Central banks should be mostly interested in shocks to the deficit/surplus outlook. But not, this year, it appears the RBNZ.

The Bank and the MPC seemed to minimise any story about the fiscal contribution to the outlook for inflation and monetary policy (you know, things like inflation still being outside the target range, even with a high OCR, for protracted periods. Those fiscal impulse charts/numbers don’t get a mention. But neither do simple stats like the fact that in December’s HYEFU, on then government plans, Treasury thought the OBEGAL deficit for 2023/24 would be 0.1% of GDP. By May’s Budget, government plans meant a forecast deficit that year of 1.8% of GDP. These are really big changes, playing down to near-invisibility by our supposedly non-partisan independent MPC.

It was all brought back to the front of mind last week when, out of the blue, this observation appeared in the OCR statement

Broader government spending is anticipated to decline in inflation-adjusted terms and in proportion to GDP. 

If you relied on Reserve Bank commentary, you’d just never know that, in the period current monetary policy choices are directly affecting, discretionary fiscal policy choices (overall balance and all that) had added, quite considerably, to inflation pressures in this year’s Budget. It doesn’t take much to guess which line the Minister of Finance will have preferred – and it isn’t the one that actually aligns with the Bank’s own responsibilities.

I am really reluctant to believe that partisan positioning is at work, even if (if it is happening) “just” for institutional self-protection reasons. But I find it difficult to see a compelling alternative explanation for the MPC’s approach to fiscal analysis and fiscal impulses in the last couple of months.

Perhaps the Opposition parties will view the Reserve Bank more charitably. But on what has been put before us, there is no reason for them to do so.

Two sets of fiscal deficits

Michael Reddell Fiscal policy, inflation, Monetary policy

In the government’s Budget, the Treasury projects that on current policies the government will be running an operating deficit for six straight years (while in the 7th the surplus is so tiny that even if it were not for Eric Crampton’s point about tobacco excise revenue we might as well just call it a coin toss as to whether, if the economy played out as Treasury projects we’d see a surplus or a deficit that year).

People have from time to time pointed out that under the previous National government there was also a spell of six straight years of deficits. In fact, here is a chart. The blue lines shows actual fiscal balances from the last surplus (year to June 2008) to the first surplus again (year to June 2015), while the orange line shows actual and Treasury forecasts from the year to June 2019 (last surplus) to the first (tiny) projected surplus (year to June 2026)

In each period, there was one really really large deficit year. In the earlier period that was the year to June 2011, which captured much of the cost to the Crown resulting from the Canterbury earthquakes. In the more recent period, the peak deficit was the year to June 2020, the period encompassing the first and longest Covid lockdown (huge wage subsidy outlays and all).

If these forecasts come to pass we”ll have had an operating surplus (or balance) in five of the last seventeen years.

What about context? In both periods there was a very big exogenous event: earthquakes in the one period and Covid (lockdowns) in the other. Both were, almost necessarily, very expensive for the government. Few people have much problem with meeting many of the direct costs as fiscal obligations.

But….there was a really important difference between the two periods. In the first, the economy headed straight into a fairly deep recession (partly domestically-sourced – our inflation rate had got above the top of the target band – and partly the global downturn associated with the 2008 financial crisis. It was all aggravated by the fact that the 2008 Budget was very expansionary – and yes, that was extravagant and it was election year, but the Treasury advised them that such an approach would not push the budget into deficit over the forecast horizon. It wasn’t one of Treasury’s better calls.

By contrast, at the end of 2019, the unemployment rate was low and, notwithstanding the brief but severe interruption to output around the lockdowns, has mostly remained very low since. When there isn’t excess capacity in the economy, tax revenue tends to come flooding in.

Here is a comparative chart of the unemployment rates in the two periods.

