Robert MacCulloch
Robert MacCulloch is a native of New Zealand ad worked at the Reserve Bank of NZ, before he travelled to the UK to complete a PhD in Economics at Oxford University.
This week at a select committee hearing, the finance minister was asked whether she knew of any evidence that fiscal consolidations could expand an economy. Willis couldn't answer. I’m not sure why a blog has to do the work of her many advisers and several hundred folks in the NZ Treasury, but what the heck, here goes.
She may not be doing flat out austerity-style government spending cuts, but Willis is firing civil servants and touting herself as the minister of fiscal restraint, determined to balance the budget. A bunch of leftist NZ economists (including the chancellor of AUT and recently made redundant former chair of Productivity Commission) have written the FM and PM a letter arguing the coalition should borrow and spend to get the economy moving. Why leftist? First, lets define what GDP is made up of:
GDP = consumption C, + investment I, + government spending G, + exports X - imports M.
If governments borrow and spend, they can increase the component G of GDP, but it often will only be a temporary boost. Another strategy is to cut, or at least constrain, government spending and reduce red-tape, to the extent that the private sector view the country as a great place to do business. Although G may fall, the rise in investment I and consumption C can more than offset it, leading to a rise in GDP. In economics language, its called an “expansionary fiscal contraction”. That’s what the PM and finance minister should be going for in NZ.
A classic example was Ireland in the 1980s. The idea that fiscal contractions can stimulate economic growth, via confidence effects and establishment of a credible framework for fiscal stability, is contrary to Keynesian wisdom. It’s that Keynesian wisdom to which the letter-signing economists were trying to appeal. The Bank of England’s chief economist, Huw Pill, who I used to see when in the US, wrote a Harvard Business School case study called, “Fiscal Policy and the Case of Expansionary Fiscal Contraction in Ireland in the 1980s”. Another phrase sometimes used to describe this phenomenon is “expansionary austerity”.
My opinion as to why our economy is floundering is that investors don’t see the finance minister’s claims that she’s reining in the size of government G as credible, and so C and I aren’t booming and the overall economy remains stagnant. An expansionary fiscal contraction is not happening. Her conservative Bill English style isn’t working. People still see large future public outgoings for ferries, Wellington tunnels, healthcare, infrastructure and pensions everywhere they look, amongst others, without a credible prospect of future lower taxes. And the mainstream media, in cahoots with Labour, are touting the prospect of higher taxes – capital gains and wealth – in a few years time to pay for it all should Labour win.
Hence Huw Pill’s ‘confidence’ effects that NZ will be a lower taxed, smaller government, less red-tape nation in the future lack credibility due to the steady-as-she-goes, tentative nature of our finance minister. Willis stated defensively her own civil service cuts are not as big as the media pretends, but that contradicts the expansionary fiscal contraction strategy she should be pursuing. She also says she’s not pursuing ‘austerity’ and kept repeating this week she’s not ‘chasing a surplus’. So what is she? A Keynesian? Maybe she should’ve signed the economists letter herself. Unlike Thatcher, this lady does seem ‘for turning’. As such, the reason for NZ’s stagnation has become clear.
The sooner PM Luxon and Finance Minister Willis defriend John Key, Bill English, Paula Bennett, Murray McCully, Steven Joyce and washed-up former Nats, including Peter Goodfellow, still vying for influence, the better.
Source:
https://www.hbs.edu/faculty/Pages/item.aspx?num=31801
This article was originally published by Down to Earth Kiwi.
