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 government decisions on fiscal and other economic policies.

The practical effect of movements in the Crown balance sheet was evident in the Crown Financial Statements for 2002/03. Due to accrual accounting, a partial revaluation of the Crown balance sheet in 2002/03 reduced the government’s operating surplus from $4 billion to $1.4 billion. This adjustment amounted to around 6% of Core Crown revenue.[2]

Crown financial policy is likely to become progressively more important over time as the recently established New Zealand Superannuation Fund accumulates financial assets equivalent to 45% of GDP or around $56 billion in current terms.[3] 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).

Hansen (2003) organises the theoretical literature within a policy framework to identify specific objectives, targets and instruments associated with the main theories.[4] The paper views the Crown balance sheet as a policy instrument and identifies seven potential objectives to which Crown financial policy could be targeted.

The objectives considered most important related to distortionary taxation, time-inconsistency of policy and agency cost of government. A fourth objective, called “downside efficiency risk”, relating to the need to avoid exacerbating existing inefficiencies or creating new ones, was also identified as relevant to the setting of policy targets. Section 2 provides a summary of these objectives and associated policy targets.

Purpose

The purpose of this paper is to fashion the above objectives into several alternative policies suitable for future quantitative analysis. In essence, the paper looks ahead to consider how policy makers would be likely to choose between alternative policy options and the requirements they would have. The aim is to provide direction to ensure Treasury’s future research is focussed on producing evidence relevant to policy decisions and avoid spending resources on comparing policies that actually would not be implemented.

The approach adopted in this paper draws from Coase’s comparative institutional method and Bayesian decision theory. The comparative institutional method emphasises that policy analysts should avoid comparing real world policy proposals (which necessarily are imperfect) against idealised textbook models. Rather, any policy proposal should be compared against the counterfactual of what would be most likely to happen in the absence of the proposed policy.

A critical fact is that the choice between policy options will be made in a world of uncertainty. Irrespective of how much research is undertaken, policy makers will be faced with considerable uncertainty about the true model of the economy and therefore the relative importance of distortionary taxation, time-inconsistency of policy and agency cost of government. Recognising these uncertainties, a detailed qualitative analysis of alternative policies is conducted based on Bayesian decision theory.

Structure

The structure of the paper is as follows. The next section (Section 2) provides brief descriptions of the main policy objectives identified in Hansen (2003) and the detailed policy targets implied by these objectives. Section 3 discusses the framework adopted in this paper based on comparative institutional and Bayesian decision theory. Section 4 applies the framework to select three high-level policies representing low, medium, and high risk. Section 5 specifies the three candidate policies in terms of the policy targets that would apply in each case. Conclusions are presented in Section 6.