Brian Easton says we should follow the Golden Rule of Fiscal Management and not borrow for consumption in the medium run

This is a re-post of an article originally published on pundit.co.nz. It is here with permission.

Asymmetry is a crucial, but often ignored, feature of credit transactions. You would normally be surprised if a shopkeeper said they would sell you 1kg of apples but not 2kg, even if you offered to pay a higher price. Yet such a response is routine if you ask for credit. As past Minister of Finance Downie Stewart recalled, Keynes advised that New Zealand should borrow as much as it could to offset the Great Depression, but if Keynes were the lender he would probably not be prepared to advance New Zealand any more. That asymmetry is at the heart of the political power of the finance sector over the real economy.

It is not an unreasonable stance. The cost to the lender of a failure to repay a loan can be substantial. Sovereign borrowers prove especially troublesome because it is difficult to enforce debt repayment against a country. Lenders go to considerable trouble to assess the likelihood of such a failure. While they do their own assessments, they are often advised by credit rating agencies (CRAs) who, helpfully for us, offer a window into lenders’ thinking.

Those who have faced CRAs in their regular visits to give New Zealand a credit rating, report they look at the whole economy in an informed, firm but understanding way. Sure, they may be ideologically to your right, but they are not stupid. While they look at a spectrum of indicators, they do not fix on any one. More important, they have to convince themselves that the New Zealand Government has a credible commitment towards its debt obligations as well as an ability to service them including to manage its investments. In the end the lender gets its profit from lending (providing the debt is honoured), so they want to do deals.

That commitment need not be as crude as adhering to a debt-to-GDP ratio target, although that is the way it is currently signalled. However, that target does not make rational economic sense insofar as it results in poor investment decisions.

For example, the government is outsourcing public medical procedures to the private healthcare sector. That avoids the government having to borrow to invest in adequate public sector facilities – such as buildings and equipment. (Other resources – such as staff – are fluid between the public and private healthcare sectors.) Rather than borrowing and investing itself, the government is getting the private sector to do the task and then paying it for the debt servicing. It is keeping its debt-to-GDP ratio down but still paying for the investment. I am more relaxed about such outsourcing than many involved in the healthcare sector, but it makes no sense that the main driver of any decision should be an arbitrary debt target.

This is but one example of the absurdity of the debt-ratio target. Another is the tangle we are getting in over the need to invest in the water infrastructure. Very substantial public funding is required unless we privatise. (Overseas experience suggests that option is not very attractive, except to ideologists.) However, the government has been trying to keep any resulting debt off the books. No doubt the CRAs will see through the muddle because any public funding will be ultimately underwritten by the government, even if it does not appear in the public accounts as a legal contingent liability.

Nowadays, CRAs must be worrying because we are currently borrowing for consumption. (It does not matter whether the funds are spent on public items rather than private ones; a social security benefit is a transfer to household spending, while public expenditure could be paid for by higher taxation and less household spending.)

We can trace this via the Crown’s net worth, the total assets of the Crown less its debt (analogous to the amount you would bequeath to a subsequent generation). When you buy a house with a mortgage, your debt goes up because that measure does not include your current ownership of the house. Your net worth remains the same. It is far better indicator of your financial position. Similarly for the government. (Your bank will remain concerned about your net debt and you will keep an eye on it because you have to service it.)

The Treasury Investment Statement reports that government’s Total Net Worth was $192m (48% of GDP), falling to $183m (42% of GDP) this year (2025) and continuing to fall throughout the next decade. It projects net worth to be $158m (or 24% of GDP) in 2034 although that does not allow for changes due to inflation.

This means the government is consuming its capital, not adding to it. There are various ways of running down net worth including directly borrowing (or selling assets) to fund consumption or running down the stock of capital. (The latter is the reason why our water infrastructure is in a mess.) The New Zealand Government is not saving but over a six-year period it is consuming more than its revenue. It may be a legitimate decision for a retired person to do this but hardly appropriate for a government which expects to live forever.

The hard truth of our current fiscal stance is that additional borrowing is being used for consumption not investment. We overlook this when we focus on the level of debt rather than what we are doing with the borrowing.

How can we make the notion of net worth, with its focus on the distinction between public consumption and investment, more prominent in public discussions? The Treasury is doing its bit in its recent Investment Statement. *

A step forward would be for the government to adopt the ‘Golden Rule’ of fiscal management which focuses on net worth. (It is already implicit in the Public Finance Act even if it seems to be ignored.) Put simply, over the economic cycle the Government would borrow only to invest and not fund current spending. (The principle allows raiding a ‘rainy day account’ to prop up consumption in the short run after a shock but the fund needs to be topped up shortly after, ready for the next shock. It certainly does not envisage six and more years of raiding.)

The Golden Rule only covers the trend in net worth; there is still a need to discuss what level it should be. That should be welcomed.

This is the approach of a fiscal conservative. It would not disturb the CRAs and the lenders they represent. The explicit adoption of a Golden Rule would increase the credibility of the government’s fiscal management. The concern of the debt-to-GDP ratio would continue but it would be seen as a constraint under which the management operates, not the purpose of the fiscal management as too often it appears to today.

* Treasury’s Investment Statement 2025 was published as this column was going to press. It raises some important issues and approaches. Time and space means that I must leave them to a later column.

*Brian Easton, an independent scholar, is an economist, social statistician, public policy analyst and historian. He was the Listener economic columnist from 1978 to 2014. This is a re-post of an article originally published on pundit.co.nz. It is here with permission.