Listener 28 February, 1998.

Keywords: Macroeconomics & Money;

While there is a widespread expectation that there will be a snap election, the political arithmetic does not stack up. There is a solid majority of parliamentarians who would suffer personally from an early election, losing there seats, there perks and their power. Even so it is possible that the political scene could change to the point where a majority might think they had a chance if an election was called early.

This column is about one economic debate which could lead to that outcome. Even if it does not, it is likely to be a dominant part of the political scene this year. Indeed, the Prime Minister was wrong (or badly advised) when on her first day of office she said 1998 would be a year of social policy concerns. As the Asian economies struggle through their financial and economic crises, the impact on New Zealand leaves us facing major economic policy choices.

Forecasters tend to under-estimate the strength of an economic downturn. The worst will be still revising down their assessments after economy activity turns up. The economy may look worse at the end of the year than the consensus thinks. Admittedly there are two major stimuli which will expand consumption: the mid-year income tax cuts and the demutualization of AMP which will put spending power into the pockets of those who receive the shares. However this may feed into importing rather than stimulating local production.

We expect then another year of slow and falling growth of economic production, with a policy tension between the government’s internal surplus and the economy’s external deficit (see below for details of the concepts). There will be political pressures to stimulate demand (and production and employment) by increasing government spending or reducing government taxation. (There will be particular pressures to bail out firms, industries, and regions which particularly suffer from exposure to the Asians, the weather, or whatever.) But this will compromise the falling internal surplus, so some will call for tax and spending cuts, while others for spending and tax increases.

Meanwhile the increasing external deficit will pose a threat to economy, with the worry that foreign investors will be increasingly unwilling to cover the current account deficit, a worry compounded if the exchange rate continues to fall steadily, so the investors make a capital loss. This is likely to drive up the domestic interest rates, which will be painful to mortgage holders, and to businesses. That will depress economic activity further, so there will be calls for a larger internal surplus to give foreign investors confidence. But a larger surplus, be it by tax hikes or spending cuts, will depress economic activity.

If at this point the reader is confused, so will be the economic debate. Virtually any policy combination of increasing or reducing government spending, taxes, and the internal deficit can be advocated. And each combination will be advocated by some political party, pressure group or politician/commentator. (Some political parties may find themselves advocating more than one combination.) The political tensions will be great, especially if there is a need for a mini-budget at the end of the year or in the run up to the 1999 budget. We could well find the government in policy deadlock (which is not as serious matter as it would have been two decades ago, for today’s economy is better at automatically regulating itself). It is not difficult to see a majority of MPs now thinking that perhaps they would personally gain from a snap election. National might think it could present itself as more responsible than Labour, while New Zealand First might think it had a chance by offering a different policy stance from its National partner. After numerous complicated twists and turns, parliament could dissolve early.

At this stage I do not know what stance I will take, because I need to know more about the detailed situation. However there will be commentators, politicians, and even economists, who already know what should be done: premature ejaculators who know the answers without knowing the questions. As the economic situation becomes clearer, and the economic debate becomes more confused, this column will return to the issue.

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Futures

In broad terms the internal surplus (a.k.a. the budget surplus) is the government’s surplus of tax and other revenue over all spending. Currently it is projected to be about $1.5 billion this fiscal year (to June). The cash surplus will be used to pay off government debt. The surplus is the difference between two large amounts (revenue and spending), each sensitive to economic circumstances, So there is a large margin of error in the forecast. It could rapidly swing into deficit if economic activity contracted.

The external deficit (a.k.a. the current account deficit of the balance of payments) is the shortfall of the nation’s receipts from exports of goods and services and the payment’s for imports of goods and services, including foreign debt servicing. It is forecast to be about $7 billion in the current year. The external deficit forecast is also the difference between two large numbers and subject to error.

Current Treasury Forecasts (December 1997)