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How New Zealand Governments Determine Their Fiscal Strategies - A Layman's Guide

Part 2: What factors do governments take into account when setting fiscal strategies?

When setting its fiscal strategy, a government needs to ensure that it complies with the principles of responsible fiscal management as set out in the PFA. For more detail on the fiscal policy framework, you can read the companion pamphlet An Introduction to New Zealand's Fiscal Policy Framework on this topic.

2.1 How much Crown debt is prudent?

The PFA requires governments to maintain debt at prudent levels, but the law does not define what a prudent level is - this is for the government of the day to determine and explain.

The PFA also requires that governments aim, on average over time, to ensure that they fund current expenses such as of the health, welfare and justice systems out of current revenue without needing to borrow. If current expenses cannot be funded by current revenue, these expenses need to be funded by borrowing, at least in part. Debt-funding pushes the costs of repayment onto future generations, even if it is people today who are getting most of the benefits.

However, borrowing for capital investments in assets, such as on bridges, roads and buildings, can be desirable. This is because it allows governments to spread the costs of that capital spending across the generations that will benefit from it. This cost-sharing could be considered fair. It also tends to create better incentives for current generations to spend an appropriate amount, as people who must fund the whole cost of an investment yet will only see some of the benefits might be tempted to under-invest.

Regardless of what the borrowing is used for, when public debt levels get too high it exposes a country to higher risks. For example, economic shocks will often lead to higher spending (eg, on unemployment benefits) and lower tax revenue and, thus, often result in the government needing to borrow more. But, an already high level of debt might restrict its ability to borrow more.

Even in the absence of shocks, a high level of public debt might make lenders start to doubt a country's ability to repay its debt, leading to higher interest rates. And higher interest rates, coupled with the higher principal to which those rates are applied, means that interest payments form a higher share of current expenses, potentially crowding out more valuable spending or requiring higher taxes.

There is no precise science to identifying the point at which public debt is "too high", or to determine a level that is prudent. A number of factors affect this judgement, so we might expect different governments to come to different conclusions based on the specific circumstances they face.

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