That difference in the unemployment rates makes quite a big difference to the fiscal outcomes, for any set of spending choices. You might criticise the previous government for doing nothing about a Reserve Bank that let unemployment linger well above the NAIRU for so long, as you might criticise the current government for doing nothing about a Reserve Bank that had the economy so overheated for so long. But the economic backdrops to those paths of fiscal deficits were simply very different: with an overheated economy and lots (and lots) of fiscal drag, the revenue was flooding into Treasury over recent years. There was simply no good macroeconomic reason for having operating fiscal deficits at all in an overheated economy, especially once the big direct Covid spending had come to an end (which it had a year ago). By contrast, the earlier government presided over a very sluggish recovery – and so weak, relative to target, was inflation that there was barely any fiscal drag. Even if the Budget was structurally balanced, cyclical factors would have left a small deficit (on Treasury and Reserve Bank numbers there was a negative output gap every year through to 2016).

If the unemployment rates and output gaps give a sense of the cyclical slack (or overheating), labour force participation rates are also valuable context

A materially larger share of the population is now in the labour force now than in the period of that previous run of deficits (and given that unemployment rates have been lower this time, the difference in employment rates is even larger. Revenue has been abundant.

I’m not really convinced there was an overly strong case for the previous government having continued to run operating deficits in the last couple of years of their stretch of six. Had the Reserve Bank been doing its job better, perhaps they wouldn’t have (the economy would have been more fully employed and inflation would have been nearer the target).

But I’m quite convinced there has been no good economic case at all for operating deficits in 22/23. 23/24, or 24/25. Take 22/23 (the year just ending) as an example: on Treasury estimates there has been a positive output gap, and the unemployment will have averaged about 3.5 per cent (well below anyone’s estimate of NAIRU). And with 6-7% inflation, fiscal drag has been a big revenue raiser. And if there has been any residual direct Covid spending (a few vaccinations?), the amounts involved must have been vestigial indeed. So cyclically the revenue was flooding in, but they still ran a deficit: it was pure choice to undertake routine operational spending without the honesty to go to the electorate and raise the taxes to pay for that spending.

The cyclical position is less favourable over the next couple of years – the recesssion (as indicated by the 2 percentage point rise in the unemployment rate) required to get inflation back down again – but the government has chosen to adopt discretionary new giveaways with borrowed money.

It isn’t just some idiosyncratic Reddell view that operating budgets should be balanced (none of this is about capital spending or arguments about infrastructure). It is there in the Public Finance Act

Now, if I was writing the Public Finance Act, I wouldn’t word things quite that way. But……the Public Finance Act is something both main parties have signed up to. It may make sense to borrow to fund useful longer-term investment, but it makes no sense to be borrowing to pay the groceries, especially in times when income has been more abundant than usual.

Just two more Budget charts. The first is one I showed on Twitter yesterday

Now, there is plenty of scope for political argument about the appropriate size of government spending, and left-wing parties will typically be keener on higher numbers than right-wing parties. My own interest here is more about fiscal balances, but it is worth being conscious of just how much larger a share of the economy is now represented by Crown operating spending than was the case even five or six years ago. Those were the days of the pre-election Labour/Greens budget responsibility rules

Next year’s spending at 33 per cent of GDP is not quite at the previous peaks (Covid and the earthquake years) but nor might one really have expected it to be. But there is an election to win I guess.

And finally, inflation. Treasury doesn’t run monetary policy but (a) the Secretary sits as a non-voting MPC member, and (b) Treasury are the Minister’s advisers on the Bank’s performance, so they aren’t just any forecaster. On the Treasury numbers, it isn’t until the year to June 2027 that CPI inflation gets back to the middle of the target range (the 2 per cent midpoint the MPC is supposed to focus on).

This chart uses Treasury’s annual numbers to illustrate what a difference the monetary policy mistake has made, and is making, to the price level

The blue line is the actual (annual) data and the Treasury forecasts. The orange line is what the price level would have looked like in a stylised scenario in which the MPC had delivered 2 per cent inflation each year over this period. The difference is substantial: the price level in the blue line is almost 13 per cent higher than in the orange line by the end of the period. The Minister of Finance appears to be quite happy for the current gap (about 10 per cent) to keep widening for the next five years. He shouldn’t be.

