Where is fiscal policy going?

Last week's Half Year Economic and Fiscal Update, the HYEFU, got the usual coverage: the headline deficit, the debt profile, Treasury's latest economic outlook. All fine and well, and important issues in their own right, but equally as usual the coverage came and went with little or no mention of whether fiscal policy is boosting or braking the economy or by how much. 

That's pretty important in its own right too - people want to know whether a government is using fiscal policy to help in bad times, and especially through really rough times like the GFC, the Canterbury earthquakes and now Covid - but for some reason it never gets the air time it deserves. It's not helped by the jargon around measuring the stance of fiscal policy which only Treasury analysts and (cough) fiscal geeks could love.

So in my regular attempt to fill in the gap, here is the winner, by a wide margin, of the Most Important But Most Neglected Graph in a Treasury Publication award, from p8 of the HYEFU.

Stepping through this, the black line is the government's fiscal balance after you take out the effects of the state of the economy (that's the 'cyclically adjusted' reference) and after you take out things like interest payments which don't affect whether the government is boosting or braking economic activity (that's the 'primary' reference). What you're left with in principle is discretionary changes in fiscal policy settings.

Treasury says that "The continuation of supportive fiscal policy across the forecast period is shown by the large cyclically-adjusted primary balance deficit" (let's call it the CAPB). And that's true: anytime the government is adding to aggregate demand (with its expenditure) more than it is removing it (through taxes), it is being supportive. 

But there's more supportive and less supportive, and that's shown by the blue bars, which show the 'fiscal impulse', which is just the difference between one year's CAPB and the previous year's. As an example, in the year to June 2019, government policy was mildly a brake, to the tune of a CAPB surplus of 0.5% of GDP. In the 2020 June year, it had become a strong boost, with a CAPB deficit of 4.3% of GDP. That makes for a 4.8% of GDP 'fiscal impulse' turnaround from one year to the next. In the June 2021 year policy becomes more expansionary again (the CAPB deficit gets bigger / there's a positive fiscal impulse, same diff). All as it should have been through Covid, and many other governments did much the same (here's my comparison of our stance and Australia's).

Things are forecast to get trickier in the June 2022 year and beyond. Fiscal policy remains supportive throughout: there are ongoing CAPB deficits, but they get smaller as (for example) emergency Covid schemes are wound down. Fiscal policy is still expansionary, but progressively less so.. An analogy would be the Reserve Bank raising interest rates, but still leaving them at pretty low levels.

How quickly to cut back support, and by how much, is one tough policy call to make for government and its Treasury advisers. Here is what the fiscal policy outlook looked like in the past three Economic and Fiscal Updates.

It's shifted around quite a lot. Treasury says (p8 again) that "the fiscal impulse is lower in 2020/21, but less negative in 2021/22 and 2022/23. This is predominantly driven by some COVID-19-related expenditure previously expected in 2020/21 now taking place in later years across the forecast period". The latest profile also reflects, I'd guess, the Covid hit being not quite as bad as first feared, and the initial bounceback bigger and earlier than expected. 

Overall, the forecast fiscal stance looks pretty reasonable: there's still a hole in the economy where the international tourism and education sectors were, so ongoing fiscal support makes sense while that hole needs filling in, but winding it back also makes sense as the rest of the economy recovers. And if we're fully back to normal (2023 onwards?) you (a) don't want to risk being procyclical with needlessly supportive fiscal policy in good times and (b) it'll be time to start thinking more about debt sustainability.

The lag in planned expenditure that Treasury mentioned doesn't wholly surprise me. It's true that fiscal policy through Covid showed that it can be remarkably agile when it wants to be: apply for a wage subsidy on a Monday and have it in your bank account on a Tuesday was a remarkably fast policy decision and rollout. It gives the lie to older thinking that fiscal policy would always be too slow to matter, and the big countercyclical lever would have to be monetary policy (ignoring the fact that monetary policy itself has long and variable lags). All that said, I suspect that there was also a chunk of projects that proved to be shovel unready, as it were, and it's a further little glimpse of the planning, policy, and implementation sluggishness that's left us with our perpetual infrastructure deficit.

