1  Introduction

Crown financial policy specifies how the government manages the Crown’s assets and liabilities.[1] Policy analysis in this area is concerned with how the structure and size of the Crown balance sheet could affect the decisions of citizens in managing their own wealth portfolios and also government decisions on fiscal and other economic policies. Crown financial policy is closely related to corporate financial policy, which is concerned with how a company’s balance sheet could affect the decisions of shareholders and managers.

The Treasury has conducted research on Crown financial policy in one form or another since at least the mid-1990s. Skilling (1997) and Davis (2001) summarise and develop the literature relevant to Crown financial policy, while Grimes (2001a) discusses the operational objectives and practices relevant to managing the Crown’s balance sheet.[2] Empirical analyses by Huther (1998), Fabling (2002) and Davis and Fabling (2002) have found tentative evidence that it may be possible to improve the performance of the Crown balance sheet.

At a practical level, changes in the Crown balance sheet impact on the government’s fiscal performance. An example is the financial year 2002/03, where a partial revaluation of the Crown balance sheet reduced the government’s operating surplus (based on accrual accounting) from $4 billion to $1.4 billion. This adjustment amounts to around 6% of Core Crown revenue.[3]

Crown financial policy is likely to become progressively more important as the recently established New Zealand Superannuation Fund accumulates financial assets over the next few decades equivalent to 45% of GDP or around $56 billion in current terms.[4] If these funds accumulate as projected, then a 10 basis point (or 0.1%) improvement (decline) in annual returns at the same risk level would confer a net present value gain (loss) to New Zealand of around $1 billion (at 5% discount rate).

Purpose of this paper

A key purpose of this paper is to organise the theoretical literature within a coherent policy framework to provide a basis for comparing policy recommendations. A second key purpose is to select a subset of key concepts that should inform the design of alternative policy options for Crown financial policy.

Organising framework

This paper adopts the framework of objectives, targets, and instruments. Objectives are high-level qualitative statements of intent, targets are quantitative expressions intended to give effect to the qualitative objectives, and instruments are policy levers subject to the control of the authorities. By way of example, in the New Zealand monetary policy regime the overall policy objective (as specified in the Reserve Bank Act 1989) is to “maintain price stability”, the current policy target is medium term inflation in the range of 1-3% p.a. and the policy instrument is the Official Cash Rate.

The Crown balance sheet may be viewed as an instrument, as policy makers ultimately have control over the gross size and structure of the balance sheet. The discussion in this paper shows that the Crown balance sheet potentially could be targeted at a wide range of markedly different policy objectives, each contributing to overall economic welfare.[5]

In the case of some objectives, the literature also suggests that other non-balance sheet instruments may be available to achieve the desired objective. Examples may be found in the form of institutional arrangements such as the Reserve Bank Act 1989 and Fiscal Responsibility Act 1994 and various regulatory and social policies.

The task for policy makers, therefore, is an instrument assignment problem. Policy makers need to identify the various potential objectives, identify the balance sheet and other possible instruments, and determine the best mapping of instruments to objectives. The optimal assignment is that which would maximise New Zealand economic welfare. Policy targets are specified as part of the implementation regime for guiding the adjustment of instruments to achieve objectives.

Structure of paper

The paper has the following structure. The next section (Section 2) provides a brief overview of seven policy objectives identified in the literature. Sections 3 – 9 discuss in turn the motivation for each objective and summarise the implications for setting of policy targets and instruments. Section 10 summarises the policy targets associated with each objective.

Up to this point I avoid, as far as possible, assessing empirically or judgementally the significance and relative importance of the objectives. I depart from this approach in the penultimate section. In Section 11 a set of criteria are developed and applied to assess a priori whether any of the seven objectives identified earlier should be omitted from further consideration in the development of policy options. This section also discusses at a high level the conflicts between the selected policy objectives. Conclusions are discussed in Section 12.