Shoulder Pads, Telethons and Fiscal Policy. The Treasury thinks the 80s are back

Let's actively shape our future economy, rather than passively watch it shape us.

Prelude:

I am indebted to my CTU colleague Jack Foster for his thoughts and contributions on this. All faults in this document are mine alone.

Some readers have been incredibly kind and have offered me money to write this Substack. That’s wonderful for my ego, but rather than giving me money, please go to https://union.org.nz/find-your-union/ and join your union. If you are already a member, thank you. If you aren’t, please have a look after reading this Substack.

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Treasury Long-Term Insights Briefing

I worked in the Beehive for 3 years as a Ministerial Advisor, until just after the 2020 election. I’ve seen plenty of Treasury documents. When the latest Treasury Long-Term Insight Briefing was released, I thought it would be another well-thought-through, if occasionally dull, document. Instead, we had what Sir Michael Cullen would refer to as an “Ideological burp”. A blast straight from the past. It’s not often I am lost for words, but this is right up there.

The report is notionally about “the role of fiscal policy through shocks and business cycles”. Great! Except one of the first findings of the report is “Cyclical management should mostly be left to monetary policy run by an independent central bank”. I can’t stress how wrong this is. Cyclical management means the management of both the business cycle (i.e. recessions and upswings) and crises (pandemics, war). Cyclical management is the job of the government as a whole. Just so I can be clear, let me repeat that in capital letters in bold. CYCLICAL MANAGEMENT IS THE JOB OF THE GOVERNMENT AS A WHOLE.

Monetary policy is important, but it typically “affects the economy with long and variable lags, with recent estimates suggesting it takes 18 months to about 2 years for the official cash rate (OCR) to have its peak impact on inflation” according to the Reserve Bank. If you have an economic cycle problem, or a crisis, that you can see from 18 months to 2 years away then amazing – by all means use it! But most economic challenges don’t fit into that camp.

Monetary policy is also conflicted. The Reserve Bank’s job is to manage inflation – not economic cycles. If growth were down, but inflation up, it would still keep increasing interest rates to reduce inflation. Government (or god forbid – New Zealanders) might have different objectives – and should be allowed to pursue them. They might prioritise jobs, or incomes, or public investment. They might prioritise their kids, the climate, or the environment. It’s the job of elected politicians to make that trade-off, not the Bank.

Let’s think about a possible scenario in the economy that has been common in developed economies. Let’s say the South Island is riding a new mining boom, jobs are plentiful, and the economy is red hot. At the same time, the North Island is struggling. Commodities are weak, and demand is low. How should the Reserve Bank Official Cash Rate deal with that cycle? If the OCR goes up to manage inflation down south, this further strangles growth on the North Island. If it cuts to stimulate growth up north, the boom on the South Island becomes even more unsustainable. We have one currency, and so we can only have one interest rate. This isn’t a theoretical exercise – the UK had exactly this problem in the 1980s and 1990s, and the regions at the sharp end are still bearing the scars more than 30 years later.

Monetary policy is also not neutral. Let’s assume a downturn occurs, and with it, growth falls, unemployment and inflation both see increases. Reducing the OCR will make new investments more attractive. But newer investment (i.e. borrowing) can happen faster in the housing market than elsewhere in the economy. House prices start to rise as borrowers can bid up housing prices based on low interest rates. Capital is now flowing into the housing market, not the productive economy. That, in turn, drives consumption (someone’s borrowing is someone else’s payment). Does that lead to long-term economic growth – or just more of the same as we have had over the past 30 years?

In another scenario, let's assume the economy is doing really well. Inflation is rising. The OCR is raised to tackle it. Borrowers pay more. Those with savings at the bank do better (the wealthy). Those with debts (the poor) do worse. Inflation falls, unemployment rises, and the boom subsides. What has happened? We have likely made existing economic inequality worse, immiserated the poor, and we start the next economic cycle even further away from our goal of broadly shared wealth.

Helping to manage economic cycles should be the job of every organ of government, not primarily the Reserve Bank. Government investment should happen counter-cyclically to smooth out demand. Revenue settings should discourage overinvestment in one sector. Industrial policy should be building new areas of economic development to create an economy more resilient to change. Training and vocational education policy should examine long-term trends to help manage skills demand needs. Housing policy should work to manage boom/bust cycles in construction. It’s hard work – but it's infinitely preferable to the alternative.

The Treasury briefing derides the timeliness of fiscal policy, stating that “many elements of fiscal policy operate with significant lags – for example, due to longer policy design and legislative processes”. It provides examples of COVID spending to justify this claim. So, the solution is just to give up on fiscal policy? Really learning from COVID would mean comprehending that we had so hollowed out the ability of government to plan for investment that we could no longer do it quickly and well. It is the job of the Treasury to fix this – not run away from it.

This means a stronger role for government, not less. For the Treasury, this means a stronger focus on value for money – not just a focus on the quantum of money being spent. Gaining a better understanding of potential investment options for the future would benefit everyone via higher-quality spending decisions, especially when decisions might need to be made quickly. Simply saying that fiscal policy is in the ‘too hard’ basket is to accept failure. We can and must do better than this.

The origin of this Treasury paper comes in part from a concern that “New Zealand has seen debt rising in recent decades, partly because responses to adverse shocks have not been matched by savings between shocks”. Only that isn’t true – and indeed the chart below that statement from the Treasury makes this very point. Debt as a percentage of GDP fell after each disaster – as highlighted in red. This isn’t a party political point – both sides delivered this.

