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

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

The new discount rates are shown here

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

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

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

Here is how The Treasury describes the two approaches

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

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

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

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

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

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

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

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

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

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

Especially as the entire thing seems like an indeterminate muddle.

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

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

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

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

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

That is pretty much everything central government actually does.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Government spending was not slashed and burned.

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

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

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

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

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

The Treasury yesterday hosted the first in their new series of guest lectures, under the broad heading “Fiscal Policy for the Future”. In introducing the series Dominick Stephens, Treasury’s chief economist, told us that the focus would be on three sub-headings: policy dimensions around fiscal sustainability, the potential stabilising role of fiscal policy, and ideas around value for money. Which sounds fine I suppose, but it perhaps wasn’t a great example of reading the times that the first lecture was about an idea that would, when it was used, involve the Crown simply giving away a lot more money (automatically).

The guest lecturer was the left-wing (a description she embraces) American economist Claudia Sahm. Sahm was formerly an economist at the Fed and these days seems to divide her time between consulting and being chief economist for a US funds management firm.

Sahm is best known for the Sahm rule US recession indicator

She didn’t develop the indicator simply for analytical interest but (as she reminded readers in a recent Substack) with a policy proposal in mind

The idea being that when the recession indicator threshold point is met, the IRS would mail out checks automatically, to lean against the incipient downturn by boosting consumer spending. It would be, in her words, a quasi automatic stabiliser

(The “automatic stabilisers” are the extent to which government budgets vary with economic cycle without any discretionary policy changes – you can think of unemployment benefits, but typically the tax side of things is much more important. We don’t have lump sum taxes, rather governments share in the gains/losses when wage bills, spending, and profits rise/fall. Relative to a lump sum taxes benchmark, the actual way we design tax systems – proportional and, in respect of income tax, progressive – tends to dampen economic cycles a bit.)

Ever since Covid Treasury seems to have been freshly keen on a more active role for fiscal policy (Stephens indicated yesterday that they are looking at making the stabilisation role of fiscal policy the topic for their next Long-Term Insights Briefing). I’ve written previously about a conference Treasury (and the RB) hosted three years ago, before it was really appreciated what a mess Covid macro management and associated misjudgements had wrought. At that point, Treasury people from the Secretary down were very upbeat, partly as a result of misapplying the hardly-surprising “insight” that if you forced people to stay home and, in many cases, not work, income support was going to be done a lot more effectively using income support tools than via monetary policy. As if it was not ever so – we provide income support to unemployed people using direct Crown payments too, rather than simply relying on monetary policy to sort everything out in the end. They were at again yesterday. Yes, there are plenty of things governments need to directly spend money on, but when it comes to macroeconomic stabilisation it is very much still “case not made”. But in fairness to Stephens, he did emphasise that if many people are Keynesians in foxholes (nasty recessions), rather fewer of them were keen on using fiscal policy to take away the punchbowl as the party was in danger of overheating. On yesterday’s showing, Sahm among them.

Anyway, that was all by way of introduction. Treasury seems to have been paying Sahm (over a period of several months) to develop her ideas in a way that might be applicable in New Zealand. If I was inclined to wonder whether this might not have been a potential budgetary saving (US macro consulting economists probably don’t come cheap), I actually found the lecture quite useful, mostly in shifting me more firmly into the camp of regarding the quasi automatic stabiliser idea as neither very workable nor very useful in the New Zealand specific context, using New Zealand macro data, and the experience of New Zealand recessions.

Sahm started by claiming that New Zealand had worse stabilisation challenges than many other (advanced?) countries, claiming that we had “really volatile output”. I wasn’t quite sure what she was basing that claim on, and just went back and dug out the OECD series of quarterly changes in real per capita GDP over the last 30 years (the period for which the data is fairly complete across the whole membership). New Zealand doesn’t really stand out – actually the median country for the variability of quarter to quarter changes over that period. What is perhaps more notable – and relevant here – is that the United States had the second lowest standard deviation of any of the OECD countries over that period. (It is also worth bearing in mind that many international comparisons, notably the OECD, use the expenditure measure of GDP, which used to be much more volatile than it has since become – an open question as to whether that is a reflection of changing reality or just better measurement by SNZ.)

