11  Selection of objectives for policy design

The analysis above has identified seven potential objectives for Crown financial policy. Ideally, the objectives would be evaluated within a comprehensive empirical framework. However, from a practical perspective, taking forward all objectives to inform the design of alternative policy options would be undesirable. This section assesses whether any objectives should be rejected a priori from further consideration. Rejection at this stage would not foreclose the objective being considered further once policy options associated with other objectives have been considered fully. The section also assesses the potential conflicts between the selected objectives.

The conclusion of this section is that the design of policy options should proceed without further consideration of objectives related to policy neutrality and any new market maker and risk management services. Rejection of additional ‘service provider’ motivations is consistent with conclusions reached in Skilling (1997) as discussed in the Introduction. In this formulation, government debt would be retained as an existing market maker service, being incorporated through the objective relating to downside efficiency risk.

11.1  Criteria for rejecting an objective

Subjecting the objectives to a priori tests incurs the risk of two types of error:

• false negative error: Rejection of an objective that would be accepted by more complete empirical and judgemental analysis; and
• false positive error: Acceptance of an objective that would be rejected by more complete empirical and judgement analysis.

The criteria should result in low risk of false negative error but be more forgiving with respect to false positive errors since the later are likely to be picked up during subsequent analysis of policy options. More generally, the criteria should be self-evident, enduring and consistent with the principles of efficient policy design.

The criteria applied below are as follows:

• infeasible: Reject an objective if implementation of Crown financial policy to achieve the objective would not be feasible;
• comparative disadvantage: Reject an objective if Crown financial policy would be at comparative disadvantage in achieving the objective relative to other instruments; or
• non-binding: Reject an objective if the policy settings implied by the objective would in practice be non-binding on Crown balance sheet variables.

11.2  Application of criteria

Table 2 summarises the judgements in relation to each objective. Two of the seven objectives – relating to provision of market maker and risk management services – are judged as failing the criteria.

Market maker services

With the exception of safe debt as discussed above, the role of government as provider of market maker services potentially fails three of the rejection criteria:

• implementation may not be feasible for substantive innovations such as the issue of securities indexed by country output or government spending;
• it is not obvious that the government possesses a comparative advantage over the private sector in the provision of new securities to fill missing markets. Unless specific reasons are identified to the contrary, we should assume the barriers faced by private market makers would apply also to the government; and
• in the event the government did expand its market maker service, it is not known whether the specific new instruments created for this purpose would contravene constraints implied by other objectives. To the extent that such securities would need to be issued only up to the level sufficient to sustain a liquid trading market, it would seem unlikely that such policies would materially constrain the risk/return properties of the overall Crown balance sheet. If this is the case, then the welfare benefits of providing additional market maker services could be investigated independently of the other policy options.

These factors suggest that the design of policy options for managing the Crown balance sheet should proceed without further consideration of ‘market maker services’.

Risk management services

Government provision of risk management services potentially fails two of the criteria. First, implementing a risk management service on behalf of citizens would face formidable information problems and issues associated with interpersonal welfare comparisons.

Second, any Crown financial policy designed for the purpose of providing risk management services would need to demonstrate a net welfare benefit relative to the status quo and other alternative policies. The latter would require comparison with a range of social policies available to protect disadvantaged citizens against risk exposures. These difficulties suggest that it would not be possible to implement a risk management service with high assurance of positive net welfare benefits.

In addition to the two objectives discussed above, four of the five remaining objectives could fail one or more of the criteria. For three of objectives, it is judged that sufficient doubt remains as to warrant including them in the set of objectives to take forward for further analysis.

Note: Absence of firm view indicated by “-“