Figure 1: New Zealand Government Debt

Source: NZ Treasury and Author's Edits

Indeed, New Zealand government debt continues to be very low in comparison to our international peers who also face risks from natural disasters and economic woes. According to the IMF our Net Debt is 25.2% of GDP. Japan, subject to earthquakes much like NZ has a net debt position of 134% of GDP. What the IMF calls ‘advanced economies’ have an average of 81.2.% of GDP – and the gap is growing in the future not declining.

The trick here is to remember that growing the economy reduces your debt-to-GDP ratio. The Treasury instead takes the view that “Building sufficient buffers to respond to future shocks and cycles is likely to require ongoing fiscal consolidation”. Cuts are needed now (exacerbating an already difficult economy in which even Simon Bridges is calling for stimulus) to pay for risks that might event in the future. Cut investment, cut debt, create fiscal space. Growth today is a nice-to-have.

That approach only works if you assume that you are somehow powerless against future crises or business cycle problems. That via smarter investments, you can’t reduce the size of any business cycle changes. That our policy settings elsewhere (competition, supply chain resilience, skills acquisition) can’t be improved, or that new support (on welfare, for example) can’t help. The government is reduced simply to the role of a canny janitor. Saving up and then helping to tidy up. Government is a passive player rather than an active agent for positive change.

The best example of this is another area where the briefing is at odds with the document's own evidence. In a disaster, “lump-sum payments may be a good fit in response to demand shocks” but “altering public consumption is typically not proposed, as such changes can be difficult to reverse once implemented”. Only the evidence from the modelling provided by Treasury shows that public consumption provides the best outcomes.

Table F.2 of the report sets out what would happen if the government spent $8.3bn on:

• Lump-sum payments to individuals in three equal payments over one year. If these transfers are sent to the bottom 80% of income earners, this equates to $2,662 per eligible individual.

• An increase in public investment on maintenance and repairs.

• Tax changes to stimulate business investment.

Figure 2: Treasury modelling of stimulus packages

Source: New Zealand Treasury

The results show less unemployment, higher GDP, and lower net debt as a percentage of GDP if there is investment in public consumption (maintenance) over lump sum payments. Yet the briefing consistently promotes such payments. It is the only option given three thumbs up by the Treasury. Might it be that lump sums are preferred as they do not support the role of the government in helping to deliver economic growth or manage the economy?

Figure 3: Treasury evaluation of stimulus tool desirability

Source: Adapted from NZ Treasury

The Treasury briefing states, “The expectation that governments will provide support to soften the direct impacts of shocks can reduce the incentives for firms, households and communities to manage their own risks”. That’s true – but not true of all risks. Some risks (like climate change) need the government to act because the costs of pollution don’t necessarily fall on the polluters. See New Zealand’s rivers and waterways for evidence of that.

Some households cannot manage risks that might occur through no fault of their own. If a major employer disappears from a town, a family may not be able to sell their home to move to where new work is available. That traps them on welfare, or in lower-paid, less productive work. That is not only an inefficient use of labour, but it’s expensive for the Crown in the form of other financial support. It’s also just a terrible experience for the communities and individuals involved. The report makes no mention of whether or not social unemployment insurance, common overseas, could have played a positive role to play here.

Supporting people through economic shocks like these is the very purpose of government. Instead, the Treasury report simply views workers as a resource to be deployed. It states “a relatively flexible labour market facilitates rapid redeployment of the workforce in response to changes in circumstance”. That flexibility often comes at a cost for those affected by change. A cost not seen by the Treasury or reflected in this report.

Conclusion

Overall, this briefing from the Treasury paints a dismal picture of an economy where the best thing that the government can do during a crisis, or during an economic downturn, is to operate quietly, in the background. Where technocrats who know better can make decisions and not let pesky elected representatives get in the way of better-looking accounts or the delivery of often arbitrary fiscal targets. In the ‘next steps’ section of the report, there is little or no role for the government to play in actively managing future economic challenges today.

As an example, the economist Isabella Weber has highlighted the role that ‘sellers inflation’ – where the rising costs of goods and services were driven by rising profit margins rather than costs or demand during COVID. If, during the next economic cycle, we see a resurgence of seller's inflation – how would we use monetary policy to tackle that? Why would we not use fiscal policy, government action, and regulation to tackle any price gouging? Should we not use government power now to tackle existing market failures - so that when there is an economic challenge in the future, we can manage it better?

The report states that “Historical information offers some guidance to the future, but relying too heavily on it carries the risk of policy responses ‘fighting the last war’”. Yet that is exactly what this report appears to be doing. During COVID, the government arguably threw the kitchen sink at things because during the GFC, the failure to act made the recession far worse. Now the Treasury is proposing making monetary policy the main vehicle because it thinks that the last response spent too much – causing inflation. Only it has no evidence to that effect. Indeed, when we look at the data for inflation for 36 developed countries, including the US, UK, Canada, France, Germany, Japan, Korea, Singapore, Ireland and whole heap of others – what we discover is that New Zealand’s inflation crisis during COVID looks just like anywhere else.

Figure 2: IMF Annual Year on Year CPI inflation (%) for 36 countries (NZ Highlighted)

Source: IMF

The Treasury sees itself as the “Steward of the public finance system”. This “requires the Treasury to advise present and future governments and the public on issues that will likely matter to New Zealanders in the future”. This is a long-term insights briefing without any view of the long-term. It provides precious little insight into how we will make New Zealanders’ lives better – only a desire to see stronger accounts. We aren’t more adequately briefed on anything other than Treasury’s ideological position.

1980s fashion is making a comeback (so I’m told). 80’s TV shows are apparently being reshot. We shouldn’t make the same mistake with our economics. Like CFCs, watching people do exercise on breakfast TV, and smoking indoors, we have no need to go back. Let's look forward instead. Let's actively shape our future economy, rather than passively watch it shape us.