This is a re-post of a article originally published on pundit.co.nz. It’s here with permission.
Don’t you think that when a credit rating agency looks at New Zealand, they only look at the government debt to GDP ratio? It looks at a large number of indicators, some of which I mention below. So why is our public debate focused exclusively on this ratio?
The appropriate ratio obviously depends on the circumstances. Suppose a business vital to New Zealand’s prosperity is about to collapse (Air New Zealand in 2001 was one example). The government could react by nationalizing the company (partially in 2001) involving a financial bailout by taking over its debts (885 million dollars). This amount would go on the public debt. The debt-to-GDP ratio would increase, but this would reflect a disaster of inept private management and not of the public sector.
It is not obvious that the government must then cut public spending to bring the ratio down. After all, for two decades until covid, Air NZ paid dividends, which more than covered the cost of the bailout. Our credit rating has not gone down. Credit rating agencies are more sane than many in the public debate.
There have been some changes in circumstances which have led to uncertainty about our debt strategy. One is that the Treasury believes that for the next few years (it only projects until 2025) the real interest rate it will pay on its loans will be negative. This means that if the additional public debt is used to finance prudent investments, future generations will be ahead. We get the impression that the debt burden is decreasing even if the debt-to-GDP ratio increases.
To explain the other significantly altered circumstance, we must go back to our story. New Zealand has repeatedly found it difficult to prudently borrow in international markets. They include during the Long Depression of the 1880s, during the Great Depression, in 1939 (we were “ saved ” by war, but that is not something we should be relying on), on various occasions during the post-war period, including 1984 when, I am told, the IMF was almost called upon.
The 2008 global financial crisis following the floating exchange rate was particularly instructive, with the government borrowing only in New Zealand currency and the debt ratio being low. The problem was that the private sector was borrowing heavily from abroad – mainly to finance housing. There was a danger that the international financial markets would crash – nothing to do with us – which would have meant that commercial banks would not have been able to roll over their loans abroad. To shorten the story, they would have gone to the government that should have taken over the debt – in a way that was unrelated to this story, it sort of did – and increased foreign exchange for repay commercial bank debts.
What could have happened could have been catastrophic, but luckily the Reserve Bank arranged a trade with the US Federal Reserve. Details shouldn’t hold us back. This essentially meant that the RBNZ could borrow US dollars if it needed to. Fortunately, this is not the case, as swaps have been a major contribution to the international confidence that has unlocked the markets. What’s relevant here is that New Zealand was one of the few central banks that the Fed made the facility available to.
Why? It had nothing to do with ANZUS. On the contrary, the Fed admitted that we have low public debt, that we were well managed on the fiscal front with significant public accounts and good credit ratings, so that they could lend us cautiously. Thus, our economic management made a small contribution – strikingly beyond our weight – in unblocking global financial markets.
One of the reasons for good quality debt is to deal with unforeseen shocks. They include international financial meltdowns, physical events (such as earthquakes), pandemics, and unknown unknowns. (A few years ago, economists wouldn’t have mentioned pandemics. They would have been one of the unknown unknowns – there’s a lot of other stuff in there.)
We could argue that it would be prudent to maintain a debt-to-GDP ratio similar to that of other countries like us that have been managed well. A typical ratio was 40 to 50 percent. But in my opinion, due to the external exposure of our private sector, we needed a lower tier; I wasn’t uncomfortable with 20-25 percent on that basis.
The Covid crisis changed all that. Countries have borrowed to deal with its economic impacts – rightly so, but not all with caution. The debt / GDP ratios of our comparators are therefore on the rise. The fact that interest rates are low suggests that their debt levels will remain “high” after the crisis is over, although we don’t know how much. The previous paragraph suggests that we too could raise our debt-to-GDP ratio target, but at this point we don’t know by how much. Hence the government’s warnings when asked about it.
The ratio is a medium term objective. The amount of borrowing in a year should reflect the need to smooth out the natural fluctuations of an economy. We should certainly be happy to use borrowing to deal with shocks. I thought the Key-English government was wrong to fund the consequences of the Canterbury earthquakes by cutting back on public services; we still suffer from their decision. (They may have been reluctant because they were still rolling out of the GFC.)
If we move to a higher debt-to-GDP ratio target, we are faced with the problem of who owns the debt – what asset is it? We don’t talk about it enough.
Right now, a large portion of covid’s financial injections appear to be chasing speculative housing: housing, stocks, collectibles, bitcoin … Some appear to be held in individual bank accounts with danger. that they spill over into consumer inflation. (Some are used for house extensions – hence the pressure on building materials and builders.) The government should try to sterilize that cash by forcing people to pay off more of their real estate mortgages and put more aside for retirement, say, Kiwisaver. (They’ll need more retirement funds if, as is generally expected, real interest rates stay low.)
All serious economists may not quite agree with what I have written here. That is why we are discussing appropriate debt management policies. There is a big part of the argument to fill out and I didn’t give any parameters. We have time to discuss these issues. The main thing is not to be trapped in the past and to recognize that anyone who is certain of the answers did not get the question.
Brian Easton, independent researcher, is an economist, social statistician, public policy analyst and historian. He was the Auditor economic columnist from 1978 to 2014. This is a re-post of a article originally published on pundit.co.nz. It’s here with permission.