Country experiences – international The New Zealand Experience

Country experiences – international The New Zealand Experience

Panel I: Country experiences – international
The New Zealand Experience
by John Janssen, Principal Advisor, New Zealand Treasury 1
𝐉𝐉𝐉𝐉 𝐉𝐉𝐉𝐉𝐉𝐉𝐉
1.
Introduction
This paper starts with an overview of the economic and fiscal reforms undertaken in New Zealand during the 1980s
and 1990s. A complete evaluation of these reforms is beyond the scope of the present paper. Nonetheless, a brief
overview introduces some of tradeoffs being considered by the symposium and sets the context for the more recent
fiscal and structural reform choices facing New Zealand post-2008. A discussion of these choices is provided in Section
3. The paper concludes with a summary and the key lessons from the New Zealand experience.
2.
Earlier structural reforms and fiscal consolidation
The decline in New Zealand’s GDP per capita relative to the OECD is well documented (see for example, Easton, 2008;
Carroll, 2013). The potential causes are varied and amongst other factors include the loss of major export markets,
terms-of-trade shocks, and limited structural reform and adjustment.
From the mid-1980s, New Zealand embarked on a process of wide-ranging reforms in terms of monetary, fiscal, and
structural policies (see Evans, Grimes, Wilkinson, and Teece, 1996; Silverstone, Bollard, and Lattimore, 1996). The
OECD (1999) identifies two phases of reform, the first from 1984-1990, under the direction of a Labour government,
and the second from 1990-1996, under a (conservative) National government. The OECD notes three distinguishing
features of the New Zealand reforms. First, reforms were both comprehensive and pursued in a fairly rapid fashion.
Second, reforms reduced the size of government and, at the same time, applied a core set of principles to public sector
management to improve transparency, accountability and efficiency. Third, although support for the reforms
sometimes waned, the reforms remained largely intact through successive governments. 2
2.1 Structural reforms
In the early 1980s, New Zealand and Australia liberalised trade through the Closer Economic Relations Agreement
(CER). However, the first phase of major reform was in response to an exchange rate crisis in June 1984. The
government responded by liberalising the financial sector, with the abolition of interest rate controls, the floating of
the exchange rate in March 1985, relaxation of entry restrictions, removal of limits on foreign ownership, privatisation
of state-owned financial institutions, and the removal of restrictions on foreign currency borrowing. Importantly, the
1
This paper is based on the presentation given at the symposium. It incorporates comments from the panel moderator, the panel
discussion, and subsequent feedback from symposium participants. Thanks also to Oscar Parkyn, Renee Philip and Tim Ng (all New
Zealand Treasury) for comments.
2
The overview presented here draws on the detailed chronology and assessment set out in OECD (1999). The two reform phases have
a close connection to the mid-1990s fiscal consolidation. The pace and nature of reforms following these two phases is not addressed
in detail, although OECD (2015) provides summary indicators.
1
reforms in the financial system yielded better control over monetary policy so as to begin the process of reducing
inflation.
The opening up of the financial sector was accompanied by similar moves on external trade, including the phasing out
of import licensing, elimination or phasing out of export subsidies, and the commencement of tariff reductions.
Beginning in 1986, the tax system was reformed so as to improve its neutrality and to broaden the base and flatten the
scale. Income tax rates were lowered and the number of tax brackets was reduced. Sales and other indirect taxes were
replaced by a broadly-based goods and services tax (GST), levied initially at 10% (it was raised to 12.5% in 1989 and to
15% in 2010). Company taxes were raised to the level of the highest personal income tax rate and tax loopholes were
eliminated.
Product markets were deregulated via the removal of state-regulated monopoly rights in certain industries and
restrictions on shop trading hours, and the adoption of a so-called “light-handed’’ regulatory structure.
