6 Conclusions
This paper has discussed how fiscal policy can support long-run growth through sustainability and structure and how it can best contribute to macroeconomic stability. An aim of the paper is to understand the institutional structures which are likely to result in good decision-making in terms of each of these lenses.
Sustainable public finances are important to ensure that the cost of financing government expenditure is minimised and to ensure that the financing of government expenditure does not impose large costs on the private sector through impacts on interest rates, exchange rates and inflation. Political economy issues, such as the incentive of politicians to shift costs into the future, mean that sustainable fiscal policy will most likely be achieved through the use of fiscal rules and formal institutions. The New Zealand framework is based on a set of legislated principles and transparency requirements. Within this framework government specifies its objectives for fiscal aggregates over a 10-year horizon.
This framework has been successful in delivering sustainable fiscal outcomes, at least over a medium term time-frame. As evidence of this, New Zealand is one of the few countries in the world in a net public financial asset position. Further, New Zealand has been in a position where operating surpluses in the current period can be used to pre-fund some of the future expected costs associated with population ageing. However, despite this level of pre-funding, projections over a 40-year horizon show that a continuation of current policy settings or expenditure growth rates would result in a deterioration of the fiscal position over the longer term. How much weight current policy decisions should place on these long-term projections is unclear and at present there does not appear to be a clear basis for making this type of assessment.
Fiscal structure refers to the composition of government expenditure and taxation. The development of endogenous growth models has identified several fiscal policy instruments that have the potential to influence long-run growth. There is also a widely respected view that a low-rate broad-based tax system supports long-run growth, although as noted there may be times when departures from this principle can be justified. Information constraints, particularly in relation to the net benefits of government expenditure initiatives, mean government faces significant challenges in exploiting the insights of endogenous growth models and in evaluating the full cost of policy initiatives, particularly the cost of financing. This implies that the institutional framework for fiscal policy decisions is important.
New Zealand has sought to overcome some of the information challenges through the devolution of decision making on expenditure to those with the most information, within a framework that specifies the objectives of policy and provides for accountability and monitoring. However, challenges remain in ensuring that government expenditure is subject to scrutiny on a sound value-for-money basis and in achieving an efficient tax structure. Two institutional solutions to this which have been discussed are the creation of rules specifying incentives to find low priority expenditure and the imposition of tight top-down revenue or spending constraints to force prioritisation.
The role of fiscal policy in macroeconomic stability is less clear than for sustainability or structure. The time-inconsistency problem implies that allocating the role of macroeconomic stability to political actors is not credible, and hence will not result in stable outcomes. For this reason, the Reserve Bank has been assigned the role of maintaining price stability within an institutional framework that is intended to ensure monetary policy is time-consistent.
The question therefore arises as to the appropriate role of the fiscal authority within an inflation-targeting regime. One view is that because, under normal circumstances, the Reserve Bank can be expected to maintain inflation and output at equilibrium levels, fiscal policy should have no regard to its impact on stability. However, the counter argument is that fiscal policy still needs to take account of the costs imposed on the private sector arising from the effects of large changes in fiscal policy, undertaken for sustainability or structural reasons, on interest rates, the real exchange rate and output volatility. Fiscal policy should take account of whether, for example, large discretionary changes are likely to result in significant crowding out of the private sector. This may, however, result in some tension between short-term impacts and long-term objectives. Somewhat more controversial is the debate about a more active stabilisation role for fiscal policy. In principle, the instruments exist. But the lesson of the past is that appropriate fiscal institutions need to be in place to ensure time-consistent policy. The types of institutions proposed range from independent fiscal authorities with considerable discretion, to fiscal councils with a more advisory role.
The framework for evaluating the roles of fiscal policy proposed in this paper therefore throws up a number of questions that warrant more extensive treatment, questions such as: What is the appropriate time horizon over which to assess fiscal sustainability? Could fiscal rules or other institutional rules improve fiscal structure? Are structural policies exacerbating the macroeconomic stability objective? Are there institutional solutions that would limit political discretion and would allow fiscal policy to play a more effective stabilisation role? How much weight should be put on short-term macroeconomic impacts when government wants to progress policies which are intended to support long-run growth? Precise answers to these questions may be elusive, but posing these questions should help direct priorities for future work on fiscal policy and for improving the design of the fiscal framework.