Sahm is keen on the automatic stabilisers. She claims New Zealand’s are more effective than average, although in the past I’ve seen people reach the opposite conclusion (for the good reason that we have flat rate unemployment benefits rather than income-related ones, and that our tax system is not highly progressive, and our taxes as a share of GDP are not overly high). But whatever useful impact the “automatic stabilisers” have in dampening the extremes of economic cycles, it is important to remember that those features of the tax and transfers systems were put in place on their own specific individual merits, and any macroeconomic stabilisation benefits are at best nice-to-haves. We have unemployment benefits because we think people (and their kids) shouldn’t starve. We have progressive taxes because of conceptions of fairness, and proportional rather than lump sum ones for similar reasons. We have bigger governments in some countries than in others not primarily from macroeconomic stabilisation considerations, but because of differing conceptions – fought through political processes – about the role of the state.

By contrast, what Sahm is proposing is a fiscal tool that would exist solely for macro stabilisation reasons. It really is a quite different beast. To be fair to Sahm, she argues that her tool isn’t necessarily a case of more total fiscal outlays in downturns, but different or better ones. But you get the sense that her personal politics leans in the direction of bigger government rather than smaller, and as we shall see – whatever might have been the case in her US calibrations – in New Zealand it doesn’t look as though it would have worked that way.

Her New Zealand starting point was to identify the agreed upon recessions, using the official New Zealand data.

One might quibble, but lets take that list and move on

She then trawled through the New Zealand data looking for a rule that would be timely, simple, easy to understand (and legislate), involving reliable data, and free from external influence. This is the proposed rule she came up with

You will quickly see that it is quite a lot more complex than her US rule (which has just one variable – the unemployment rate – to trigger similar sized (in aggregate) payments.

Who would be eligible? Her basic proposal was that payments (around $1000 a head [UPDATE altho I suppose larger if children were excluded; she didn’t clarify one way or the other]) should be made to the bottom 80 per cent of people by income (no doubt greatly welcomed by middle class kids doing after school jobs, their older siblings at university, and the retired). In her time working with Treasury she had, it seemed, been regaled with stories of the previous government’s “cost of living” handout, and she (fairly) noted that the advantage of pre-positioning an instrument is that you can sort out all/most of those sorts of issues in advance.

Where I started getting uneasy was with the consumption indicator (I wasn’t clear whether she was using private consumption or total but what follows is relevant either way). First, as she acknowledges, she is finding empirical regularities (data mining might be a bit unfair) not laws of nature, and it is over a sample of only five recessions, (two of which really ran into each other, one of which was very very unusual in nature). Perhaps the thing that most surprised me was that there was no sign she had done her analysis using real-time data – which is what any automatic instrument would have to be keyed off. She mentioned the point in passing, but surely between Treasury and SNZ they could have got her the real time (ie first contemporaneous release) data to check?

Those revisions matter. As just an example, on a very quick Google around the eve of the 2008/09 recession this was how the Treasury March 2008 Monthly Economic Indicators report saw the latest GDP numbers

That was production GDP, up by an estimated 1 per cent. The current official estimate for that series for that quarter is an increase of 0.13 per cent.

(In passing I would note that anything that is a legislated mechanical rule then puts a great deal onus on the processes and capability and integrity of the organisation producing the data. Their staff and management will know that a great deal may rest on one tenth of a decimal point in some circumstances. In years gone, I would probably have played that down as an issue in New Zealand, but…..SNZ has been in the headlines in the last 10 days or so for reasons that don’t fill people with confidence in their integrity or capability, and in recent decades SNZ has been run by generalist public servants from the SSC/PSC stable, not fierce statisticians. It wouldn’t be my biggest worry by any means, but….)