The principles of public sector reform were set out in the State-Owned Enterprises Act 1986, the State Sector Act 1988,
and the Public Finance Act 1989. The principles sought to improve public sector performance by: clarifying objectives;
strengthening incentive structures; increasing transparency and accountability; and measuring performance against
clear expectations. Where there was no public policy objective or market failure, the provision of goods and services
was to be left to the private sector. Applying these principles to the wide-range of government owned businesses saw a
programme of privatisation, with net asset sales amounting to NZ$10 billion by 1990 and a further NZ$6.5 billion by
1996.
In terms of monetary policy, the Reserve Bank Act 1989 formally recognised that ‘‘the primary function of the Bank is
to formulate and implement monetary policy directed to the economic objective of achieving and maintaining
stability in the general level of prices”. The Act itself does not define precisely what is meant by ‘‘price stability’’.
Rather, it leaves these issues open to a Policy Target Agreement (PTA) negotiated between the Minister of Finance and
the Governor of the Reserve Bank. As well as setting out inflation targets, the PTA specifies events which may lead to
inflation outcomes outside of the target range.
In the second phase of reforms, starting in 1990, a deteriorating economic and fiscal situation had a significant
influence on the reform programme. In December 1990, the new National government introduced a package of
initiatives which included labour market reform, reductions in social spending, and a tightening and reduction of
unemployment and other social transfers. In the case of publicly-provided pensions, the eligibility age was
progressively increased from 60 to 65 years between 1992 and 2001.
Labour market reforms were embodied in the Employment Contracts Act 1991 which sought to promote an efficient
and flexible labour market. The Act gave employers and employees the freedom to choose with whom, and within
what structures, they associated, and made the nature and structure of employment contracts a matter for the parties
themselves to determine. The authorities also put in place grievance and dispute-settlement procedures, and
maintained a statutory minimum code of employment rights relating to a minimum wage, leave, and occupational
health and safety (OECD, 1999).
2.2 Fiscal consolidation and reform of the fiscal framework
In an assessment of New Zealand’s fiscal policy during the 1970s and 1980s, Wheeler (1991) concluded that extensive
use of fiscal policy in a demand management role had not contributed to sustainable growth. Rather, expansionary
fiscal policy had led to a deterioration in the net debt position. Although some fiscal consolidation was achieved
during the 1980s, it was not sustained into the early 1990s. Relative to the Treasury’s October 1990 fiscal projections,
the new government made decisions across the December 1990 package and the 1991 Budget that were expected to
achieve fiscal savings of more than NZ$3.3 billion in 1991/92 (around 4.5% of GDP), rising to nearly NZ$5 billion in
1993/94 (around 6.3% of GDP).
In order to safeguard improvements in government finances and increase policy credibility, the Fiscal Responsibility
Act (FRA) was introduced in 1994. As a result, fiscal policy in New Zealand has to comply with principles of responsible
fiscal management. The principles include requirements to run operating balances sufficient to achieve and maintain
prudent levels of public debt.
Although fiscal targets are not prescribed in legislation, governments are required to set short-term fiscal intentions
and long term objectives for key fiscal aggregates related to the principles. The principles of fiscal responsibility and
(enhanced) reporting requirements were incorporated into the Public Finance Act in 2004.
The fiscal consolidation of the early 1990s was primarily expenditure based, with a fiscal (operating) surplus achieved
in 1994. These operating surpluses were maintained until 2008, facilitating a reduction in the net public debt ratio (see
Figure 1). 3
Figure 1 – Net public debt
Source: The Treasury
Note: Years ended March until 1989 then years ended June. So as to yield a consistent time-series, the definition of net debt used here
differs to that used elsewhere in the paper.
2.3 The longer term impact of reforms
New Zealand’s overall economic performance has improved since the early 1990s and New Zealand’s GDP per capita
growth has subsequently kept pace with other advanced economies. However, this improvement has been insufficient
to close the sizable gap that had already opened up with other economies. New Zealand’s GDP per capita remains
around 15% below the OECD average, with the vast majority of the gap attributable to a gap in labour productivity.
