6  Future work

The New Zealand fiscal management framework is set out in the Public Finance Act 1989. The importance of a predictable and sustainable fiscal strategy is already recognised in five principles for prudent fiscal management[16]. The government is required to state whether its fiscal strategy is consistent with these principles:

• reducing total debt to prudent levels to provide a buffer;
• once debt is at prudent levels ensuring that, on average, total operating expenses do not exceed total operating revenues;
• achieving and maintaining levels of total net worth that provide a buffer against factors that may impact adversely on total net worth in the future;
• managing prudently the fiscal risks facing the government; and
• pursuing policies that are consistent with a reasonable degree of predictability about the level and stability of tax rates for future years.

There are significant difficulties in determining what constitutes a ‘prudent buffer' when underlying factors giving rise to risk are without historic precedent. Nobody knows when New Zealand's imbalances will unwind, whether the process will be disorderly, or how large the cost could be.

Scenario-based analysis forms a useful input into precautionary fiscal decisions. As a first step, this paper has focussed on the effectiveness of low debt as a potential buffer against large unforeseen shocks (bullet point one). However, rebuilding a buffer will take time, so an obvious immediate use for this work would be to apply our understanding of downside risk to analysis looking at the appropriate level for long-term budget targets.

The work in this paper could also be extended in three other ways. Firstly, work could be extended to take into account the maturity profile of the government's existing debt portfolio. Liquidity risk relates to the amount of debt issuance at a point in time, which includes funding requirements at a given point in time plus repaying pre-existing debt as it matures. To date, this scenario analysis has only focused on the net increase in debt[17].

Secondly, analysis could be extended to cover assets, especially liquid sources of cash (bullet point three). Liquid assets can reduce liquidity risk over the very short term. Longer-term less liquid assets can also be sold to pay down debt. Our focus on gross sovereign-issued debt provides a useful source of international comparability. However, once a risk scale based on international comparability has been derived, analysis could be expanded to include liquid assets. This analysis could provide an indication of how long the government could self-fund should markets temporarily be closed. The role of foreign currency assets is especially important.

Finally, the concept of liquidity risk could be applied to other government policy. The concept of liquidity risk is a useful input into other advice on our broad fiscal policy settings and the many micro-focussed interventions that may be used in a crisis situation.