1 Introduction
A common and useful analytical tool for fiscal policy is the structural budget balance, which is an attempt to distinguish between the cyclical and structural components of the government's revenue and expenses. To illustrate, in 2009, New Zealand had a fiscal deficit for the first time in 15 years. Some of the deficit will be attributable to the automatic stabilisers which operate in response to an economic downturn. This cyclical component of the deficit can be expected to automatically unwind as the economy recovers to its potential. However, if a deficit position would exist even if the economy was operating at its potential, then there is a structural element.
In policy terms, the cyclical and structural components of the budget balance correspond to the automatic stabilisers and discretionary policy respectively. Estimating the magnitude of the structural component of a fiscal deficit tells policy makers how much active fiscal adjustment is required to restore the budget to balance. In good times, judgement about how much revenue is cyclical, and how much is structural, is critical to policy formation if fiscal policy is to avoid costly mistakes. Also, the change in the structural budget balance is indicative of whether discretionary fiscal policy is adding stimulus or withdrawing demand in the economy.
It is common practice internationally to estimate a cyclically-adjusted balance (CAB), which is the budget balance adjusted for the business cycle. The New Zealand Treasury has published estimates of the CAB since the 1980s. More recently, overseas experience suggests that other non-structural, or windfall, elements to the budget balance should be analysed. These include the terms of trade, asset prices and unbalanced growth.
This paper looks at the Treasury's current indicator with the aim of achieving four objectives. First, the methodology is reviewed in light of lessons drawn from experience and international practice. Second, an assessment is made of further adjustments that could be made for other non-structural elements. This leads to the notion of a structural budget balance (SBB) which is the budget balance adjusted for both business cycle and other temporary effects. Third, uncertainty is explored through the use of sensitivity analysis and confidence intervals. Lastly, new results are presented of New Zealand's structural fiscal position over history.