The explanations and underlying causes of New Zealand’s productivity performance have been long debated and
widely contested (see the Treasury, 2014). While there is a range of potential explanations, three main themes emerge
from the debate. The first explanation emphasises a weakening in the pace of economic policy reform and the role of
the state sector in restraining economic performance. The second explanation highlights links between productivity,
high real interest rates and the exchange rate, low rates of saving and consequential lower levels of investment and
exports. The third explanation emphasises New Zealand’s small population and distance from international markets.
Each explanation emphasises different features of the New Zealand economy, which distinguishes it from other
advanced economies. There are merits in all three arguments and they are not mutually exclusive.
Notwithstanding the gap in GDP per capita, structural reforms and fiscal consolidation have made the New Zealand
economy more flexible and resilient. Over the longer term, the economy has been able to respond to declines in
employment in some industries with growth in employment in others. As a consequence, employment increased and
the unemployment rate fell until the onset of the global financial crisis (Carroll, 2013).
3
For details and initial assessments of the fiscal framework and fiscal consolidation, see Janssen (2001) and Wilkinson (2004). For
more recent reviews, see Brook (2013) and Ter-Minassian (2014).
3
3.
Recent fiscal consolidation and ongoing structural reforms
Although there are lessons from the last cycle and the crisis itself (see Section 4), macroeconomic settings in New
Zealand were generally well placed in terms of responding to events post-2008.
3.1 Recession, recovery, and revisions to potential output
In the first three quarters of 2008, real GDP fell in line with the average of past recessions in New Zealand. In this initial
phase, the recession was less severe than had been experienced in 1967, 1982 and 1991. The initial phase commenced
before the global recession, and was driven by monetary tightening (in response to rising inflation and inflation
expectations) and exacerbated by severe drought in late 2007 and early 2008. Although the overall cycle has been “Ushaped”, the 2008-09 recession has been New Zealand’s second longest and most severe since the mid 1950s (after that
of 1976-78). The recovery has also been the second slowest to regain the pre-recession level of real GDP, in both
aggregate and per capita terms (see the Treasury, 2013a).
The Treasury revised down its forecast level of potential GDP by five percent in the 2009 Budget, with a further two
percent reduction in the December 2012 update. As the economy was on a lower growth path, tax revenue fell and
stayed lower. In contrast, expenses were largely unaffected by the recession, apart from those such as unemployment
benefits.
The fiscal balance reversed, from a surplus of 3.0% of GDP in 2008 to deficits of 2.1% in 2009, and 3.3% in 2010. Costs
related to the Christchurch earthquake added to expenses, increasing the deficit to 9.2% of GDP in 2011 (or 4.6% of
GDP excluding earthquake costs). 4
3.2 Fiscal policy responses
After allowing automatic fiscal stabilisers to support the economy to some degree in the initial years of the downturn,
the government implemented a range of initiatives to slow the growth of expenditure (see the Treasury, 2013b). These
measures included a reduction in the allocation for new spending, savings across the state sector in Budget 2011 of $1
billion over three years, and changes to spending programmes (eg, pension subsidies, student loans, and welfare). 5
Policy changes have slowed the growth rate of expenses rather than lowering nominal spending. Core Crown expenses
are forecast to fall back to around 30% of GDP, similar to the level seen prior to the fiscal expansion in the late 2000s.
The most recent Treasury update (December 2014) forecasts a small fiscal deficit of NZ$572 million (0.2% of GDP) in
2014/15. A surplus of $565 million is forecast in 2015/16, rising to $4.1 billion in 2018/19 (just under 1.5% of GDP). Net
debt is forecast to be 26.5% of GDP in the June 2015 and 2016 years, before falling to 22.5% of GDP in 2018/19 (see
Figure 2).
4
The fiscal balance referred to here is the Operating Balance Excluding Gains and Losses (OBEGAL).
For an explanation of how new spending allocations are set relative to existing baselines, see Mears, Blick, Hampton and Janssen
(2010).
5
Figure 2 – Fiscal balances and net debt
Note: Operating balance excludes gains and losses
Source: The Treasury
3.3 Choices about the pace of fiscal consolidation
The nature of the New Zealand debate regarding the speed of fiscal consolidation is quite different to the international
debate (see the Treasury, 2012; 2013b). Debt sustainability analyses suggest a need for fiscal consolidation in many
economies. At the same time, there is a growing body of empirical analysis suggesting that the appropriate pace for
fiscal consolidation should be carefully tailored.
