The Debt Bogey Returns

Written By: - Date published: 9:00 am, May 28th, 2009 - 30 comments
Categories: budget 2009, economy - Tags:

Seems this op-ed was off-message for one of our larger media outlets, we’re happy to run it:


Alan Blinder, Professor of Public Affairs at Princeton recently warned Americans: ‘ Prematurely changing fiscal and monetary policies – from stepping hard on the accelerator to slamming on the brake – can be hazardous to the economy’s health’. He was talking about the US economy and urging the President to do two things. One is to resist the ‘deficit hawks’ agitating to lower US debt. The other is to learn the lessons of the 1936 depression when President Roosevelt , spooked by growing debt, chose to tighten spending. The faltering green-shoots of recovery immediately withered and died.

If Professor Blinder was a New Zealander, he might label Treasury as the deficit hawks to be resisted. He might also point to the 1991 budget as the history lesson from which we should learn.

The Treasury argues that we are at risk of a credit downgrade. To back this up they forecast debt to GDP ratio to 2023 of 75%. Forecasting over a 15 year period is so hairy that it would be dangerous to allow these numbers to influence policy especially in the midst of a recession that economists couldn’t even predict as recently as 2007.

Since the main role for Government debt is to smooth consumption over the business cycle, we would expect to see debt going up in bad times and coming down in good. This is the optimal debt management strategy. Therefore, the excessive focus on reducing deficit right now in order to control future Government debt is the worst possible timing.

Indeed, recent economic studies argue that the optimal quantity of debt might in fact be considerably higher than ours around two-thirds for the US economy. Therefore, rather than yielding to the deficit hawks, and undertaking dangerous fiscal tightening, the Minister ought to deliver an effective stimulus package directed at those sections of the economy that are most likely to respond with increased demand. While the current tax cuts were presented as a stimulus package, they went to high income earners who have a high propensity to save. There is little immediate ‘stimulus’ from such tax cuts. Instead a one-off payment to those who are suffering under the recession has the highest chance of being effective. This is the sort of package that Australia, US and Europe are undertaking.

One doesn’t have to be an economist to see that there is something fundamentally wrong with Government sacking employees during a recession. The PSA estimates that over 1,000 Public Service jobs were lost in the last six months. An environment of job insecurity has immediate detrimental effect on household spending. For every IRD employee who is made redundant, there are five or ten who fear redundancy and start cutting back spending. Given high household debt, such fears lead to a reduction in household spending which is far more pervasive than those directly affected by job losses. As we witnessed during the sub-prime meltdown, it is not the facts but the fears that drive markets. Businesses which rely on domestic household spending are suffering with record reduction in retail spending. Job insecurity harms these businesses.

Reading the 1990 pre-budget advise by Treasury, and the 2008 versions provide striking similarities. Both were written for a new National Government — the 1990 version was read by Ruth Richardson, the 2008 by Bill English. Both emphasise the high budget deficits being forecast, and urge the Government to respond to these deficits with spending restraints. Ruth Richardson, convinced that fiscal restraint was called for, produced the 1991 ‘Mother of all Budgets’. There followed the largest contraction in post-war New Zealand.

Treasury claims this is an important budget. In the midst of a recession Ministers and Treasury should be continually fine-tuning policy setting. Every morning, the Minister should be asking himself and his officials: is today the day for a mini-budget? Yearly budgets are crude tools for ‘ordinary times’. These are extra-ordinary times, where only continued vigilance, and real-time fiscal policy can have any hope of working.

Rhema Vaithianathan & Begoña Domínguez are both Senior Lecturers in Economics at the University of Auckland Business School

30 comments on “The Debt Bogey Returns”

  1. gingercrush 1

    Oh no wonder Labour is using Rhema for Super City costings they are obviously far-left. If someone really thinks New Zealand should have government debt in the region of what the US has. I really fear for that person. Sure that person must have a commerce degree. Almost likely they have post-graduate qualifications/ But really New Zealand should have debt similar in ratio to what the United States has? Somehow I find that really dumbfounded.

    • Zetetic 1.1

      They’re both PhDs.

      But please, continue to share your wealth of knowledge with us gingercrush. Maybe you could elaborate on optimal debt ratios in small export-driven economies?