It can work after all

At our usual blistering pace - the Fair Trading Amendment Bill was introduced in Parliament 11 months ago, and is still with its Select Committee (Economic Development, Science and Innovation) - we are getting closer to prohibiting 'unconscionable conduct'. 

'Unconscionable'? It's not a term defined in the Bill, though the proposed new Section 8 of the Fair Trading Act lists a set of factors intended to help courts recognise it when they see it. And it's not a term you see much used in everyday speech, either. But if you substituted 'disgustingly ratbag', you'd be pretty much there. 

It seems a bit odd that our existing legislation has a hole in it this big, but never mind, we're filling it in. While you can always argue about potential over-reach or under-reach, and the similar issues that crop up with the design of any legislation, the general thrust of the Bill ought to be welcome to everyone: to consumers, obviously, to economists, who recognise that markets if they're going to weave their magic need to work without oppression or deceit, and of course to the vast majority of businesses who operate decently.

The trouble has been, though, that the Aussies, who legislated for this back in 2010, came a cropper when one of their regulators tried to ping what they saw as an obvious candidate: in the Kobelt case, the Aussie High Court disagreed. That case had been brought by ASIC, the Aussie financial regulator, but the ACCC, who you'd imagine would normally be running the bulk of these unconscionability cases, was seriously rattled by the ASIC case falling over. I listened to ACCC Commissioner Sarah Court talk with some degree of passion about it at the RBB Economics conference last year and again at this year's CLPINZ conference. 

You can see why the Aussies were beginning to wonder if they needed something other than full 'unconscionability' - maybe some kind of 'unfair' provision - to catch stuff that looked pretty bad but didn't quite reach the statutory unconscionability threshold. And we might have to confront the same issue, given that our proposed legislation looks a lot like theirs.

But fear not. The good news, just this week, is that that the ACCC has scored a thumping great unconscionability win, and it looks as if the law might bite after all. This time, it was about the gross mis-selling by Telstra of mobile phone contracts to certain indigenous customers. The ACCC's statement is here, and there's a good piece in the Australian Financial Review (if you've got a sub) here.

Interestingly, despite admission of liability, apologies, and extensive remediation on Telstra's part, the agreed penalty which will be put to the courts by  the ACCC and Telstra for approval is a stonking A$50 million, which (I learn from the AFR article) would be the second largest consumer law fine in Australia, second only to the A$125 million imposed on Volkswagen for the "dieselgate" faking of emission tests (Volkswagen is apparently appealing, after a judge had upped the initial proposed penalty from A$75 million).

Hopefully our unconscionability provision, when it finally emerges blinking in the sunlight, won't be called on often. But it's good to know that it can be made to sheet home to the worst of the rogues and the bullies. To be honest, if I was asked which would I rather see criminalised first, cartel behaviour or odious pressure selling, I'd have to sit down and have a good think, and the answer mightn't be cartels.

The Bank's other stuff

Yesterday's Monetary Policy Statement went entirely as expected - no change to the Official Cash Rate (still 0.25%), no change to the Large Scale Asset Purchasing Programme (still capped at $100 billion), and the introduction of the signalled Funding for Lending Programme, intended to provide a new source of cheap funding to lenders (three year funding at the OCR rate). 

If used fully, the new FLP would amount to $28 billion. In Australia, the equivalent Term Funding Facility, which has been going since April, has a capacity of some A$200 billion, or about NZ$212 billion. Divide by 7 as a rough pro rata rule of thumb and the Aussie TFF would be a NZ$30 billion or so programme here, so the good news is that we've introduced a similar-sized stimulus.

There is a line of thinking that providing extra funding for lending might be the proverbial 'pushing on a string' if, in still unsettled Covid conditions, borrowers aren't much minded to take on more debt or banks aren't much minded to take on more risk, and it's true that (as of early November) the Aussie one has seen only A$83 billion taken up, or some 40% of the total available. But as the RBNZ said in the Statement, the actual take-up may not matter so much if the new FLP gets the cost of borrowing down, or as the Bank put it (p21)

The key success metric of the FLP will be whether it results in declines in funding costs, and encourages recent declines in these costs to be passed through to lower household and business borrowing costs. We could see a scenario where FLP funds are only drawn down in small amounts, but its availability encourages a broad decline in interest rates. We would consider this scenario successful, even though actual use of the FLP would seem minimal.