There are two main considerations in the New Zealand debate. First, the appropriate level of public debt for New
Zealand needs to be considered in the broader context of high net external liabilities (mostly private sector debt),
which is often cited by credit rating agencies as posing risks to New Zealand macro-stability. Second, there are a
number of reasons to believe that a given pace of fiscal consolidation will be less contractionary in the New Zealand
economy than it would be for many other economies.
Although the literature on New Zealand fiscal multipliers is small, the results are broadly consistent with there being
small positive fiscal multipliers in the short-term (ie, the next few quarters) and close to zero multipliers in the
medium term, that is, over the 1 to 3 year horizon (see Claus, Gill, Lee and McLellan, 2006; Dungey and Fry, 2009;
Fielding, Parkyn and Gardiner, 2011).
The explanation for relatively small fiscal multipliers stems from New Zealand being a small, relatively open economy
with a floating exchange rate and an independent inflation-targeting central bank. The Reserve Bank has an important
role to play in stabilising aggregate demand in the economy. Therefore, as long as monetary policy is not hitting the
zero lower bound for interest rates, a well signalled and credible fiscal consolidation path should – all else equal – be
offset by lower-than otherwise interest rates, and associated exchange rate depreciation, which should boost net
exports.
This interaction between fiscal and monetary policy is supported by more recent empirical work. This shows that, all
else equal, annual GDP growth can be expected to slow by around 0.3 percentage points in the short-term if
government spending is reduced by 1% of GDP. However, these estimates are sensitive to a range of factors, in
particular the responsiveness of monetary policy to economic slack and the responsiveness of private demand to both
monetary and fiscal policy changes (see Vehbi and Parkyn, 2013; Murray, forthcoming).
To say that fiscal multipliers in New Zealand are small or “close to zero” is not to say that fiscal policy has no impact. A
switch in the mix of macroeconomic conditions would be expected to have sectoral impacts even if the impact on
5
aggregate GDP broadly nets out. For example, the mid-2000s loosening in fiscal policy, and the consequently tighter
stance of monetary policy had the effect of boosting non-tradable sector output and slowing tradable sector output.
Fiscal impulse measures for New Zealand suggest that in the recession and the initial years of the recovery, fiscal policy
provided support to the economy. This stance continued until 2012, when the fiscal impulse turned contractionary as
measures were introduced to restrain government expenditure growth.
New Zealand’s planned fiscal adjustment will subtract from aggregate demand at a time when private sector and
earthquake-related spending will be adding to it. It is the balance of these competing influences that determines the
overall path of output. If the government was not reducing its call on resources, monetary policy would need to be less
stimulatory than currently planned. Taking all of these factors into account, Treasury forecasts indicate spare capacity
in the economy to be gradually taken up and for inflation to settle around the centre of the Reserve Bank’s target
range.
3.4 Ongoing reforms
The most recent Treasury update (December 2014) forecasts real GDP growth of between 2% and 4% over the next four
years. Growth was faster than potential over 2014, reducing unemployment to below 6% and adding to demands on
productive capacity. Strong construction sector activity, high net immigration, and interest rates which remain low by
historic standards, continue to support the expansion (see Figures 3 and 4).
Figure 3 – Real GDP growth
Sources: Statistics New Zealand, the Treasury
Figure 4 – Contributions to GDP growth
Sources: Statistics New Zealand, the Treasury
The current government is focused on managing the economic upswing, while lifting New Zealand’s underlying
potential growth rate. 6 To achieve this, the government is:
o
o
o
o
returning its own accounts to surplus and then reducing debt;
driving better results and better value for money from public services;
pushing ahead with a wide-ranging series of microeconomic reforms to create a more productive
and competitive economy;
continuing to support the rebuilding of Christchurch, New Zealand’s second largest city following
the 2010 and 2011 earthquakes.