      • gingercrush 1.1.1

        We need a sustainable debt track.
        Debt’s not a huge problem but the less the better. The simple way to do that is forget tax cuts. Ideally, undo the previous ones too. But I suspect Key wants to keep his hundred bucks a week. Introduce a capital gains tax. Screw the property traders (see them in the paper already trying to create the next bubble). Capital gains will stop overinvestment into housing as well as keep debt under control. Oh, and raise taxes for the richest few percent like they did in the UK.

        Were you lying when you wrote this yesterday?

    • IrishBill 1.2

      Again I have to question your perception of economic reality. The above strikes me as a (quite conservative) orthodox economic analysis. I hadn’t realised how fringe-right you were until now, GC.

      • gingercrush 1.2.1

        Really? So you’re quite happy for this government to rack up debt levels to a similar ratio to the United States. You don’t find that troubling? So on top of high personal debt which is itself a huge problem for New Zealand you’d also be quite happy for New Zealand’s debt levels to be that high? How is huge government debt and huge personal; debt good for any economy?

        And why exactly is questioning such high debt levels fringe-right? If that is fringe-right you’re so far to the left that its beyond a joke.

        • IrishBill

          The post doesn’t suggest raising our debt to GDP ratio to that of the US. The fact you have to pretend it does to justify your claim it is far left (which I assume would make the current US government far left?) only shows how fringe you are.

          I would also point out that it was your claim that this orthodox economic analysis was “far left” that prompted me to make the observation your economic spectrum is out of whack with the rest of the world. I see nothing in your non-rebuttal that would cause me or any other right-thinking person on the street to question the veracity of that observation.

  2. vto 2

    Why are debt levels going to soar here in NZ? Is i because the govt is going to keep spending at, plus or minus, current levels with money it doesn’t have and tells us it wont be able to repay until 2020 or some such? If so, then that is just dumb. If there is, by dint of this meltdown, less money in the world then the govt (like every person with feet on the planet) should spend less. If that means less services etc then that is an unfortunate reality. I don’t think anyone should realistically expect that NZ’s living standards should keep going up forever. Or even stay the same. That ignores history.

  3. Lew 3


    I don’t think anyone should realistically expect that NZ’s living standards should keep going up forever.

    Isn’t this perpetual state of growth the fundamental core of the ACT/National economic paradigm?


    • vto 3.1

      Well yes it seems to be Lew. Not just for act/nat but for labour also. And I don’t know why – probably because to express the contrary view would spell political death. That whole perpetual growth thing definitely has flaws – a bit like anything perpetual, it doesnt actually exist.

  4. How on earth are these debt forecasts calculated anyway? Is it expected that we’ll be in constant recession for the next 15-20 years and our tax take won’t increase?

    Surely not…. I would hope.

  5. Tom Semmens 5

    One thing about Treasury that has always been a mystery to me. Their forecasts, first of the surplus then of the deficit, have been wildly out. So wildly out as to make their predictions useless. Almost all their forcasting and economic advice is straight out of a Randian la la land and is underpinned by a now hopelessly discredited and out of date economic theory that almost everyone outside the US Republican party moved on from a decade or more ago. Their “advice” could be written up as a guest post on Kiwiblog by anyone of about ten of Farrar’s loons, all for free and in about fifteen minutes. The Treasury’s ideological rigidity (and economic irrelevance) in the face of the real world is astonishing given they ensure they are the only source of advice the government has on economic matters.

    Yet somehow they retain the most highly paid staff in the civil service (completely untouched by any hint of job cutting) and somehow they move on from the Treasury with their teflon reputations intact to become hired guns like Graham Scott at thousands of dollars cost to the taxpayer. High priests of the market sucking the public tit as they preach “do as we say, not as we do.”

    I can only suppose they survive in the same way pedophile priests survive – ideological bedfellows will always look after their own, regardless of their real world sins.

  6. Dr Begoña Domínguez 6

    Neither Rhema or I suggest that NZ’s government debt should jump up to the level of the US debt. What we say is that Treasury’s worries over NZ’s debt level are unfounded and come at the worst possible time. Well-established economic theory arguments say that debt should be used to smooth consumption over the cycle, it should increase now when we are at the bottom of the cycle. It should go down later when we are at the top of the cycle. Moreover, NZ’s level of debt is very low compared internationally.
    I suggest you read Aiyagari, S. R & E.R. McGrattan, 1998 ?The Optimum Quantity of Debt? Journal of Monetary Economics. 447-469 where they suggest that the optimal debt for the US is two-thirds. This is not fringe economics. The Journal of Monetary Economics is the top journal in Macro. These are top people in their field.
    Personally, I fear more people who do not take the time or have the ability to read an article carefully and moreover do not hesitate to use their unfounded opinions to insult the writers of the article.

