Monday, 21 December 2020

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.

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