New responses to macroeconomic policy
The 2013 amendment of the Public Finance Act 1989 expanded the fiscal framework to incorporate additional
principles of responsible fiscal management relating to: the interaction of fiscal policy with monetary policy;
intergenerational equity; the efficiency and fairness of the tax system; and the effectiveness and efficiency in the
management of the government’s s resources.
The government’s long-term fiscal objective is to reduce net debt to 20% of GDP by 2020. Beyond 2020, the
government intends to maintain net debt within a range of around 10% to 20% of GDP. This range acknowledges that
debt will fluctuate over the economic cycle.
In the 1990s New Zealand pioneered the compilation of a complete audited balance sheet for the public sector, and
remains one of only a few countries that do so systematically. Analysis of the balance sheet allows for a richer
understanding of developments in the public finances. This is because the balance sheet provides additional
information regarding: a range of indicators of fiscal sustainability; the ability to absorb exogenous shocks; and the
public sector’s capacity to deliver public goods and services over time.
The government has moved to more consistent and deliberate management of its balance sheet. The strategy will
rebuild fiscal buffers through reducing debt as a share of GDP and resume New Zealand Superannuation Fund (NZS
Fund) contributions when conditions permit. The strategy also encourages asset ownership only when it is necessary
6
For a more comprehensive description, see the paper on New Zealand’s growth strategy prepared for the Brisbane
G20 conference, available at https://g20.org/wpcontent/uploads/2014/12/g20_comprehensive_growth_strategy_new_zealand.pdf
7
to deliver core public services. This implies the disposal of assets that are surplus to requirements or no longer fit for
purpose, introducing private-sector capital and disciplines where appropriate (eg, public-private partnerships), and
better monitoring of actual investment performance against expectations.
The government has recently completed a Government Share Offer (GSO) programme in three energy-related State
Owned Enterprises and the national airline. The programme is expected to yield between NZ$4.6 billion and NZ$5.0
billion. It has helped to deepen public equity markets and increased share ownership. The proceeds will fund new
capital investment without issuing public debt.
With regard to macro-prudential policy, in October 2013 the Reserve Bank introduced quantitative restrictions on the
share of high loan-to-value ratio (LVR) loans to the residential property sector. The use of macro-prudential tools is
intended to promote greater financial system stability but their implementation can also contribute to achieving
monetary policy objectives.
The delivery of public services
New Zealand has a long tradition of performance-oriented public financial management, underpinned by a welldefined accountability framework, accrual accounting and budgeting under Generally Accepted Accounting Practice
(GAAP), appropriation of budgetary resources by outputs, costing of outputs, and the use of capital charges.
The government has placed increased emphasis on better articulating budgetary priorities and reallocating resources
to them. It has taken a recipient-focused approach to the analysis and reform of expenditure programmes (ie, the
“investment approach” used in recent welfare reforms). The government has set ten Better Public Services (BPS) results
to be achieved over the next five years. These results include reducing crime, reducing long-term welfare dependency,
and reducing educational underachievement. Delivering these results will require government departments to work
together, and to work collaboratively with Crown entities, non-governmental organisations (NGOs) and the private
sector. In addition, departments are now required to prepare four-year rolling plans which provide an integrated view
of the department’s medium-term strategy and how it will manage within existing funding levels.
Microeconomic policy responses
Microeconomic policy reforms are set out in the Business Growth Agenda (BGA). The BGA has six key areas of focus
relating to: export markets; capital markets; innovation; skilled and safe workplaces; natural resources; and
infrastructure. The BGA builds on other structural policies of the past five years, including significant changes to the
tax system in the 2010 Budget (eg, increasing GST from 12.5% to 15%; lowering tax rates; and changing depreciation).
New Zealand has a large stock of natural resources. The government is seeking to maximise the value New Zealand
derives from these resources in a sustainable manner and alongside robust environmental reporting and safety
standards. To support this, the government is making changes to the Resource Management Act 1991 to provide more
certainty, timeliness and cost-effectiveness around resource allocation decisions.