    • IrishBill 6.1

      Fringe right wing troll owned by Dr of Economics. Biggest slap-down I’ve seen on a blog for a while.

    • gingercrush 6.2

      So you think Treasury’s concerns about government debt levels are unfounded? This despite a credit credit agency in Standard & Poor telling us that our government debt levels are a concern and that we risk a downgrade if our debt isn’t sorted out. What are the consequences of a downgrade by Standard and Poor? You of course know the consequences and are choosing to ignore them. In a time when businesses are struggling. In a time when individuals are struggling. Don’t you think interest rate hikes are the last things they need? If our economy is struggling why would you want to see it harder for business, banks, the government and individuals to borrow money? Interest rates would of course go up if our credit rating went down. This would be problematic for the economy and have real effects.

      It is of course not just Treasury saying there is a risk of a downgrade. S&P themselves are saying there is a risk of a downgrade. Do you think we should not be taking this seriously and thus should simply spend money? Have those stimulus packages the United States and others have done saw their economies recover again? How is their unemployment tracking? Are their economics still contracting? What about Europe and the stimuls packages they’re doing. Are they still not contracting? What about Japan. It has done several stimulus packages over several years and they have been shown not to work. After all, they had their worse contraction for their economy just recently. This despite them spending billions towards providing stimulus for their economy.

      Of course countries need some economic stimulus. No one actually doubts that. But the levels of spending other countries are doing for their economies haven’t exactly worked. They’re just increasing debts above levels that are sustainable. Without any real evidence that stimulus is working. You can’t really believe debt doesn’t matter. You can’t even abscribe how much debt New Zealand can have which is optimal.

      Bah an earlier post ot trying to rebut this and rather better than this rebuttal was wiped somehow. Not that I suggest either are any good.

      • Zaphod Beeblebrox 6.2.1

        Dr GC How can you definitively say they haven’t worked? There’s no way you can say what would have happened otherwise. Most of the US stimulus package hasn’t even been given over yet and you’re already proclaimimg it a failure.
        It will be a long time before we will be able to look at the effects of this recession, I guess the actions of governments in future will be measured by how well they looked after their citizens, how well they limited social unrest (crime, family breakdowns, suicides etc..) and how well they adapted to what is needed for the future

    • burt 6.3


      Not sure it was a slap-down, certainly a reiteration of the general Keynesian principle of govt working counter the business cycle.

      The issue that wasn’t addressed IMHO is that the adherence to that general principle seems to do little to manage the cycle.

      Grown and productivity have been the victims of the Labour govt simplistic ‘pay off debt’ approach. What could we change to change the cycle from one of simply repeating the same BS over and over again ?

  7. Tom Semmens 7

    Dr. Dominguez – if you have a moment, could you comment on the quality of advice given by Treasurry? is it normal, for example, for a government in a liberal democracy to have only one source of economic advice? And is it normal in the early 21st century for that government to have its sole source of advice so completely captured by such rigid economic orthodoxy as comes from our Treasury?

    I am curious to know if we are stuck with something unusual or if it is a standard phenomena across the OECD.

  8. Dr Begoña Domínguez 8

    Tom Semmens, I am concerned about the quality of the advice given by Treasury in this instance. I am worried about the lack of economic arguments behind their advice. I am also concerned about the quality of their forecasts and I doubt there is a sound economic model behind.
    My experience in Europe tells me this is not a standard phenomena. In the last decade, governments are relying more and more on independent advisory groups formed by top professionals of different fields. I know many of the Economists who are working for the Economic Bureau of the Prime Minister of Spain and they are top Economists in the world. I believe this practise is improving greatly the quality of policy making in Europe and it would be great to see the same movement in NZ.

  9. burt 9

    ” Prematurely changing fiscal and monetary policies – from stepping hard on the accelerator to slamming on the brake – can be hazardous to the economy’s health’

    Yes exactly. Look at the mess that was created with the labour party had their famous David Lange tea break during the reforms of the 80’s. Labour got too scared of loosing an election and pulled on the reform handbrake.

