Posted By

Tags

Fiscal response inevitable in an uncertain world

Dominick Stephens, Michael Gordon and Satish Ranchhod
Wellington, May 14, 2020

The 2020 Budget was dominated by the government’s response to the Covid-19 pandemic.

With the world economy facing its biggest shock since the Great Depression, the required fiscal response was inevitably going to be well beyond anything seen in our lifetimes.

Indeed, it turned out to be even larger than we had allowed for.

With the Budget 2020 announcements, the government has committed a total of $62 billion for economic support and recovery, equivalent to around 20% of annual GDP.

Of this, around $26 billion had already been announced before today’s Budget, another $16 billion was unveiled today, and the remaining $20 billion will be allocated to specific programmes at a future date.

 

Lift in borrowing

The package will require a significant lift in government borrowing over the coming years.

The bond issuance programme has been expanded to $190 billion over five years, compared to $42 billion in the Half-Year Update in December 2019.

Net core Crown debt is expected to rise from around 20% currently to a peak of 53.6% of GDP, close to the record high that New Zealand reached in the early 1990s.

The government has chosen to go hard and go early in its response.

On the whole, we think this was the right thing to do; the economy needs support, and the Reserve Bank of New Zealand (RBNZ) is struggling to provide it.

This Budget will reduce the risk that Covid-19 causes permanent damage to the economy, and

opens a much clearer path to recovery.

Mounting risks

But this approach is not without its risks.

New Zealand has long been staring down the barrel of massive increases in government spending due to the aging population. That means, future governments will either have to spend less or

tax more, which could sap the economy’s dynamism.

Taking on more debt now puts us in an even weaker position to deal with this challenge.

We, and most other economists, expect interest rates to remain low for some time.

But if interest rates were to unexpectedly rise, the debts being taken on the Budget Day could become a very heavy burden to future taxpayers.

A general risk with using fiscal policy to provide stimulus to the economy is lack of flexibility.

If RBNZ finds it has overstimulated the economy, it can easily reverse course

by increasing interest rates.

Governments cannot fine-tune in this way.

Uncertain times

The current economic situation is especially uncertain. While we and most other economists believe that the size of the impending economic downturn requires massive stimulus, we could be wrong. If the economy does prove surprisingly resilient, the government could find that it has overstimulated the economy.

Leaving $ 20 billion of the support and recovery fund unspent does mitigate this risk; in theory, some of that spending could be cancelled.

But if the government did end up providing too much stimulus, RBNZ would have to run with tighter monetary policy than otherwise.

The overall size of the stimulus measures announced was larger than we expected, and larger than what RBNZ assumed in this week’s Monetary Policy Statement.

That casts some doubt on our forecast of a negative OCR, for two reasons.

First, more fiscal stimulus means less need for additional monetary stimulus.

Second, more government debt issuance gives the RBNZ more scope to buy government bonds and expand its quantitative easing programme rather than lowering the OCR.

Dominick Stephens is Chief Economist and Michael Gordon and Satish Ranchhod are Senior Economists at Westpac. The above is an edited version. For full text of the above article, please visit www.westpac.co.nz

Share this story

Related Stories

Leave a Reply

This site uses Akismet to reduce spam. Learn how your comment data is processed.

Indian Newslink

Previous slide
Next slide

Advertisement

Previous slide
Next slide

Advertisement

Previous slide
Next slide

Advertisement

Previous slide
Next slide

Advertisement

Previous slide
Next slide

Advertisement

Advertisement

Previous slide
Next slide

Advertisement

Previous slide
Next slide

Advertisement

Previous slide
Next slide

Advertisement