1  Introduction

Assessments of the influence of fiscal policy on the economy often use terminology such as a “tighter fiscal stance” or “contractionary fiscal policy”.[1] The actual fiscal balance may not be a good measure of changes in fiscal policy. This is largely because developments in the actual balance reflect both changes in fiscal policy as well as how changes in the economy influence tax revenue and government spending. The aim of this paper is to develop a measure of whether changes in fiscal policy are adding to, or subtracting from, aggregate demand pressures in the economy. Consistent with the terminology generally used in this literature, we define such a measure as an indicator of fiscal impulse.

Indicators of fiscal impulse can be a useful component in a fiscal analysis toolkit that also contains measures of the structural fiscal position, analysis of tax and spending trends, and longer-term fiscal projections. Indicators of fiscal impulse can enhance the ex post interpretation of changes in fiscal policy as well as helping to identify relatively large ex ante forecast changes in fiscal policy. However, we do not see impulse indicators as some sort of stop or go trigger for fiscal policy initiatives. Policy initiatives should also be assessed with reference to underlying micro-economic and public finance analysis. Ideally, fiscal impulse indicators would be augmented with assessments derived from macroeconomic and perhaps time series models. Further, while assessments of fiscal impulse may play an information role, their calculation does not imply a shift in fiscal policy away from its current medium-term focus to a more active counter-cyclical role. Indeed, the analysis in this paper constitutes a significant health warning to the unqualified use of fiscal impulse indicators.

The limited availability of fiscal information on a consistent basis restricts historical estimates of fiscal indicators for New Zealand.[2] The analysis in this paper covers the period from the early 1990s to the end of the 2002 Budget forecast horizon (year ending June 2006). Key features of fiscal policy over this period are, first, the shift from persistent operating deficits to consecutive operating surpluses since 1994 and a significant reduction in the ratio of public debt to gross domestic product (GDP).[3] Second, forecasts of the fiscal position in the mid 1990s indicated scope for a fiscal adjustment, and the then Government announced tax reductions and additional spending. Third, looking forward, the current Government is aiming to run operating surpluses.

One of the requirements of the Fiscal Responsibility Act 1994 is for the Government to set long-term fiscal objectives. The Government formulates its budget to ensure that aggregate levels of taxation and spending, including forecast new operating and capital spending, are consistent with progress towards its long-term fiscal objectives. Adjustment towards the objectives may result in changes to the fiscal balance over time. These changes are not necessarily a deliberate attempt to influence aggregate demand. Rather they are the consequence of a number of individual budget decisions and progression towards the long-term fiscal objectives.

Nonetheless, Governments may also be concerned about macroeconomic stability and therefore the potential short-term impact of fiscal policy on aggregate demand. For example, strongly pro-cyclical fiscal policy could place additional pressure on monetary policy and lead to undesirable swings in interest rates and the exchange rate. Because large changes in fiscal policy may have an impact on aggregate demand in the economy, they will need to be taken into account by the Reserve Bank of New Zealand (RBNZ), which operates to achieve an inflation target.[4]

The remainder of this paper is set out as follows. Section 2 sets out definitions of fiscal impulse and discusses some of the limitations of simple aggregate indicators. Section 3 outlines issues that arise in estimating indicators of fiscal impulse. Section 4 provides estimates and sensitivity analysis for New Zealand. Finally, Section 5 provides concluding remarks.