We do not run a price level targeting regime. That means bygones are treated as bygones and we don’t attempt to pull the actual inflation rate back down to the orange line having once made the policy mistake that pushed it so far above. It does not – or should not – mean indifference to the arbitrary redistributions that big unexpected changes in the price level impose, strongly favouring borrowers (especially those with nominal debt and long-term fixed interest rates) and heavily penalising financial savers (holders of real assets can be largely indifferent over time). Inflation – and especially unexpected inflation – is deeply damaging, and there were good reasons for reorienting monetary policy to deliver medium-term price stability. But now the powers that be appear unbothered by 7 years in succession of inflation above the target midpoint. It seems about on a par with being happy to set out to deliver six successive years of operating deficits. Poor fiscal policy, poor monetary policy, poor performance from both the Governor and MPC and the Minister of Finance (the latter not only having direct responsibility for fiscal policy, but overall responsibility for monetary policy and the people he appoints to conduct it). It will be interesting to compare the Reserve Bank (considerably more up to date) forecasts next week.

I’m going to be away for the next couple of weeks so there won’t be any new posts here until after King’s Birthday.

Sources of inflation

Michael Reddell Fiscal policy, inflation, Monetary policy, Treasury

I was on Newstalk ZB this morning to talk about the ASB recession forecasts and this article on the Herald reporting some recent statistical analysis from Treasury staff that attempted to provide another perspective on what has caused New Zealand’s high inflation rate.

I don’t want to add anything on the ASB forecasts other than to say that (a) their story and numbers seem quite plausible, but (b) macroeconomic forecasting is a mug’s game with huge margins of uncertainty and error, so not much weight should be put on anyone’s specific forecast ever (with the possible exception of a central bank’s forecast, which may be no more accurate than anyone else’s but on which they may nonetheless act, with consequences for the rest of us).

The Treasury staff analysis was published a couple of weeks ago as a 2.5 pages Special Topic in their latest Fortnightly Economic Update. You can tell from the Herald headline why one of their political journalists might have latched onto this really rather geeky piece

But there is less to the analysis than the headline suggests. The term “government spending” doesn’t appear in the Treasury note at all (I think “fiscal policy” gets one mention). The focus of the paper is an attempt to better understand the relative contributions of demand and supply factors to explaining inflation, and while fiscal policy is one (at times significant) source of demand shocks and pressures, there is no effort in the paper to distinguish the relative roles of fiscal and monetary policy (or indeed, to distinguish either of those policy influences from other sources of demand pressures). That isn’t a criticism of the paper. The technique staff used, introduced for those purposes a few months ago by a Fed researcher (his paper is here), isn’t designed for that purpose.

Loosely speaking, the technique uses time series modelling techniques to look at both prices and volumes for (most of) the items included in the CPI. When there are surprises with the same sign for both a price and the corresponding volume that is (in their words) suggestive of a demand shock (increased demand tends to lift prices and volumes) and when the surprises have opposite signs this is taken as suggesting a supply shocks (disruptions in supply tend to see lower volumes and higher prices go together). It is a neat argument in principle.

But it doesn’t look to be a very good model in practice. Here is The Treasury’s summary chart. the source of the line that (on this analysis) demand and supply shocks may have contributed roughly equal amounts to inflation over the last year, and that demand shocks were more important back in the early stages of the surge).

Not only is a large chunk of recent inflation not able to be ascribed to either demand or supply shocks, but there have been periods even in the quite short span shown here when the identified demand and supply shocks don’t explain any of the then-current inflation at all (eg 2019).

This is even more evident with some of the sub-groups they show results for. Thus, home ownership (which in the CPI is mostly construction costs)

For most of the decade, neither (identified) demand or supply shocks explain the inflation, and that is so again in the most recent data. And if the model suggests that sharp rises in construction cost inflation in recent times have little to do with demand at a time when house-building has been running at the highest share of GDP in decades, so much the worse for the model.

Services make up a large chunk of the economy, and a fair chunk of the CPI too. Here is the chart for that group

Not only are there periods when neither demand or supply shocks (as identified by the model) explain any of services inflation, but how much common-sense intuition is there is the idea (which the chart suggests) that for most of the period what services inflation can be explained is all either supply shocks or demand shocks and not some combination.

