Finance Minister Grant Robertson will show the Government's forecasts today. Photo / Mark Mitchell
ANALYSIS:
When he lifted benefits in his 2021 Budget, Finance Minister Grant Robertson proclaimed he was “righting the wrong” of Ruth Richardson’s “Mother of all Budgets”, which famously pared back government spending.
Today, Richardson has the right of reply of sorts, when Treasury publishes the Government’s Half-Year Economic and Fiscal Update (HYEFU), which will give us some idea of the economic pickle we’re in next year.
Robertson will also publishthe Budget Policy Statement (BPS) in which he sets out how much new spending he wants in next year’s Budget and which areas will be prioritised for new spending.
What’s this got to do with Ruth Richardson? Well, the HYEFU, the BPS and the host of other EFUs (the PREFU and BEFU, for those following along at home) exist thanks to her.
Richardson is the author of the rules that force the Government to release these documents, thanks to a little-known and underappreciated piece of legislation called the Fiscal Responsibility Act (FRA), which she drew up as minister of finance and shepherded through select committee after she left that role.
The Fiscal Responsibility Act did not survive the Fifth Labour Government and was repealed by Michael Cullen. However the guts of the legislation - the requirement to publish multiple “EFUs” each year, giving a medium-term view of what the economy looks like in the future, and the requirement for the minister of finance to set out how the Government plans to manage its Budget in advance of actually delivering it - live on; Cullen dropped those requirements into the Public Finance Act when he repealed the Fiscal Responsibility Act and there they exist to this day.
The whole point of the Fiscal Responsibility Act was to put political pressure on politicians to behave “responsibly” (responsibly by Richardson’s definition - obviously there’s considerable debate about just what fiscal responsibility means).
The idea for the legislation came from Richardson’s experience in caucus of bringing leader Jim Bolger and Bill Birch around to supporting Labour’s mammoth reforms to the Reserve Bank, which ushered in the independence it currently has over monetary policy.
Richardson wondered at the time whether a similar approach might be taken to fiscal policy - the side of the economy that’s managed by the government.
The idea captured the neoliberal spirit of the age. By the time it got to select committee, submitters proposed ideas like forcing the government to target a particular credit rating, and restraining government spending until that credit rating was achieved.
This posed several problems, including issues - which have reared their head again in the debate over Three Waters entrenchment - around the sovereignty of Parliament, which has every right to tax and spend as much or as little as it pleases, regardless of the impact on the Government’s credit rating.
The solution was to create a high level of accountability over public spending, forcing Treasury to publish regular, detailed forecasts of public spending and its effect on the economy, and forcing the government to outline how it would manage the economy effectively, including by setting out a strategy for the level of debt and taxation the government would carry.
This would put political pressure on the government to keep spending and debt levels in check. The legislation would appear to have been successful in its aim. New Zealand has gone from being among the more indebted developed countries in the 80s and 90s to among the least today.
Debt levels have reduced and stayed low, and spending levels have remained roughly at the same level (whether this is because of the FRA or for some other reason is a valid question).
That brings us to what Robertson will deliver today.
Of the two documents, HYEFU, belongs to the Treasury. It is a book of independently produced economic and fiscal forecasts showing what Treasury thinks will happen to the Government’s books (that’s the “fiscal” bit of the title) and to the wider economy (the “economic” bit).
Both are important - particularly in these unusual economic times, but both should be treated separately because one (the economy) is pretty sick, while the other (the fiscal) is fairly healthy.
The other document, the BPS, is a political document and it outlines decisions the finance minister takes with the budget.
Let’s look at the HYEFU first.
It’s the first set of forecasts Treasury has published since the Budget in May. A lot of water has gone under the bridge since then. The big story in the economy is that inflation is forecast to be higher in the short term.
The BEFU forecast CPI inflation of 5.2 per cent next year, 3.6 per cent in 2024 and 2.7 per cent in 2025.
Look for those numbers to be revised well upwards in the HYEFU.
The Reserve Bank’s Monetary Policy Statement from November forecasts much higher CPI inflation of 7.5 per cent and 3.8 per cent in 2024 and 2.4 per cent in 2025.
Expect to see fairly grim inflation numbers and correspondingly grim house price forecasts. High inflation means higher interest rates means lower house prices. Indeed, Robertson has already foreshadowed this, saying last month that the worsening economy would start to show up in the HYEFU.
But - there’s a pretty big “but” here: Treasury’s forecasts were put together before the Reserve Bank’s most recent Monetary Policy Statement, where the Bank forecast much higher interest rate hikes and a recession next year - largely as a result of those interest rate hikes.
What that means is that the HYEFU forecasts are already partly out of date, as they will not take in the full impact of what the Reserve Bank is doing to the economy.
It could mean that the all-important forecasts for how much the economy has grown or shrunk will be quite out of date and might not register the recession that is likely to occur from the Bank’s rate hikes.
This will flow on into out-of-date forecasts for unemployment, tax revenue and government spending. A recession means less employment, less revenue from taxes like payroll and GST and higher spending on things like benefits.
