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Special Topic:  External Review of Treasury’s Fiscal Policy Advice

Twenty years have passed since the Fiscal Responsibility Act came into force in 1994, with the provisions of fiscal responsibility subsequently being absorbed into the Public Finance Act, and further changes to these principles recently being adopted. With this in mind, last year the Treasury commissioned an independent review of the fiscal policy advice that it has provided over the past decade.

Whilst it appears that New Zealand’s fiscal policy institutions have served it well through recent history, and are well regarded internationally, no country should rest on its laurels. The fiscal accounts have come through the global financial crisis (GFC) better than many countries, but as the government finances return to surplus it was seen as appropriate to review the way in which the Treasury provides advice.

The Review of the Treasury’s Fiscal Policy Advice, and the Treasury’s response to the Review, have now been published on the Treasury website [1]. The following sections outline the findings of the Review.

Commissioning an international expert...

The Treasury commissioned Teresa Ter-Minassian, a former Director of the Fiscal Affairs Department at the IMF, to conduct the Review. Ms Ter-Minassian visited New Zealand twice to interview experts including current and former Treasury officials, current and former Ministers of Finance, members of the Finance and Expenditure Committee and the Opposition, and a number of academics and private sector representatives.

Ms Ter-Minassian was asked to consider the overall quality of the Treasury’s advice, noting the following aspects in particular:

  1. The information, frameworks and tools of analysis used by the Treasury
  2. The coordination of fiscal with other economic policies
  3. The Treasury’s advice on the evolving fiscal policy framework
  4. The Treasury’s understanding of, and role in evaluating, the drivers of Government expenditures.

...confirmed the strength of performance

The Review found that the Treasury’s advice has been consistent with sound principles and practices of responsible fiscal management, and appropriately mindful of fiscal policy’s equity, effectiveness and efficiency objectives. It also notes the success in effectively influencing the Government’s fiscal policies over the period, and the improvements in inclusivity and a range of stakeholder inputs that have been sought.

The fiscal framework is found to have provided the Government flexibility to accommodate the adverse shock of the GFC and the fiscal costs of the Canterbury earthquakes. This is all very positive news for New Zealand.

...with some room for improvement

The Review also made a series of recommendations regarding the Treasury’s advice. These are expected to help inform the Treasury’s work programme over the next few years, highlighting the long-term benefits that can be gained from conducting a Review of this sort.

Avoiding pro-cyclicality

One of the main aims of fiscal policy is to avoid ‘pro-cyclicality’ - running loose fiscal policy which puts upward pressure on interest rates and the exchange rate when the economy is expanding, exacerbating macroeconomic imbalances, or running excessively tight fiscal policy in times when the economy is contracting.

The Review notes that whilst New Zealand has been successful in avoiding pro-cyclical fiscal contractions in the aftermath of the GFC (Figure 1), it has been less successful in avoiding pro-cyclicality during upturns. This is recognised as a common challenge for many countries worldwide, and may be due to many factors including difficulties in estimating the output gap contemporaneously. The Review uses the Treasury fiscal impulse[2] estimates to show that fiscal policy was pro-cyclical during half of the years of positive economic growth between 1998 and 2012.

Figure 1 - Estimates of the fiscal impulse
Figure 1 - Estimates of the fiscal impulse.
Source: The Treasury, 2013 HYEFU, as used in the Review

For this reason the Review recommends that the Treasury continue to focus on avoiding pro-cyclicality in fiscal policy, and in particular that reduction in net debt remains paramount in fiscal strategy advice and the primary option for any future unforeseen shocks such as revenue surprises.

The tools used by the Treasury could be developed further....

Various improvements to the modelling that the Treasury undertakes have been identified in the Review. Many of these are incremental developments to the Treasury’s suite of models that would allow the Treasury to stay on the frontier of modelling work in fiscal policy.

The Treasury is found to have not given enough credence to the possibility of shocks of similar size to those experienced during the GFC, and it is recommended that in future the alternative scenarios run as sensitivity tests on the economic projections do incorporate these.

It is also recommended that the Treasury undertake a series of modelling developments to allow improvements in analysing the effects of fiscal policy. These include changes to the summary indicators used to judge the fiscal impulse (e.g. looking at the sensitivity of tax revenues to domestic demand changes), and analysing the extent to which fiscal multipliers may vary over the economic cycle.

It is also recommended that the Treasury consider developing a new general equilibrium model for looking directly at the short and medium-term impact of fiscal policy.

.... as could analysis of the balance sheet

New Zealand is recognised as pioneering in the construction of a complete balance sheet for the government, looking at social, commercial and financial assets and liabilities. The Review highlights the Investment Statement 2014 as an important addition to the analysis in this area. However, similar to the scenarios considered for economic forecasts, it is recommended that the Treasury develop its analysis of the balance sheet to also look at alternative scenarios for the economic fundamentals, and in particular pay attention to the correlation within and among the portfolios.

... but the Treasury looks well placed to understand and control future fiscal pressures

Whilst there are clearly areas the Review shows need development, it highlights the work the Treasury has undertaken to understand spending pressures in the longer-term. This is in the context of the future pressures of an ageing population as shown in the Long-term Fiscal Statement. However, it also notes the drive towards a holistic medium-term and recipient-focused approach to the analysis and reform of public spending programmes, known as the ‘investment approach’. This approach helps identify key and at-risk areas or individuals where additional spending can create greater value for money in terms of saved future spending.

The Treasury is thus developing an enhanced monitoring framework to look at the sustainability, efficiency and effectiveness of government spending, and improving the evidence base for the social assets portfolio (the property, plant and equipment of government), including large-scale infrastructures.

The Review recommends that the Treasury continue to improve performance information, through not expanding the number of indicators too widely, benchmarking against comparator countries, and that this be undertaken collaboratively with other government departments to ensure that suitable cross-government incentives are created. However, it is recognised that as with many aspects of the fiscal policy framework, New Zealand is at the leading edge of international experience, and that lessons learned here may be taken as international best practice.

Notes

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