The Treasury

Global Navigation

Personal tools

Government
Publication

Budget 2010 Home Page Budget Economic and Fiscal Update 2010

Additional Fiscal Indicators

There are different approaches to assessing the relationship between the economy and the fiscal position, and the relationship between fiscal policy and the economy (see the 2008 Budget Forecasts, http://www.treasury.govt.nz/budget/forecasts/befu2008, pages 86 and 87). One approach to assessing these relationships uses summary fiscal indicators. The following sections explain Treasury's perspective on these indicators, the relationship between them, and how they are calculated.[1]

The nature of the tax changes, the recent economic shock, and in particular the long-lasting changes to key economic variables mean that these summary fiscal indicators are subject to more-than-usual uncertainty. In particular, the fiscal impulse indicator is not a good guide to discretionary fiscal policy stimulus. For this, and other reasons described below, Treasury is currently reviewing both the fiscal impulse and the cyclically-adjusted balance indicators.

The cyclically-adjusted balance and fiscal impulse

The cyclically-adjusted balance (CAB) is a summary indicator of what the fiscal balance would be if the economy was operating at potential output. In this sense the CAB is concerned with the relationship between the economy and the fiscal position. The CAB can act as a guide in assessing the sustainability of fiscal policy. It does this by gauging the extent to which the fiscal balance reflects temporary cyclical factors rather than long-lasting factors. The fiscal balance can therefore be described as:

Fiscal balance = CAB + cyclical component

The cyclical component can be calculated by adjusting tax and spending flows by the output gap, the difference between actual output and potential output. Potential output, and so the output gap, is not directly observable and has to be estimated. Cyclical adjustment also takes into account the responsiveness of different tax types, and unemployment, to the output gap.[2] Since the approach removes an estimate of the cyclical component of taxes and unemployment spending from the fiscal balance, the CAB is a mix of discretionary fiscal policy, demand driven influences on spending (eg, population changes), and prices differing from trend. Because it includes estimated variables and is sensitive to new information, particularly regarding the output gap, the CAB is subject to uncertainty.

In addition to its role in assessing fiscal sustainability, it is common, especially in cross-country comparisons, to use the change in the CAB as an indicator of change in discretionary fiscal policy and the impact of fiscal policy on the economy. The Treasury's fiscal impulse indicator uses the change in a cash based version of the CAB for the core Crown. The appropriateness of using the change in the CAB for these tasks is subject to some debate.[3]

Limitations of summary fiscal indicators

If potential output evolves smoothly through time and does not change between forecast rounds then changes in the path of output, and the associated output gap, tend to reflect cyclical developments from the demand side of the economy. In this case, the use of the output gap to adjust taxes and spending will mean that movements in the CAB will tend to reflect discretionary fiscal policy changes. However, when potential output is changing then movements in the CAB are less clearly related to discretionary fiscal policy changes.

If changes to GDP are permanent, then the change in tax revenue will be treated as a non-policy driven structural shift (although the ratio of tax to potential output will be less affected). On the spending side, lower inflation will reduce the rise in some government expenses (eg, benefits). Spending on unemployment benefits increases as the unemployment rate rises. However, the majority of government expenses are more structural in nature and do not respond immediately or directly to movements in nominal GDP (and so the ratio to potential will rise if potential output is falling).[4]

In addition to the impact of non-policy related changes, summary indicators such as fiscal impulse do not allow for the composition of fiscal policy changes or how a change in fiscal policy will be transmitted through the economy. Treasury research using time series statistical analysis indicates that spending and taxes have different effects on New Zealand GDP.[5]

Notes

  • [1]There is no unique terminology for these summary indicators. For example, the terms cyclically-adjusted balance (CAB) and structural budget balance (SBB) are often used interchangeably. The CAB removes cyclical factors. The SBB removes all temporary factors: cyclical; temporary fiscal policy measures; and one-offs. If these last two factors are not large then the two measures will be similar. The terms fiscal impulse, fiscal stance and fiscal stimulus are also used interchangeably.
  • [2]Treasury’s approach to estimating the cyclically-adjusted balance and fiscal impulse is set out in Treasury Working Papers 01/10 and 02/30 refer http://www.treasury.govt.nz/publications/research-policy/wp/2001/01-10/ and http://www.treasury.govt.nz/publications/research-policy/wp/2002/02-30/
  • [3]These issues are covered in the Treasury Working Paper 02/30 - refer above for website link.
  • [4]These effects can operate in reverse under upward revisions to potential output and/or higher inflation.
  • [5]See Treasury Working Paper 06/08 - refer http://www.treasury.govt.nz/publications/research-policy/wp/2006/06-08/. The degree to which the fiscal impulse indicator matches the time series estimates depends on the exact form of the latter. In neither of the time series specifications does the summary indicator match the time series estimate across the entire sample period.
Page top