Efforts to address infrastructure challenges and reverse the historical pattern of variable and inconsistent investment
have been guided by a National Infrastructure Plan. The Plan provides a common direction for how economic and
social infrastructure is used, planned, funded, and built. Over the last three years almost NZ$16 billion has been spent
on infrastructure assets such as roads, rail, ultra-fast broadband, irrigation, electricity transmission, and the rebuilding
of Christchurch. The Treasury’s National Infrastructure Unit (NIU) has published the first comprehensive report on the
10-year capital intentions of Crown agencies and local governments.
The supply of land for housing has been improved by the introduction of the Housing Accords and Special Housing
Areas Act 2013. More generally, the government is reining in what local councils can charge residential developers,
investing in building industry skills, and boosting productivity in the sector. Tariffs and duties on building products
have been removed to reduce costs through increased competition.
Government investment in science and innovation has increased by more than 60 percent since 2007/08 and will
reach NZ$1.5 billion in 2015/16. This includes business R&D grants delivered via a stand-alone Crown Entity charged
with working across the whole innovation system to accelerate the commercialisation of innovation by firms.
New Zealand’s labour market rates well on most measures of flexibility. In general it is able to achieve equality and
efficiency objectives and resolve most employment relationship problems quickly and at minimal cost. Key changes
being implemented include: the introduction of the starting out wage to lower the barriers to work for young workers
and less-experienced workers; flexible working arrangements; and a voluntary 90-day trial period to encourage
businesses to take on new staff and give new employees an opportunity to enter the workforce.
Significant reforms have been made to the welfare system. The goal is to improve outcomes for vulnerable New
Zealanders by helping people at risk of long-term benefit dependency to move into employment. The reforms involve
an active, work-based approach. At the core of the system is the investment approach, designed to ensure the service
delivery agency takes a long-term view, and focuses on investment to improve individuals’ employment outcomes,
thereby reducing the future liability of the benefit system.
New Zealand’s schooling system currently performs strongly for the majority of students, but not all. The government
is adopting a range of measures to lift school-level achievement. These include alternative pathways for students at
risk and introducing changes to enhance teaching and leadership in the schooling system. In recent years, the
government has worked to improve the performance and value for money of the tertiary education system by setting
better performance incentives and improving the information available for students about employment outcomes.
In March 2015, the launch of direct trading of the New Zealand dollar against the Chinese Renminbi in the Chinese
onshore market was announced. Direct trading will increase the integration between the New Zealand and Chinese
financial systems, and deepen the economic relationship between the two countries. New Zealand is negotiating
comprehensive, high-quality Free Trade Agreements (FTAs) and implementing existing FTAs.
4.
Summary and key lessons
The pace and nature of structural reform in New Zealand has varied over time, with significant episodes of reform in
the 1980s and 1990s. An assessment of this earlier period by the OECD (1999) identifies (with the benefit of hindsight) a
range of issues and considerations. In particular, some commentators have argued that the sequencing of reforms was
less than optimal. Stabilisation and liberalisation in the domestic economy was undertaken after liberalisation of the
external sector. Inconsistent progress towards fiscal consolidation, combined with rigidities in the labour market and
non-traded sector meant that monetary authorities faced a difficult challenge in reducing inflation. 7 However, there
were a number of arguments in support of advancing reform rapidly (eg, to respond to the crisis, to take advantage of
reform support and reduce rents and vested interests, and to correct a history of poor policy credibility). Proceeding
with reform in one area was likely to raise the pressure and momentum for necessary reform in other areas.
While New Zealand policy makers may have underestimated the time needed for adjustment, the OECD (1999)
acknowledge the challenges in reaching definitive conclusions about why economic recovery was slow in coming in
the face of large policy changes. This partly reflects the challenge of identifying the relevant counterfactual. In
addition, numerous factors were influencing the economy, including: the lags between policy implementation and
their full effects; the 1987 stock market crash; entrenched inflation expectations; constraints on export market access;
and limited economies of scale, given the small domestic market.