But much the biggest issue is that inflation line in the rule. I’ve not seen anything similar in her US proposal. The general idea is that if (core) inflation is high you really don’t want to be adding automatic stimulus to the fire (any more than discretionary bits, like the “cost of living payments”). As Dom Stephens pointed out, there is an argument the restriction isn’t tough enough even as Sahm expressed it: after all the Reserve Bank is supposed to be aiming at 2 per cent, and if inflation is above target overall macro policy is still supposed to be bearing down on inflation (although here I would note the lags, and if macro policy isn’t adjusted until inflation is all the way back to target midpoint it is almost certainly rather too late). But lets stick with Sahm’s version.

She presented this chart (Treasury sent out her presentation to attendees but hasn’t yet put it on their general website)…

…and claps herself on the back. Her fitted rule, she claims, triggers in all the recessions except the 1997/98 one (which had as much to do with drought and bad domestic monetary policy as Asia). Unfortunately, I think she has been misled by some of her data, and doesn’t have any real domestic context. As a starter, from the bottom half of her table (“technical recession”) the 1989 sharp fall in consumption was from a base quarter immediately prior to an increase in GST, so at very least you’d need to adjust the rule for such (easily observable) events.

But what about the real recessions (top half of the table)? There is some ambiguity about the 87/88 event as her table says N to automatic payments but her text seems to say yes. But either way, there is absolutely no way that macro policymakers in early 1988 would have been wanting to add fiscal stimulus (automatic or otherwise). Inflation (headline and core concepts) was coming down but was far too high (for the Bank and for ministers), and every single one of the regular Reserve Bank reports in those days called for more fiscal consolidation to ease the pressure on monetary policy and the real exchange rate. Same goes for the 1991 recession. We were still trying to drive down inflation (it was too high relative to the new official target) and fiscal policy was all in a flurry by the averted threat of a double credit rating downgrade. Aggressive fiscal consolidation was the order of the day, both for fiscal reasons (primarily) but also to ease pressure on monetary policy),

Skip over 97/98 for the moment and we come to 2008/09. The sectoral model of core inflation – probably the best retrospective indicator of core trends – was well above 3 per cent all through 2008 and into 2009, so although I’m not sure what core measure Sahm is using in the table, inflation certainly wasn’t anything like acceptable to the Bank in the early days of the recession (Sahm’s focus). It was a year of fiscal expansion……but mostly because (a) Treasury misjudged the permanence of the high levels of government revenue at the peak of the boom, and (b) it was election year and the government was losing (and presumably preferred specific own-brand giveaways to mechanised ones). Even had the rule been in place, it probably wouldn’t have triggered before final Budget decisions were being made in April and early May 2008.

As for Covid, if I was trying to design an automated rule I’d just take the Covid period out of my sample. The (discretionary) wage subsidy – which might have been too generous, but did its job – was put in place in late March 2020, months before the Q1 consumption data were available. Not only would the rule have been far too late to trigger, but in the specific circumstances it would have been too small to be relevant (swamped by the size of the wage subsidy). And, as it turned out, the last thing that was needed in 2020 was more encouragement to people to spend…..when the overall policy response helped generate the worst breakout in inflation for decades.

She calls the current episode a “technical recession”, but the unemployment rate has risen already by more than a full percentage point and per capita GDP is down as much as it was in 2008/09 (and consumer spending has been very weak). So it feels like another downturn when the rule triggered but payments would not sensibly have been made because…..inflation.

It was Dominick Stephens who pointed out recessions are sometimes the solution (to inflation) not the problem to be resisted. And I think that does mark our experience out at least somewhat from the US – notably we went into the severe 2008/09 recession with a pre-existing inflation problem, and they did not.

So, curiously, what we are left with is that I can think of only one episode in the last 37 years (the data sample) when triggering the rule and making payouts might have been helpful (and I stress “might” because she isn’t modelling responses, or comparing alternatives), and that is the one of her real recessions where payments would not in fact have been made: the 1997/98 episode. Which seems a bit awkward for the proposal.