It’s possible that all of these very important numbers will be just as out of date as the inflation and interest rate forecasts.
One really important number to look at is what is called the fiscal impulse.
This measures the effect of government spending on stimulating the economy. This is a hugely important number politically, given one of the big questions that will hang over Wellington from now until the election is whether the Government is doing enough to suck demand out of the economy and reduce inflation.
The fiscal impulse roughly shows the total impact of Government support on aggregate demand from one year to the next.
Because the fiscal impulse shows the total level of government support compared to the previous year, this year’s fiscal impulse is likely to show the government is running a more contractionary fiscal policy than it actually is. This is because the fiscal impulse will show that the current fiscal policy is less stimulatory than the massive stimulus unleashed during the pandemic - it does not necessarily mean the fiscal policy is contractionary.
Today, we will very likely see Government spending reduce as a percentage of GDP, but we need to remember what is going on in that figure. The numerator, the amount of spending, is shrinking as temporary Covid support dries up, while the denominator, the size of the economy, continues to grow (at least for now - maybe not next year).
And as a recap, the most recent forecasts have Government spending at $128.4 billion next year, falling to $127.1b in 2023 before slowly rising to $138.2b by 2026.
As a share of GDP, however, expenses are forecast to fall, not increase, dropping from 35.4 per cent of GDP in 2022 to 29.8 per cent in 2026.
A thing to watch out for here is an involuntary increase to the fiscal impulse.
Higher unemployment, which is likely to be included in the HYEFU (even without the inclusion of the latest MPS data) will mean more government spending as unemployment support kicks in in the form of higher welfare payments. This is a normal (it’s called an “automatic stabiliser”) part of recovering from a recession, but it puts additional pressure on the Government to restrain spending elsewhere.
Another measure of the extent of stimulus is whether the government is running a surplus or a deficit. Given the state of the economy, it’s highly likely tomorrow’s numbers will show the Government running an OBEGAL (operating balance before gains and losses) deficit for the next few years. The May forecasts showed deficits out to 2025 - given the worsening state of the economy, it’s likely the return to surplus may be delayed.
One funny thing we’re likely to see in the numbers is relatively healthy revenue, despite a looming recession. That’s because inflation is pushing up wages and prices, leading to an increased tax take. That’s great news for the Government’s books from an accounting standpoint, but it’s bad news for the wider economy because it speaks to the high level of inflation we’re seeing.
One thing to think about here is the importance of separating the fiscal (the government’s books) from the wider economy. The wider economy is certainly unwell with a recession forecast and uncontrolled inflation, however, whatever crisis there is in the economy, we do not yet have a fiscal crisis - which, in plain English, is a crisis on the Government’s books. In even plainer English, we won’t run out of money.
There’s a deficit, but it is still forecast to eventually turn into a surplus, and net debt is still incredibly low relative to other developed nations at just 19.5 per cent of GDP.
The distinction is an important one heading into an election year. The political question everyone wants answered is whether the Government has mismanaged the economy - and that’s a fair question given the state of inflation.
The state of the Government’s own books, however, is fairly positive, with the only question mark being the relatively small but persistent deficit.
The Budget Policy Statement is when Robertson announces the operating and capital allowances - this is the amount of new money for day-to-day spending and investment.
These numbers have already been forecast. In the Budget, Robertson announced there would be a $4.5b operating allowance. This is the money Robertson can use for new public services or to top up existing ones for cost pressures.
Those cost pressures will be particularly difficult to manage in the coming budget.
Inflation means that there are additional wage and price increases for delivering existing Government services. Even in May, when inflation was forecast to be lower, Treasury warned the Government would need to top up spending by $3.5b just to stand still - that leaves just $1b for new projects.
This year is peculiar though - $2b of that has already been “allocated” as part of a new way of longer-term budgeting in which agencies are given allowances that last for multiple years, giving them certainty of funding.
Robertson faces a big choice this Budget - to increase the allowance to fund the growing cost of public services, or to keep it as it is or even trim it in a bid to tame inflation. Keep an eye on what Robertson does here - it is one of the defining decisions of the next year.
Another thing to look out for is reallocations outside of the operating allowance.
Usually, a finance minister will find most of the new money from the extra taxation netted by a growing economy - perhaps supplemented by a bit of borrowing. Increasing the allowance this year might have to come largely from borrowing because the Government is already spending more than it earns.
But a finance minister can also create “new” spending by cancelling some old programmes and reallocating the cash.
This appears to be a direction Robertson is moving in. It would allow him to have his cake and eat it too - he’ll have an operating allowance big enough for public services, and winning the election.
But he can also supplement this with new initiatives funded not from the allowance but from reallocation. The big question is whether Robertson can find the money he needs without culling Government programmes people actually like.
From time to time, the Government chooses to include a policy announcement at HYEFU.
One thing the Government has promised to clarify this week, has been whether it will extend its transport subsidies - the petrol tax and road user tax cut, and the half-price public transport fees.
Watch this space.
Labour members will debate and vote on the party's tax policy this weekend