The reform process was motivated by a widespread recognition that New Zealand’s economic performance was
lagging behind that in other OECD economies. As noted previously, the OECD (1999) concluded that although support
for the reforms sometimes waned, the reform process remained largely intact through successive governments. This
conclusion remains broadly appropriate today, albeit that the types of reforms needed now and the political context
differs to that of the 1980s and 1990s. 8
Fiscal policy has seen a consistent emphasis on maintaining relatively low levels of public debt. While the fiscal
framework has no legislated numerical rules, there has been strong political commitment to self-imposed fiscal
targets. Moreover, the flexibility of the framework allows governments to set broadly similar debt objectives with
somewhat different preferences for the size the government. Some commentators have seen the latter as a weakness
and argued for a legislated expenditure rule (see Wilkinson, 2004). However, the pros and cons of such an approach are
complex (see Mears, Blick, Hampton and Janssen, 2010; Ter-Minassian, 2014). In practice, fiscal consolidation has
primarily relied on changes to structural expenditure, with the caveat that assessing the overall structural fiscal
position is challenging in New Zealand given the influence of fluctuations in the terms-of-trade and labour supply via
net migration.
7
The sequencing issues were particularly relevant to the path of the real exchange rate and the performance of the tradable sector.
See the relevant chapters in the volume edited by Silverstone, Bollard and Lattimore (1996).
8
For example, in 1996 New Zealand shifted from a first-past-the-post electoral system to a mixed-member proportional system.
Coalition governments have since been the norm.
9
Indeed, these latter influences were present in the last cycle. The economic expansion from 1998 to 2007 was long and
large by New Zealand’s post-war standards, with average annual GDP growth of 3.6% and strong employment growth.
The unemployment rate fell from 8% in 1998 to around 4% by 2007. Domestic demand was underpinned by a large
increase in net migration, rising house prices, and a lift in key export commodity prices. There was strong growth in
public and private consumption, as well as housing construction. The cycle was associated with a range of emerging
domestic and external imbalances: average house prices grew faster than rents and incomes; domestic credit growth
was rapid; the current account deficit widened; and the exchange rate appreciated above its long-term average (see the
Treasury, 2014).
There are lessons to be learnt from this period and the global financial crisis. While New Zealand’s low public debt
helped in coping with the crisis, in hindsight, fiscal policy settings may have been too loose before the crisis. Strong
revenue growth kept the government in fiscal surplus, yet growing public spending put upward pressure on inflation.
This meant that monetary policy had to be tighter – and interest and exchange rates higher – than they otherwise
would have been.
A range of steps have been taken to increase the resilience of the banking sector. These include: adopting tougher
international capital adequacy standards; developing an additional tool for the resolution of troubled banks; and
introducing regulation that can help prevent the build-up of risks across the financial sector. Many of these changes
are primarily about reducing the risks of future financial crises. However, some tools also have the potential to help
smooth cyclical fluctuations in economic activity (eg, LVRs).
New Zealand’s experience also highlights how the initial conditions that influence trade-offs can evolve through time
and interact with the specific characteristics of shocks faced by the economy. For example, New Zealand’s fiscal
position in the mid-1990s, while improving, did not yet have sufficient fiscal space to allow for the full operation of
automatic fiscal stabilisers in response to the Asian financial crisis. In contrast, during the post-2008 period a more
measured approach was feasible. In the event this was important given the wide range of short- and medium-term
influences on the fiscal balance (eg, terms-of-trade movements, the earthquake rebuild, changes to potential output).
As discussed in Section 3, the pace of the subsequent fiscal consolidation has been influenced by specific
considerations, including the appropriate level of prudent debt and the interaction of fiscal multipliers with monetary
policy conditions. Wider policy responses have been oriented toward rebuilding fiscal buffers and raising potential
growth. The responses comprise a mix of macroeconomic, public sector, and micro reforms. They include:
enhancements to the fiscal framework and macro-prudential policy; a direct/indirect tax switch; partial sale of state
assets; labour market and welfare reforms; specific targets for public services; a wide-ranging micro reform
programme; and an independent institution to investigate and research productivity (ie, the New Zealand Productivity
Commission).
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