The Budget Policy Statement this week has frustrated some fiscal hawks who want to see the Coalition Government get the Crown accounts back into surplus as soon as possible.
Finance Minister Nicola Willis would do well to ignore this peer pressure and stick to the gradual path of fiscal consolidation she appears to prefer — even if it means more debt.
Her budget policy statement said international evidence shows reducing deficits is best done over the course of several years and without gutting services New Zealanders rely on.
“We won’t be chasing a surplus in any one particular year at any cost, particularly when that cost would be to frontline public services,” she later told reporters.
Willis was not specific about what evidence she had been looking at, but it could have been a broad review of academic research published by the International Monetary Fund (IMF) last year.
Staff from the financial agency recently advised the minister should aim at restoring a budget surplus over the four year forecast period, meaning the 2027/28 fiscal year.
New Zealand does not face anything akin to the sort of crisis that would require the Government to slash spending overnight and risk scarring the already troubled economy.
Net core Crown debt has likely already peaked at about 44% of GDP and net debt is also nearing its peak at about 23.2%. Credit rating agencies are very comfortable with these levels.
This gives the new Government the luxury of time; it does not need to rush to surplus.
Easy does it
In 2023, the IMF published a working paper which reviewed a broad range of academic research into fiscal consolidation programmes.
A surge in many countries’ public debt since the pandemic had rekindled interest in fiscal consolidations and the complicated policy choices that come with them, it said.
Most countries had seen their debt-to-GDP ratios climb during the pandemic and few had brought them back down to pre-pandemic levels.
These states will need to rebuild fiscal space for the next crisis, but also to prepare for the cost pressures that will come with climate change and an ageing population globally.
Most consolidation policies in the review moved slowly, adjusting the primary balance by just one or two percent of GDP each year for three or four years.
Those who moved faster tended to be in some sort of immediate trouble, unlike NZ.
“Countries that opted for large and quick consolidations were often those with concerns about fiscal sustainability or high credit risk premia,” the IMF wrote.
Gradual consolidations tended to stabilise debt more permanently and helped to limit the damage to economic output that can occur after a fiscal shock.
“The advantage of a gradual consolidation, especially when it is large, is that it spreads out output losses over time, making it more politically and socially acceptable and hence giving the overall consolidation plan a higher likelihood of success,” it said.
First do no harm
There is no avoiding the fact that fiscal consolidation generally has a negative impact on economic activity and income distribution in the short-term.
With New Zealand already in recession, rushing to get back to surplus at any cost could do more harm than good.
The IMF warned some consolidations in advanced economies ended up being “self-defeating” as they depressed economic output and ultimately led to a higher debt-to-GDP ratio.
Protecting investment in human and physical capital, as well as social spending, helped to avoid this outcome and would pay dividends in the long run.
“Gradual, credible, and durable consolidations increase the likelihood of stronger medium-to long-term growth. Significantly lower domestic financing costs stemming from fiscal consolidation are associated with stronger growth dividends,” it said.
“Income distribution may also improve or recover in the long run as stronger growth following a successful consolidation can improve the wage share or reverse its decline and reduce interest rates, which reduces capital income for richer households”.
While National’s pledge to cut income taxes makes consolidation more difficult, having them targeted at median incomes may help to offset the distributional effects of cutting services.
Coalitions fare worse
Another interesting finding in the IMF paper was that coalition Governments tended to be less successful at fiscal consolidation.
The authors said this may be due to “inherent challenges” in consensus building and the sustained implementation of consolidation measures.
Parties with a Parliamentary majority and no imminent elections were more likely to succeed in fiscal consolidations — New Zealand’s coalition has neither luxury.
Whether or not Willis has read the IMF’s paper, she has signalled she wants to consolidate spending slowly and protect the most critical services along the way.
The evidence suggests this is the best path to success, even if it frustrates fiscal hawks.
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