Seems this op-ed was off-message for one of our larger media outlets, we’re happy to run it:
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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 DomÃnguez are both Senior Lecturers in Economics at the University of Auckland Business School
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