No, I’m not talking about the cycleway – although if Bill English does want to cut “nice to haves” surely this is a place to start 😉
I’m talking about this comment from Ganesh Nana, where I both agree with him and disagree with him simultaneously.
The plans (to cut spending) were criticised by BERL chief economist Ganesh Nana, who said cutting more state sector jobs and squeezing spending further at this point in the cycle risked keeping the economy down for longer.
It is true that when we have a cyclical downturn, cutting spending without a coordinated cut in interest rates from the central bank is likely to exacerbate the cycle.
And it is true we are in a cyclical downturn – output in the economy is below its potential level.
However, there are three factors that could well justify SOME cuts to government spending – as long as they don’t try to close the deficit immediately.
- The Reserve Bank still has the ability to respond by loosening monetary policy (although the effectiveness of cutting at current lows is a matter of debate),
- The cuts are focused on extremely low productivity elements of spending, as a result the contractionary impact will be smaller than in the case of indiscriminate cuts.
- Most importantly, the focus of the cuts are to remove the “structural” deficit.
The third point needs more explanation. Fundamentally, the “potential size” of the New Zealand economy is now believed to be smaller than it previously was. As a result, in order to have government taking up the same share (a share that is determined by the tax take, which is hopefully set according to the share society desires) the level of government spending does need to be lower – or else we run a structural deficit.
Structural deficits are not cool, it implies that the government won’t balance the books over the economic cycle and will cause unnecessary disruption to economic activity when it does try to – and as a result, it is often seen as a good idea to minimise them.
Now, for an economist I am actually relatively comfortable with short-term structural deficits. I believe that estimating “potential” is tough, and as long as spending is transparent small structural deficits and surpluses are hard to separate from cyclical ones. However, while the government should buffer the economy over the “cycle” it is true that in its structural sense it does need to balance its books like a household.
As long as any tightening is based on the three points listed above, I don’t think Dr Nana needs to be too concerned regarding the impact on the broader economy. However, if they do go further just for the kicks, then his concerns are very relevant.