    So, we re-tried the monopoly state provider model one more time and it failed again like it has every time. Today we get to see if National has the balls to chuck out some of Labour’s policies designed to entrench welfare dependency in the middle class.

    • Draco T Bastard 9.1

      Well, when the businesses start paying cost price or better to maintain societal living standards then we can get rid of the governments subsidy of business commonly referred to as Working for Families.

      Dependence is guaranteed – it cannot be got rid of. We usually refer to it as interdependence though. What you refer to as welfare dependence is society being interdependent upon itself rather than the alternative, which you seem to support, where everyone is truly and fully dependent upon the rich. Such a dependence really will bring about another revolution as almost everybodies living standard takes a dive.

  10. Tom Semmens 10

    Dr. Dominguez – very interesting, thank you. I note that John Key has got himself an ” independent scientific advisor” (Professor Peter Gluckman), but I would be concerned if the government turned increasingly to third parties to provide it with advice. It seems just another step along the road of either sidelining or politicising the public service. After all, outsourcing simply moves accountability for the advice given out of the public service and into the private or public-private sector and eventually you’ll just end up with an unsatifactory situation such as exists in the United States, where the battleground has shifted from an open, accountable public service to highly politicised appointments of unaccountable people to key advisory positions.

    I think I would prefer the government to set up other centres of economic policy advice within the civil service. Before the Rogernomics revolution, such an alternative body existed in (of all places) the Ministry Of Works. tellingly, when Rogernomics revolution began the MoW policy advice unit was amongst the very first targets of the Treasury ideologues.

    Treasury believes in the free market – but cannot tolerate any competition to itself in the marketplace of ideas. Given how much Treasury hates such independent policy units, it may be a good idea to start lobbying to have such a unit set up outside Treasury.

  11. Deepred 11

    For the record, Standard & Poors are under investigation by the US Securities & Exchange Commission for various reasons, including the Subprime Chernobyl:

    S&P also got its predictions horribly wrong with the Icelandic meltdown, and apparently it was also in denial about it.

  12. StephenR 12

    In the last decade, governments are relying more and more on independent advisory groups formed by top professionals of different fields

    This has been the case for a few decades in the US too, except they’re called thinktanks. Allows a government to choose which type of independent advice they’d like to receive too, wink wink.

  13. Rhema Vaithianathan 13

    A couple of points. Yes, fiscal policy will affect interest rates. That’s why there is monetary policy – to ensure that the interest rate effects of fiscal policy are mitigated. So, any change in fiscal position requires re-setting of monetary policy. This is always the case – and this is the challenge of optimal monetary and fiscal policies. Looking purely at the first round effects on interest rates (as I have heard the Prime Minister do) without subsequent effect on OCR is misleading.

    Any trader worth their salt doesn’t need to look at S & P, but at the fundamentals. These are what drive the cost of borrowing. It is a live debate in economics as to whether credit downgrades per se have a big impact on the economy – as opposed to those events which lead to the downgrade.

    The Irish experience being used to estimate the cost of credit is misguided. There are so many differences – including the presence of toxic debt in their system, and the need for large bailouts which sees their debt rising to 100% of GDP. Even in the absence of a downgrade, we would have expected their country-specific risk (i.e. the premium required to lend to Ireland) increase.

  14. r0b 14

    It’s great to see academics contributing posts and joining in the discussion here. As the academic role includes “critic and conscience” of society, I would have expected to be seeing more of this by now.

    So here’s a call to academics, this is a “new” medium for disseminating and discussing ideas – get in to it!

  15. burt 15

    I think RedLogix made a excellent summary of the debt situation here.

    National has blown it

    Anymore debt and our credit rating gets hammered, and cost across the board rise. Gets worse than that and no-one will lend to us at any price.

    Not too many commentators have realised the significance of the $50 billion dollar ‘hole in govt accounts over three years’ announcement this week……

    There will be no ‘stimulus’ here in NZ . English has no choice but to cut expenditure and massively.

  16. The first step when faced with debts you cannot repay is to face up to the fact that you need help and do not bury your head in the sand. The next is to work out what you have coming into the home and going out. See where you can make savings which would allow you money towards paying off your debts. Following this you need to get help and advice and answers to your debt management questions.

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