There's always interesting stuff in the body of the Statement and this time round I was especially interested in what the RBNZ had found as it went around the business traps, and in its comments on house prices.

"Many businesses", the Statement said (p18), "expressed concern about finding required staff. Some firms noted that re-deploying staff from one industry to another can be difficult, particularly for skilled jobs. Many firms rely on hiring skilled workers from abroad, which they have been unable to do because of the border closure". 

Granted, the large numbers at risk of losing their jobs in the most affected sectors - the Statement reckoned that pre-Covid international tourism and education made up 6% of GDP - won't always be a good fit for the vacancies available elsewhere, and labour market policy is always going to struggle to assist the transition. "Active" labour market policies (like these successful ones) try to ease the process, but you do wonder whether we've got enough of them. And the reported dependence on overseas skills again makes you wonder how well our labour market is working to match up the demand for skills with the supply of them.

House prices have grabbed everyone's attention, not least because the latest resurgence wasn't supposed to happen in a world where (supposedly) shell-shocked households were hunkering down, not trading up the house. It got a fair bit of attention at the media conference at the Bank after the Statement (tune in around the 29:25 mark, and stay with the rest of the video). But the Bank was quite right to say that it's not its ever-lower interest rates that are the big moving part in the house price increases. As it - completely correctly - said in the Statement (p28):

High house prices in New Zealand largely reflect structural and regulatory issues in New Zealand’s housing market. In particular, land use restrictions, such as urban planning rules, limit the land available for housing and how intensively it can be used. These land use restrictions impede the ability of the market to increase the supply of houses when demand for houses increases. As a result, house prices tend to increase more than otherwise in response to higher housing demand. Other supply-side issues include infrastructure  planning, the building consent process, and the cost of building.

You can berate the Bank all you like, and launch market studies into the building materials trade till you're blue in the face. They're all in the twopenny halfpenny place. Nothing's going to happen to high house prices until the supply side of the market starts to work a lot, lot better.

More market studies

We've got more market studies lining up: as Labour announced during the election campaign there will be two new ones, into supermarkets and building materials. 

No dramas there, but there are two aspects I'd like to pick up on.

One is that the Commerce Act says that either the Commerce Commission (s50) or the Minister for Commerce (s51), now Dr David Clark, can initiate a market study if either "considers it to be in the public interest to do so". "In the public interest" isn't defined, but the FAQ that went out with the announcement included this:

A study is considered to be in the public interest if it promotes the purpose of the Commerce Act – to promote competition in markets for the long-term benefit of consumers within New Zealand, and the following criteria may be relevant:

• There are existing indications of competition problems in the market (such as high prices or low levels of innovation).
• The market is of strategic importance to the New Zealand economy or consumers.
•  It is likely there will be viable solutions to any issues that are found.
•  A formal Commerce Commission study would add value above work that could be done by other government agencies.

That's not a bad checklist. I wouldn't have run with the "strategic" point myself but the others look good. It mightn't be a bad idea to lock the criteria in, in some codified form.

The timing of the announcement though was not ideal. Last December, when I said "I'd heard rumours" about the next market studies, it was pretty much an open secret around the competition policy traps that supermarkets and building materials were next cabs off the rank. Either of them could have been got underway then, once the Commission's resources had been freed up after the petrol market study was finished, rather than nine months later in the middle of an election campaign. 

I don't mind candidates for office telling us what they plan to do: heaven knows, we've seen enough in New Zealand of politicians springing things on us. But we are in the early stages of bedding in our new regime and it would be better if the initiation of market studies were kept away from electioneering. We don't need the risk that business, and perhaps wider public, support for our shiny new market studies gets chipped away if the process appears politicised. 

