The requirements for fiscal sustainability in New Zealand

Abstract

New Zealand, like many other countries, is experiencing a changing demographic profile from one dominated by young people during the twentieth century to one where the population is more evenly distributed across age groups. This has implications for the government's future fiscal position and sustainability of its spending programmes. This article discusses the link between the government budget constraint and fiscal sustainability, measures of fiscal sustainability, and why it is important. We examine New Zealand Treasury's approach to assessing fiscal sustainability, review lessons from previous fiscal adjustments, and discuss criteria to evaluate policy changes designed to achieve fiscal sustainability.

Keywords:

• long-run fiscal sustainability
• fiscal consolidation
• public debt
• public social expenditure
• taxation
• New Zealand

JEL Classifications:

• E61
• E62
• H68

Acknowledgements

We are grateful for the comments received from Matthew Bell, Anne-Marie Brook, John Creedy, Neil Cribbens, Hon Sir Michael Cullen, Norman Gemmell, Viv Hall, John Janssen, Brian McCulloch, Bill Moran, Michael Reddell, Paul Rodway, and Graeme Wells, and from participants at the New Zealand Association of Economists Conference held in Palmerston North on 27–29 June 2012, the Treasury Long-Term Fiscal External Panel meeting held at the Victoria Business School on 30 August 2012, and the Affording our Future Conference held at Victoria University of Wellington on 10–11 December 2012.

Notes

1. See Buckle and Cruickshank (2013, Figure 1) and Bascand and Dunstan (2014).

2. For a fuller review see Buckle and Cruickshank (2013). There are also econometric techniques that have been developed to test the sustainability of government debt and deficits. Bohn (2007), for example, provides a critique of standard stationarity and cointegration techniques that have been used, and suggests alternative approaches that could be taken. As far as we are aware, these sorts of approaches have not been applied in the New Zealand context.

3. The description of infinite and finite horizon fiscal sustainability measures draws on Pradelli (2012).

4. This configuration of the government's inter-temporal budget constraint is an approximation used for illustrative purposes and abstracts from a number of considerations including the financial assets of the government, cash and accruals measures, as well as inflation.

5. As a simple numerical example, if the growth-adjusted real interest rate, r = (i – y)/(1 + y) = (6 – 3.5)/(1 + 3.5) = 0.55 and the initial stock of inherited debt, d_n–1 = 20% of GDP, then to stabilise government debt at 20% of GDP, the government needs to run a primary surplus of 0.55 × 0.2 = 0.11% of GDP.

6. Sutherland et al. (2012) based on a summary of literature suggested a threshold of 75% gross debt to GDP beyond which government debt has a negative effect on economic growth. However, that summary drew on literature, including Reinhart and Rogoff (2010), that has been called into question either because of concern with how the data was compiled (see e.g. Herndon, Ash, & Pollin, 2013) or because of uncertainty about the direction of causality (see e.g. Dube, 2013).

7. See Buckle and Cruickshank (2013) Figure 3, p. 19.

8. See National-ACT Confidence and Supply Agreement (2011). A Confidence and Supply Agreement is an agreement that a minor political party or independent Member of Parliament will support the government in motions of confidence and appropriation (supply) votes by voting in favour or abstaining.

9. For more analysis of crowding out in the New Zealand context, Hall and Rae (1998) develop a small open economy model which shows the impact of the fiscal balance on the interest rate premium.

10. See, for example, the discussion in Davis and Fabling (2002).

11. The Long-Term Fiscal Model is available online: http://www.treasury.govt.nz/government/longterm/fiscalmodel.

12. This was one of the key points stressed during the Long-Term External Fiscal Panel process and which influenced a change in emphasis in the third Long-Term Fiscal Statement (New Zealand Treasury, 2013) compared to the previous two statements (New Zealand Treasury, 2006, 2009).

13. Generally, governments tend to protect expenditure that is likely to enhance productivity and economic growth, such as education, transport, and communications expenditure, and cut back on social security (welfare) payments as well as spending on defence, housing, and cultural affairs. Health, public services, and environmental protection tend to hold their own during fiscal consolidations (Sanz, 2011). This contrasts somewhat with the New Zealand experience where government expenditure on economic activities (including transportation and communications) was reduced relative to other areas from the mid-1980s and public health expenditure has tended to be protected during fiscal adjustments.

14. New Zealand Superannuation Fund (NZSF) assets are not included as financial assets for the purpose of this measure because NZSF assets are held for specific policy reasons. Advances, which include student loans, are also not included as financial assets because they are substantially less liquid than other government financial assets and are not held for purposes associated with government finances (Government of New Zealand, 2009).