The Treasury paper notes some overseas comparisons, in particular that for the US

The results for New Zealand show lower supply-side contributions to inflation than estimates for the US and Australia. In the US, supply-side drivers account for about 60% of the annual change of the PCE deflator that the model can explain (Figure 7).4

(the footnote is to the original Fed paper)

and they show this US chart which I assume comes from the same model

Note, first, that the PCE deflator has a materially different treatment of home ownership – using imputed rents – than either the NZ or US CPIs.

But perhaps more importantly, in the original Fed paper there is this line

And here is a relevant chart from the same paper (grey-ed periods are NBER recessions)

Not only does it show the entire period since 1990 (one of my uneases about the New Zealand work by Treasury is showing only the last 10 years), but it also illustrates that, as defined for the purposes of these models, both supply and demand factors are large influences, almost always positive, over the entire 30+ years. In other words, if there is anything unusual about the current situation it is not the relative contributions of supply and demand influences but simply that inflation is high (both demand and supply influence). It simply doesn’t seem to add much value in making sense of why things unfolded as they did over the last couple of years. (Although it is interesting how different the last 10 years of the chart look for the US, as opposed to New Zealand in the first chart above.)

What these US charts also illustrate is that supply and demand shocks/drivers here don’t mean the same as they typically do when thinking about monetary policy. Monetary policymakers will (rightly) talk in terms of generally wanting to “look through” supply shocks – the classic example being spikes in world oil prices, which not only flow through to the CPI almost instantly (faster than monetary policy could react) but also make us poorer. The focus instead is on whether these headline effects flow through into generalised inflation expectations and price-setting more broadly. Climate-induced temporary food price shocks (from storms or droughts) are seen in the same vein.

Those sorts of shocks are generally thought of as being as likely to be negative influences on headline inflation as positive ones. Oil prices go all over the place, up and down. Much the same goes for fruit and vegetable prices. These are the two main things excluded in that simplest of core inflation measures, ex food and energy. Some of the Covid-related disruptions are probably more one-sided: there aren’t really obvious favourable counterpoints to severe supply disruptions (even if such disruptions themselves generally unwind over time). But even taken altogether they aren’t the sorts of things that will produce positive influence on core inflation over single year for over 30 years (as in the US core inflation chart immediately above).

When macroeconomists think of inflation they often do so with a mental model in their heads in which this period’s inflation is a function of inflation expectations, some influence from the output/employment gap, and then any residual (supply shock) types of items. Those supply shocks can run in one direction for a couple of years in succession (and probably did in the last couple) but the expected value over long periods of time is generally thought to be pretty close to zero. Monetary policy determines core inflation – monetary policy shapes expectations and influences and responds to developments in the output (or employment) gap. Of course, monetary policy takes account of trend supply developments – adverse shocks may not only raise headline inflation, and risk raising inflation expectations, but can lower both actual and potential output (many positive supply shocks work in the opposite manner).

I don’t want to be particularly critical of The Treasury. We should welcome the fact that their analysts are trying out interesting different approaches and keeping an eye on emerging literature, and even that they are making available some of that work in generally low-profile publications. That said, Treasury is not some political babe in the woods, and I’d have thought there should have been some onus on them to have provided a bit more context and interpretation in their write-up. For example, whereas the US is often treated as a closed economy, New Zealand clearly isn’t. I don’t have a good sense as to how general imported inflation – or that reflecting exchange rate changes – is going to affect this sort of decomposition. If, as I believe, a wide range of central banks made very similar policy mistakes, we’ll be seeing more inflation from abroad (if our Reserve Bank takes no steps to counter it) not tied to demand pressures in particular domestic sectors. I’m also not really clear how the lift in inflation expectations that we observe in multiple surveys fits into this sort of decomposition exercise.

Oh, and it was perhaps convenient that of the CPI groups Treasury showed, motor fuels was not one of them. Headline inflation currently is held down quite a bit by the NZ Cabinet shock – holding down petrol excise taxes etc.

