Monday, 28 Jun 2021
View point: 
Personal (opinion)

Staff and teams are writing in their individual capacity and the views are not necessarily a "Treasury" view. Please read our disclaimer.

In a low interest rate environment, central banks are often constrained by the Zero Lower Bound so fiscal policy has become more important, and since the global financial crisis, the effects of fiscal policy shocks have attracted much attention. In particular, policy makers are keen to know the effects of government investment, which is usually a key component of fiscal stimulus packages. Unfortunately, there are few studies on the effects of government spending in New Zealand, with the majority not differentiating between government consumption and government investment. Because different components of government spending may have distinct effects, using aggregate spending multipliers to inform policy making may be misleading. The Treasury has produced a Working Paper The Macroeconomic Effects of Government Spending Shocks in New Zealand (WP 21/02) which estimates separately the macroeconomic effects of government consumption shocks and government investment shocks in New Zealand.

Most estimates of government spending multipliers from developed countries are smaller than 1, suggesting that government purchases crowd out private demand. On the one hand, as a small open economy with a flexible exchange rate regime, New Zealand is expected to have small multipliers. On the other hand, New Zealand has a low public debt level, a high foreign share in public debt, and a highly indebted household sector, all of which may lead to large multipliers. As a result, the size of government spending multipliers in New Zealand remains an empirical question.

Using a structural Vector Autoregressive (VAR) model, the author calculates cumulative government spending multipliers, defined as the cumulative change in output divided by the cumulative change in government consumption or investment, for different time horizons. The author finds that the government consumption multiplier is only 0.4 at the 1-year horizon, then decreases over time and turns negative after three years. The government investment multiplier is around 1.4 at the 1-year horizon and remains above 2 in the following years. Importantly, the real exchange rate appreciates after positive government spending shocks, consistent with classic theory. The results are largely driven by the dynamic responses of the private sector: private consumption and investment decline after an increase in government consumption, but rise after an increase in government investment. The main possible reason for this is that government investment raises overall economic productivity.

A contribution of this paper is that the author highlights the importance of selecting the appropriate series for government investment when estimating its impact. The author argues that a commonly used interpolated series for government investment is problematic, and it explains why other related literature obtains negative government investment multipliers in New Zealand.

A policy implication of the paper’s findings is that government investment is a powerful stimulus tool in New Zealand. However, this result should be interpreted with caution. Firstly, there are usually significantly delays inherent in infrastructure projects. In particular, there are delays between appropriations and actual outlays, and it takes time for infrastructure projects to be completed and ready for use. Because the author’s model does not consider the implementation delays, it may overestimate the stimulating effect of government investment short-term. Secondly, the author’s model estimates the average effect of government investment since the 1990s, but the current effect may depend on specific economic circumstances, including the infrastructure investment gap. If New Zealand is facing a big infrastructure investment gap, then government investment may be more beneficial in the long run.

There are two issues which the Working Paper does not cover. The author shows that the shocks identified in the paper are likely to be unanticipated; however, due to the nature of the fiscal policy making process, anticipated shocks are probably more intriguing. Also, the author does not consider the implementation delays inherent in infrastructure projects, so the author’s result tends to overestimate the short-run effect of government investment. Both issues may make for valuable future research.