A long-term briefing insight document prepared by the Treasury says government should let the Reserve Bank respond to economic crises and only intervene where necessary

Central government should rely less on fiscal policy to respond to economic shocks and leave the Reserve Bank to control cycles in most circumstances, a new Treasury report says.

Part one of Treasury’s long-term insights briefing, published Thursday afternoon, analyzed how governments could use the balance sheet to sustainably manage shocks and cycles.

It was a thinly-veiled review of spending decisions made during the Covid-19 response which concluded future governments should be more careful about taking on large debts. 

“Experience across many countries shows that fiscal policy is easy to loosen in a downturn or shock but difficult to tighten in an upturn. This can lead to debt ratcheting upwards over time,” it warned. 

New Zealand’s debt levels are still comfortably below the 50% of gross domestic product threshold Treasury considers to be okay to spend outside of a crisis. But the country no longer has abnormally low levels relative to other small and medium advanced economies.

This has largely been due to crises costing about 10% of GDP each decade. Examples include the Global Financial Crisis, the Christchurch Earthquakes, and the Covid-19 pandemic. 

Governments have not saved enough to offset the spending done in response to these events and net public debt has risen from near zero in 2008 to over 42% today. 

The response to Covid-19 was the most costly economic shock, with an estimated $66 billion price-tag equal to 20.4% of GDP. Whereas recovering from the Canterbury earthquakes cost the Crown $23 billion, or 11.3%.

While it avoids saying it directly, Treasury’s paper implies the Labour Government overspent on the pandemic response and continued to do so against the agency’s advice in 2021.

Treasury said the wage subsidies and similar schemes during lockdowns were around 35% of costs, while pandemic specific health systems cost another 18%. This left almost half of the $66 billion bill spent on “a wide range of initiatives with varied objectives”. 

Examples included small business cashflow loans, Jobs for Nature, shovel-ready infrastructure projects, increases to welfare benefits, additional public housing, and even school lunches.

Treasury said it recommended strong fiscal stimulus at the start of the pandemic, as interest rates were already near zero and the financial system was not set up for negative rates. 

But it started to advise more targeted spending during the August 2021 lockdowns and opposed any further stimulus from Budget 2022 onwards.

Then-finance minister Grant Robertson closed the Covid Response and Recovery Fund in that budget but spent the remaining $3 billion on other priorities. Programs such as Jobs for Nature, expanded school lunches, and shovel-ready infrastructure projects continued.

“The COVID-19 response showed the challenges of using fiscal policy to respond to shocks and cycles. Many programmes within the fiscal response, particularly those not tied to the shock, had a lagged impact on the economy and proved difficult to unwind in later years,” Treasury said in the briefing. 

The agency specifically warned against building new infrastructure to offset economic downturns, due to the long lag between investment decision and construction. It would be more useful to quickly ramp up maintenance and repair work, it said.

Lessons learned 

Treasury concluded that managing cyclical swings in the economy should mostly be left to the Reserve Bank, with discretionary fiscal policy only used when monetary policy was constrained or to tackle the distributional impacts of an economic shock. 

Discretionary fiscal policy doesn’t include automatic economic stabilizers—such as increased benefit spending and weaker tax collection—or rebuilding and maintaining government functions and services if damaged.  

“Monetary policy changes can be reversed more readily and can often be implemented faster. The government’s spending and taxation decisions should generally seek to optimise long-run value for money rather than moderating economic cycles,” Treasury said. 

If future governments do need to use fiscal policy to manage a shock, it would be best to prepare a set of “tools” in advance so they can be deployed quickly and effectively. 

Whether these are lump-sum payments, wage subsidies, infrastructure maintenance, credit guarantee schemes, or something else, they should always be temporary and targeted. 

Finance Minister Nicola Willis took this briefing—which is prepared independently—as vindication of her criticisms of the Labour Government’s spending decisions. 

“Treasury’s language is spare and polite, but its conclusions are damning,” she said in a press release. 

“The report makes clear significant errors were made in the fiscal response to Covid. Treasury is urging policy makers not to repeat those mistakes. Our Government will not.” 

She noted the “particular mention” of programmes funded from Covid money but not tied to the specific shock, such as school lunches and other semi-permanent stimulus measures. 

“That is a very diplomatic way of saying New Zealanders are still paying the price of the previous government extending a big-spending approach initially intended for a pandemic response.”