My own approach to the question of where the responsibility lies for core inflation (and note that Treasury focuses on headline not core) tends to be simpler. When this century the unemployment rate has dropped below about 4 per cent core inflation has tended to become quite a serious problem (mid-late 00s and now). The Reserve Bank itself has been quite clear in its view that employment is running above the “maximum sustainable employment” (itself determined by other government policies), and thus, by implication, the unemployment rate – at near-record lows is below sustainable levels. That is a function of excess demand relative to the ability of the economy to supply. Core inflation – the bits we should most worry about, because we could usefully do something about them – is an excess demand story, risking spilling over into embedded higher inflation expectations.

And when ZB’s interviewer asked me this morning whether Mr Robertson or Mr Orr was to blame (fiscal or monetary policy), I was quite clear that the answer was monetary policy (Orr and the MPC). That isn’t because monetary policy loosenings in 2020 were necessarily the biggest source of stimulus to demand, but because the model is one in which (a) fiscal policy is transparent, and (b) monetary policy moves last, with the responsibility to keep core inflation at/near target. You might think (I certainly do) that less should have been done with fiscal policy, but it isn’t up to the MPC to take a view on that, it is their job simply to have a good understanding of how the whole economy, and the inflation process in particular, works, and to adjust monetary policy accordingly. In extremis, fiscal policy can overwhelm the best efforts of central banks, but that wasn’t an issue or a risk here, or most other countries, in recent years. Central banks simply got things wrong. (They had company in their mistake, but they were/are paid to get these things right.)

Dipping into the HYEFU

Michael Reddell Fiscal policy, Taxation, Treasury

Just a few things caught my eye flicking through yesterday’s HYEFU summary tables – if you don’t count points like the fact that The Treasury projects we will have had five successive years of operating deficits (in a period of a high terms of trade and an overheated economy), and that net debt as a per cent of GDP (even excluding NZSF) is still increasing, notwithstanding the big inflation surprise the government has benefited (materially) from.

This chart captures one of the things that surprised me. It shows export volumes and real GDP, actual and Treasury projections. Exports dipped sharply over the Covid period (closed borders and all that), but even by the year to June 2027 Treasury does not expect export volumes to have returned either to the pre-Covid trend, or to the relationship with real GDP growth that had prevailed over the pre-Covid decade.

The Reserve Bank does not forecast as far ahead as the Treasury but has quarterly projections for these two variables out to the end of 2025. Here is a chart of their most recent projections

It is a quite dramatically different story.

The issue is here is not so much who is right – given the vagaries of medium-term macro forecasting there is a fair chance that none of those four lines will end up closely resembling reality – as that the government’s principal macroeconomic advisers (The Treasury) have such a gloomy view on the outward orientation of the New Zealand economy. One of the hallmarks of successful economies, and especially small ones, tends to be a growing number of firms footing it successfully in the world market. Earnings from abroad, after all, underpin over time our ability to consume what the rest of the world has to offer. Quite why The Treasury is that pessimistic isn’t clear from their documents – one could guess at various possibilities in aspects of government economic policy – but it does tend to stand rather at odds with the puffery and empty rhetoric the PM and Minister of Trade are given to.

Then there was this

On Treasury forecasts the CPI in 2025 will have been 13.3 per cent higher than if the Reserve Bank had simply done its core job and delivered inflation on average at 2 per cent per annum (the Reserve Bank’s own projections are very similar). It is a staggering policy failure – especially when you recall that the Governor used to insist that public inflation expectations were securely anchored at around 2 per cent. It is an entirely arbitrary redistribution of wealth that no one voted one, few seem to comment on, and no one seems to be held to account for, even though avoiding such arbitrary redistributions (benefiting the indebted at the expense of depositors and bondholders) was a core element of the Reserve Bank’s job. We don’t – and probably shouldn’t – run price level targets, but let’s not lose sight of what policy failures of this order actually mean to individuals.

And the third line that caught my eye was this

A good question for the National Party might be to ask how much of this 3.5 percentage point increase in tax/GDP they intend to reverse, and how, or would any new National government simply be content to leave little changed what Labour has bequeathed them?

As longer-term context (slightly different measure to get back to the 70s) the only similarly large increases in tax/GDP seem to have been under the 1972-75 and 1984-90 Labour governments.