Theirs and ours

Yesterday the Aussies had their latest Budget: I won't recap all the details as they're easily available all over the place, and if you want some expert economic commentary you could try National Australia Bank's or Westpac's, and you can also go to the horse's mouth and read the Aussies' Budget Strategy and Outlook Budget Paper No. 1 2020-21. I'll just note that I particularly liked the big boost to investment by way of instant expensing of capital spending, available to every firm except the very. very biggest ones; the job subsidies for businesses who hire currently unemployed younger people; the targeting of tax reliefs to the lower end of the income scale; and the focus on increased infrastructure spending.

As regular readers know, the thing I like to look at, but which usually gets under-reported or not reported at all, is whether fiscal policy is boosting or braking the economy. It can be self-evident: when you spend up on the scale of anti-covid stimulus that both our Grant Robertson and their Josh Freydenberg have, it's pretty obviously a boost. But not always: the headline fiscal numbers can be misleading, and in any event it's also useful to know the extent of the stimulus and not just the direction.

So here are the numbers for the 'fiscal impulse': it's an approximation based on in-the-background calculations of variable debatability, but for all that it's still the best measure we've got. I've shown Australia's (from last night's Budget) and New Zealand's (from September's Pre-Election Economic and Fiscal Update or HYEFU). For fiscal policy tragics, I've calculated Australia's as the year on year change in the underlying cash balance as a percentage of GDP, and for New Zealand I've used Treasury's numbers.

What's interesting is that both governments have reacted very similarly indeed. The Aussie stimulus giveth a bit more in the current 2020-21 year, and taketh away a bit more in the subsequent 2021-22 year, but there's not much other difference in the overall pattern since covid hit (pre-covid, the Aussies were playing a bit more of a macho 'I can get back to fiscal surplus faster than you can' political game than we were). Personally I take a bit of policy comfort from the similarity: if they were very different, you'd be inclined to think one (or both) may have lost the plot.

It's also got me thinking a bit more about that fiscal tightening you can see planned for 2021-22 in both countries. Normally a fiscal tightening of 5.4% of GDP (Australia) or 3.7% of GDP (us) would be a massive brake on an economy, and when I wrote up the HYEFU I doubted if the New Zealand economy in 2021-22 would be in anywhere strong enough shape to cope with it. You could say the same about Australia's even larger brake: on their Treasury's forecasts, unemployment will still be 6.5% in June 2022.

But I'm beginning to appreciate that the fiscal tightening might be a bit more apparent than real. Suppose a big slab of 2020-21 fiscal support consisted of temporary wage subsidies, entirely appropriate while companies were facing weak demand. Covid disperses, demand picks up, the subsidies are yanked (and turn up as part of that fiscal 'tightening in 2021-22), but businesses don't really mind. The temporary government cash has been replaced by ongoing customer cash, all good. It's not experienced as much of a 'tightening' at all.

Fair enough, but another way of putting it is that the current forecasts of a reasonably quick withdrawal of fiscal support depend on that recovery in the non-government economy. I'm inclined at the moment to stay on the cautious side. It would be great if both economies bounced back big and quick - the proverbial V-shaped recovery - but I wouldn't be surprised if we ended up with a W or other variant. I suspect both countries' fiscal policies will have to be a bit more supportive, for longer, than their Treasurers currently expect.

Keep up the stimulus

Last week I was making the point that one of the key things to look for in the Pre-Election Economic and Fiscal Update or PREFU was whether fiscal policy was going to be supportive or contractionary over the next wee while, and to what extent, and whether the proposed fiscal stance matched up with the likely state of the economy. 

You might have thought that Ministers of Finance need no special advice on aligning fiscal policy with the cyclical needs of the economy. Surely (you might have thought) they let it rip when times are bad, and wind it back when times are good: obvs, to use the technical macroeconomic term.

And if so you'd be in for an unpleasant surprise, at least if you were a citizen of the US or the EU. Overnight we had this presentation from the OECD on their latest economic outlook. It included this graph, where the blue bars are the same measure of the stance of fiscal policy I used in looking at least week's PREFU, except that the OECD shows bars above the line as fiscal tightening and bars below as loosening (our Treasury does the opposite, it's arbitrary, either works). The yellow triangles are a measure of how poorly each regional economy is faring. The grey shaded area is the GFC.