And that is before we start on the other problems with the scheme.

For example, if one could identify a new and reliable rule – for indicating that the economy was probably in recession – why not just (a) advertise it widely, and (b) pass it on with a strong commendation to the central bank MPC. If it is a great and reliable rule (a) the Bank would be likely to use it in some form or other, and (b) the markets and the public would recognise that conditions were likely to ease, and respond accordingly. And to turn things on their heads, if there is a preloaded fiscal response, doesn’t that make it more likely that the central bank will be even slower than usual (this isn’t personal to the RB, central banks generally tend to be too late) to react, relying in part on the coming fiscal hit to buy them a bit more time to wait and see? A realistic assessment of such a policy proposal would need to make allowance for those sorts of interactions.

And then there is politics. Why would any political party or coalition want to preload lump sum handouts, rather than (a) look to the RB to do its job, and (b) keep the fiscal fuel for its own spending or tax cutting priorities (and perhaps again this is a difference to the US: here the government automatically (by construction, having supply) has a majority for its own budget plans? And why would much of the public think that big handouts to beneficiaries, high school kids, the retired etc would be a great idea at a point in the cycle where – again by construction – the unemployment rate is perhaps only a little off cyclical lows – and some of those lows (as recently) may have been quite extremely low. (This is, incidentally, one of the conceptual problems with the rule – which is just based on empirical regularities. Unemployment rates do drop below sustainable levels, well below at times. There is no good reason to think that additional policy stimulus is required just because the unemployment is finally heading back towards some sort of NAIRU.)

Monetary policy isn’t perfect. Our central bank these days is certainly anything but. But the case for looking beyond monetary policy for cyclical stabilisation just hasn’t really been made convincingly, and – particularly here in the New Zealand case – a simple automated rules looks to have been as unfit for purpose as was the idea (touted a bit in the US) of having the Fed mechanically implement a Taylor rule.

Oh, and then there was the profound asymmetry. There is nothing in this sort of rule – or even a readily conceivable alternative one – that could credibly operate on the other side of the cyclical; pulling money out of the system according to some rule. It really is easier to give money away than to take it back. Much better to keep fiscal policy doing what it does best, and leave cyclical stabilisation efforts to the central bank (a case that, admittedly, would be more compelling in New Zealand were the central bank and its key public faces not so egregiously bad, and unwilling ever to admit or learn from inevitable errors).

But, as I say, I found it useful to think hard about Sahm-type rules in the specific context of New Zealand and its experiences in recent decades.

PS. Finally, I thought I’d take a look at the US Sahm rule indicator. It isn’t yet indicating that it is time for additional stimulus (0.5 is the threshold). But then the market doesn’t think the Fed should be cutting yet either. And when it is time for taking the foot off the brake, if I were an American taxpayer contemplating huge debt and deficits, I think I’d prefer to see the Fed do the stabilisation action.

PPS Sahm did not that a tool like this might be more useful when monetary policy was constrained (ie at a lower bound). But since there are ready technical solutions to lower bound issues – that don’t cost taxpayers billions of dollars – perhaps it would be better for central banks (chivvied along by Treasurys if necessary) to final fix the lower bound issues and leave monetary policy free to do its job, imperfectly (in the nature of human institutions).

UPDATE 13/6 Thinking a little more about Sahm rule types of proposal, they seem best suited to a world in which the economy is routinely running at or around capacity and then a demand-shock recession arises out of the blue (and thus an increase, even a modest one, in the unemployment rate might reasonably indicate a case for policy stimulus). But that isn’t often the case (probably generally, but certainly not in New Zealand in recent decades). As just one example, around two thirds of OECD countries had their lowest unemployment rates in the period 1995 to 2007 in 2007 itself, often in the December quarter, the very eve of the recession getting underway,