7 Conclusions
New Zealand has come through the worst global financial crisis since World War II relatively well. This illustrates that there are a lot of positives standing in the country's favour. Notably, New Zealand has low government debt, a relatively strong financial sector, and macro institutions, such as a floating exchange rate, that provide flexibility in a crisis situation.
Despite this, New Zealand, as an indebted country, potentially remains exposed to sovereign liquidity pressures. Namely, a reliance on a continued inflow of capital leaves us exposed to significant changes in investor sentiment. Liquidity crises are notoriously difficult to predict as they are, to a large measure, psychological phenomena. Predicting a trigger point is difficult, although, through comparative analysis of historic consolidations, a rough risk scale can be derived. The new modelling techniques used in this paper suggest that, all being equal, a significant natural disaster or cyclical tax volatility similar to the levels seen over the past 16 years are unlikely to be large enough (in their own right) to trigger a crisis, although some government action may be required to maintain confidence. A more prolonged or persistent growth shock would carry higher liquidity risk. However, regardless of whether a crisis eventuates, other detrimental effects, such as higher borrowing costs or a credit rating downgrade, could still impact on the fiscal position.
The scenarios in this paper are purely hypothetical. While we use an earthquake in Wellington as indicative shock, no attempt has been made to take into account lessons following the tragic 22 February earthquake in Canterbury. With respect to rebalancing, we avoid identifying any triggering event. In this regard, we use new modelling to highlight the preconditions for a sovereign crisis. Firstly, a surprise decline in growth would have to reduce government revenue. Secondly, market participants would need to believe that this loss was permanent. Finally, the decline would need to have been of sufficient size that the adjustment necessary to close the government’s structural deficit is deemed difficult or improbable.
A key lesson from this paper is that a stronger Crown balance sheet provides a buffer allowing the government more room to act in a crisis. However, in a more significant crisis the adjustment could still fall heavily on taxpayers through fairly rapid changes to tax or government spending.