In both the US and the EU you'll see the local fiscal response was bang on: decent sized fiscal stimulus. And in both regions you'll see that it was taken away much too soon. There are all sorts of reasons why the GFC was a doozy, but premature fiscal braking was one of the larger moving parts. Inevitably politics played a large part, including a Republican Congress wanting to unwind anything President Obama initiated.

The OECD says, rightly, that eventually everybody's fiscal house will have to be put back in order, and done the right way, but as of today "Undertaking fiscal consolidation measures now would be premature". I suspect in our case the eventual retrenchment won't be able to get started  before 2023.

The other big messages are that the world economic outlook, on the OECD's latest base scenario, is a bit better than it was when the OECD took its last stab at a guess back in June ...

... but before rushing out into the street to celebrate, bear in  mind that the range of uncertainty around the base scenario is still very wide, as it is here at home.

Finally, the OECD points out (on p10 of the Outlook) that

With long-term interest rates close to zero in many advanced economies, the social rate of return on public investment is likely to exceed the financing costs for many projects. Investment is particularly needed in areas that have large positive externalities for the rest of the economy and where under-investment might otherwise occur due to market failures, including in health care, education, and digital and environmental infrastructure.

Here in Auckland the Bridge has been out, aggravating the already inadequate transport infrastructure, the water supply is iffy, and housing land remains stratospherically expensive: I passed a sub-division the other day, admittedly with largish sections in a nice rural area, where section prices are "from $985,000". When are we going to start fixing it, if not now?

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.

An excellent resource

Interested in staying up with Australia's criminalisation of cartels, and New Zealand's impending move to do the same? Then head over to the MLex site and download your free copy of  'Collusion Damage: Australia’s struggle to secure its first criminal cartel convictions — and make jail time a deterrent at last '.

It's an excellent resource. As the report says, "Since the first individual criminal cartel charges were laid early in 2018, MLex has been present at every material court hearing in Canberra, Melbourne and Sydney", and the expertise shows. The report is on top of all the cases currently live. My take, not theirs, but after reading this report, and also going by the coverage of the case in the Australian Financial Review, I do wonder from a variety of perspectives if the ACCC is going to succeed with its alleged cartel case against the underwriter banks left with unsold ANZ Bank shares. 

There's a chapter in the report about New Zealand's impending regime, where I agree with MLex that "It’s true that the Commerce Commission will still have the full suite of civil offenses at its disposal and will be under no obligation to unleash a criminal prosecution for trivial matters. Yet ensuring that well-meaning, small businesses -  those that aren’t large enough to have in-house counsel or even to employ a law firm to review their decisions - don’t get caught up with criminal offenses designed to ensnare larger, possibly global players, will remain a challenge for the agency".

In writing up the CLPINZ session on cartel criminalisation I'd also wondered about potential overkill, and had assumed we in New Zealand would end up with some arrangement similar to that between the ACCC and the Commonwealth Director of Public Prosecutions, which hopefully would set some seriousness threshold before unleashing the criminal process. But I learn from the MLex report that "Unlike the ACCC, the Commerce Commission will be able to take its investigations to court directly, without handing the file over to public prosecutors; however, it will be required to ascertain how its planned prosecution measures up with the Solicitor General’s Prosecution Guidelines, which demand “evidential sufficiency” and proof that the prosecution is in the public interest". As the Guidelines say, "The predominant consideration is the seriousness of the offence", and hopefully a conservative approach will be the way to go, rather than feeling the collar of commercial naïfs.

Speaking of resources, I came across the MLex report on its useful Twitter feed. If you're interested in competition tweets, head over to my own Twitter posts and help yourself to my Twitter 'Competition' list (currently 73 members). And if New Zealand economics is your thing, then the 'NZ economics' list (52 members) should be of interest. If there are local competition or economics folks I've missed, let me know and I'll add them.