The Reserve Bank of New Zealand has taken a stab at the government’s underlying deficit, saying much of the deterioration in the government’s fiscal position looks to be structural, and therefore likely to remain even as the effects of the recession fade.
An improvement in New Zealand’s structural deficit would lead to a lower exchange rate, the RBNZ said, saying public sector savings could be made faster than in the private sector, as this would come from an explicit policy choice.
The RBNZ also warned that the underlying structural deficit may be larger than Treasury estimates if part of the improvement in New Zealand’s export prices is not sustained.
The fiscal deficit had deteriorated sharply in recent years, with Budget 2010 forecasts pointing to a core Crown operating deficit, excluding investment gains and losses, of 5.1% of GDP for the 2011 fiscal year, the RBNZ said.
Some of that deterioration had been due to the shift from the economy running beyond capacity through the middle part of the previous decade to one with surplus resources currently, the RBNZ said.
“However, much of the deterioration in the fiscal position appears more structural, and will thus persist even as the effects of the recession fade. The Treasury estimates that the cyclically adjusted fiscal balance is in deficit by 4% of GDP.
“Similarly the OECD estimates that New Zealand has a cyclically-adjusted general government deficit (a measure that captures central and local government, and capital and current spending) of around 3.5% of GDP,” the RBNZ said.
Reduced tax rates and weakened trend growth in GDP would limit the extent of any future increase in taxation revenue, the RBNZ said.
“Core Crown revenue peaked at 34.5% of GDP in the year ended June 2006. Budget 2010 prjected that revenue would be 29.6% of GDP this year.”
Most cyclical adjustment measures did not take account of moves in New Zealand’s terms of trade.
“Tax revenues are currently being boosted by a terms of trade that is well above its long-term average. As such, if part of the improvement in export prices is not sustained, the underlying structural deficit may be even larger than the Treasury and OECD estimates suggest,” the Bank said.
“Stimulatory fiscal policy helped support aggregate demand over recent years. However, that support has meant interest rates have probably been higher than they would otherwise have been. And it is likely that the exchange rate has also been higher that it would otherwise have been.
“Discretionary actions to tighten fiscal policy typically result in some fall in the exchange rate, because monetary policy is typically set somewhat looser than otherwise to offset the reduction in domestic demand. Fiscal consolidations can sometimes boost the exchange rate as market confidence lifts.
“In contrast to the case in New Zealand, where sovereign debt is quite low, this sort of reaction typically occurs in cases where markets have already turned very negative on the fiscal situation of the country concerned and the exchange rate has already been under downward pressure.
The pressure the current exchange rate is placing on the tradable sector is significant. Improving national savings could relieve some of this pressure. Changing private sector savings behaviour is a slow process, whereas changing public sector savings can be made in the shorter term as an explicit policy choice.”