Friday, 18 September 2020

The most important bit

Every year we get Treasury's economic and fiscal updates - the latest, the Pre-Election Economic and Fiscal Update or PREFU on Wednesday - and every year the analysts and the pundits get stuck into the size and pattern of government spending and taxation, the size and trend of the fiscal surplus or deficit, and the size and trend of government debt. All worthy topics, to be sure. 

Yet every year one of the most important aspects of the update struggles to get a proper look in. It should be right up there with the politicised argy-bargy over whose plan for debt is better than whose. This year it's arguably the single most important aspect of the update.

It's whether fiscal policy is boosting or braking the economy. That's important anytime, but doubly important now: once because of fighting the impact of covid, obvs, but also because the other big policy tool for managing the economic cycle, monetary policy, has mostly shot its bolt, so perforce most of the the heavy stabilisation lifting from here will need to be done by Grant Robertson rather than by Adrian Orr.

Here's what the expected impact of fiscal policy is looking like. All these kinds of fiscal impact calculations are by guess and by God, but they're all we have and despite their inherent measurement challenges they're probably in the right general area. I've included the likely impact as shown in the PREFU and the shape that had been expected back in the May Budget.

First of all fiscal policy is strongly expansionary over the next two years, as it should be. And the shape is looking more realistic and more appropriate in the PREFU than it looked back in May at Budget time. I wasn't sure that the government machine was capable of delivering that big a boost in 2019-20 in that short a time (unless it was very heavily weighted to get-it-into-people's-bank-accounts-quickly initiatives like wage subsidies). And it's become apparent that fiscal support will need to be kept going for longer than previously thought, so healthy fiscal stimulus in both 2019-20 and 2020-21 rather than one big hit in 2019-20 is looking a better plan.

The odd thing, though, is the planned and quite large (3.7% of GDP) contractionary impact from fiscal policy in 2021-22. Sure, at some point a Minister of Finance has to tack back on the other course, either (in the short term) because the economy is now strong enough not to need further fiscal stimulus or (in the longer term) because deficits and debt will need some repair work. But 2021-22 is not that point. On Treasury's forecasts the unemployment rate will still be 7.6% in June 2022, still unacceptably high and in no way the appropriate time to slam on the fiscal brakes. 

Another way of getting to the same point is to look at the 'output gap', which is how far the economy is below full employment of its resources. Here's the PREFU estimate (which I backed out of the data supporting Figure 1.6 in the PREFU). An economy still substantially (4.0%) below full potential in mid June 2022 is an economy that is not ready for fiscal retrenchment.

What I drew from the PREFU is that fiscal policy is at the moment appropriately supportive, but also that - barring a miraculously early development and deployment of a covid vaccine - there is a degree of unreality about how quickly the current levels of stimulus can safely be withdrawn.

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