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New Zealand's Fiscal Policy Framework: Experience and Evolution - WP 01/25

5.  Experience with New Zealand’s Fiscal Policy Framework

Fiscal outcomes over the 1990s provide insights into the strengths and weaknesses of the fiscal policy framework.

5.1  Fiscal outcomes

New Zealand’s fiscal position improved substantially during the first half of the 1990s. To gauge the extent to which the economic cycle influenced the fiscal position, Figure 2 provides an estimate of the cyclically-adjusted, or structural balance.

With revenue remaining broadly stable as a share of GDP, the change in the fiscal balance was achieved largely through the expense side.

The decline in expenses partly reflects lower finance costs as interest rates fell, and fiscal surpluses and asset sales reduced the level of debt. (Expenses excluding finance costs were around 38% of GDP in 1992 and 32% of GDP in 2000.) Approximately NZ$19.2 billion was raised from the sale of government businesses and other assets between 1987 and 1999. Proceeds contributed to the repayment of public debt, and a zero net-foreign currency debt goal was reached in 1996. Progress against stated long-term objectives for net debt is given in Figure 3.[16]

Although significant progress was made in reducing operating expenses as a share of GDP from the levels evident in the early 1990s (see Figure 4), progress against the stated long-term objective stalled during the mid- to late-1990s.[17]

In addition to the decline in finance costs, the decline in expenses through the 1990s also partly reflects the economic upswing and the associated fall in unemployment benefit expenses. The increase in the age of eligibility for New Zealand Superannuation (NZS) and fiscal discipline in the core public sector also contributed to the decline in expenses-to-GDP. Changes in the profile of the major components of total expenses (by functional classification) are illustrated in Figure 5.

Figure 2 - Operating balance and cyclically-adjusted operating balance: Estimate and forecasts (June years, % GDP)
Source: The Treasury, December Economic and Fiscal Update, 2000.

Note: This analysis removes the effect of valuation changes (including changes to the liability of the pension scheme for government employees, the liability of the accident compensation scheme, losses/gains on sale of assets, and foreign exchange losses/gains). The estimate requires assumptions about potential output and the responsiveness of revenues and unemployment expenses to output. These assumptions are based on, and are sensitive to the latest available information. The estimate of potential output is derived using a Hodrick-Prescott filter.

Figure 3 - Net Crown debt: Actual and forecasts (June years, % GDP)
Figure 3 - Net Crown debt: Actual and forecasts (June years, % GDP).
Source: The Treasury, December Economic and Fiscal Update, 2000.

Figure 4 - Expenses: Actual and forecasts (June years, % GDP)
Figure 4 - Expenses: Actual and forecasts (June years, % GDP).
Source: The Treasury, December Economic and Fiscal Update, 2000.
Figure 5-Expenses: Functional components (June years, % GDP)

Figure 5-Expenses: Functional components (June years, % GDP).
Source: The Treasury.

Longer-term (10-year) fiscal projections in the mid-1990s suggested rapid progress toward the then long-term fiscal objectives. For example, the baseline projection in the 1996 FSR indicated the elimination of net debt by 2001/02. This degree of debt reduction (and eventual asset accumulation) represented a higher level of government saving than the then Government considered desirable. A “structural” fiscal correction aimed at longer-term economic and social objectives became an option. Personal income tax reductions and additional spending plans were announced in early 1996. This structural correction was predicated on relatively strong assumptions regarding expenditure control that are discussed below and in Section 6.2.

Notes

  • [16]The general trend in net debt tends to match operating balance trends. However, the operating balance is an accrual measure and recognises non-cash items (e.g., retained surplus of SOEs and Crown entities). The relationship between net debt and the operating balance is reconciled in each Economic and Fiscal Update. The 1994 FSR expressed the long-term objective for net debt as between 20% and 30% of GDP. This was changed to 20% of GDP in the 1995 BPS and to 15% of GDP in the 1998 FSR. An objective for gross debt was introduced in the 1997 BPS and is currently 30% of GDP. The current formulation of the net debt objective is 20% of GDP (excluding assets accumulated for the purpose of funding future public pension expenses).
  • [17]The long-term objective for expenses was changed in the 2000 BPS to “Expenses around current levels of 35% of GDP”. Note that the historical trend in expenses is somewhat distorted by the effects of valuation changes and foreign exchange losses/gains (see Note to Figure 2). For example, foreign exchange losses in 1992 were around $1.8 billion (2.4% of GDP).
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