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Executive Summary
- This paper investigates the macroeconomic effects of fiscal policy in New Zealand for the period 1983:1-2010:2.
- The analysis extends the previous modelling work at the Treasury by allowing for the possibility that taxes, spending and interest rates might respond to the level of debt over time. The model included the government’s long-term interest rate, which is also likely to be an important variable in the wider economy linked to the cost of capital of firms and the borrowing rate for households.
- The results show that the fiscal multipliers from changes in government spending in New Zealand appear to be positive but small in the short-run, at the cost of higher interest rates and lower output in the medium to long-run. The impact multiplier is estimated to be about 0.26 which implies that a 1 percent of GDP change to government expenditure increases GDP by 0.26 percent.
- The sign of the short-run effects of tax changes is less clear cut but the results suggest that an unexpected one dollar increase in taxes would lower GDP on impact by 23 cents and have a similarly negative medium-term impact on GDP.
- The results show that a fiscal expansion leads to a statistically significant increase in the long-term interest rate which results in crowding-out of activity in the medium and long-term. The corresponding effect on inflation is modest which implicitly implies that monetary policy moderates the inflationary effects.
- The analysis of past fiscal policy through the model suggests that discretionary fiscal policy has had a generally pro-cyclical impact on GDP over 1998 to 2010, and a material impact on long-term interest rates.
- The approach adopted here only portrays average estimates of fiscal multipliers across the sample time period. Future work would extend this framework to a time-varying setting in order to investigate possible changes to the effectiveness of fiscal policy over time.
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