If you know the answer to how much public debt New Zealand should bear, you do not understand the issue.
You do not think that when a credit rating agency reviews New Zealand it looks only at the public debt-to-GDP ratio? It looks at a whole lot of indicators, some of which I mention below. So why does our public discussion focus exclusively on that ratio?
The appropriate ratio obviously depends on the circumstances. Suppose a business vital to New Zealand’s prosperity was about to collapse (Air New Zealand in 2001 was an example). The government might respond by nationalising the business (partially in 2001) involving a financial bail-out by taking over its debts ($885m). That amount would go onto the public debt. The debt-to-GDP ratio would go up, but that would reflect a disaster of inept private management not of the public sector.
It is not obvious that the government should then squeeze public spending to get the ratio down again. After all, for two decades until covid, Air NZ has paid dividends, which have more than covered the cost of the bail-out,. Our credit rating did not drop. The Credit Rating Agencies are more sensible than many in the public debate.
There have been a couple of changing circumstances which have led to the uncertainty about our debt strategy. One is that the Treasury thinks that for the next few years (it forecasts only until 2025) the real interest rate it pays on its borrowing will be negative. That means that providing the additional public debt is used to fund prudent investment, future generations will be ahead. There is a sense in which the debt burden is actually falling even if the debt-to-GDP ratio is up.
To explain the other markedly changed circumstance, we need to go back into our history. On a number of occasions New Zealand has had trouble borrowing for prudent purposes in international markets. They include during the Long Depression of the 1880s, during the Great Depression, in 1939 (we were ‘saved’ by the war, but that is not something we should rely upon), on various occasions during the postwar era including in 1984 when, so I am told, the IMF was nearly called in.
Especially instructive was the 2008 Global Financial Crisis following the floating of the exchange rate, the government only borrowing in New Zealand currency and the debt ratio being low. The problem was that the private sector had been borrowing heavily offshore – mainly to fund housing. There was a danger that the international financial markets were going to jam – nothing to do with us – which would have meant that the trading banks would not have been able to roll over their foreign borrowings. To shorten the story, they would have gone to the government which would have had to take over the debt – in a way not germane to this story, it sort of did – and raise the foreign exchange to pay off the trading bank debts.
What might have happened could have been catastrophic, but fortunately the Reserve Bank arranged a swap with the American Federal Reserve. The details need not detain us. Essentially it meant that the RBNZ could borrow American dollars if it needed them. Fortunately it did not, because the swaps were a major contribution to giving the international confidence which unjammed the markets. What is relevant here is that New Zealand was one of only a handful of central banks to which the Fed made the facility available.
Why? It was nothing to do with ANZUS. Rather the Fed acknowledged that we had low public debt, were soundly fiscally managed with meaningful public accounts and good credit ratings, so they could prudently lend to us. So our economic management made a small contribution – punching above our weight – in the unjamming of the world’s financial markets.
One of the reasons for a good quality debt position is to deal with unexpected shocks. They include international financial meltdowns, physical events (like earthquakes), pandemics and the unknown unknowns. (A couple of years ago economists would not have mentioned pandemics. They would have been among the unknown unknowns – there are many other things in there.)
We might argue that it would be prudent to maintain a debt-to-GDP ratio similar to that of other countries like us which were well managed. A typical ratio there was 40-50 percent. But in my view, because of the external exposure of our private sector, we needed a lower level; I was not uncomfortable with 20-25 percent on this basis.
The Covid Crisis has changed all this. Countries have been borrowing to deal with its economic impacts – rightly, but not all of them prudently. So the debt-to-GDP ratios of our comparators are rising. That interest rates are low suggests that their debt levels will remain ‘up there’ after the crisis is over, although we are not sure how high. The previous paragraph suggests that we too could raise our debt-to-GDP ratio target, but at this stage we do not know by how much. Hence the government’s cautions when asked about it.
The ratio is a medium term target. The amount of borrowing in any year should reflect the need to smooth out the natural fluctuations of an economy. We should certainly be willingly to use borrowing to deal with shocks. I thought the Key-English Government was wrong to fund the consequences of the Canterbury Earthquakes by squeezing the public services; we are still suffering from their decision. (They may have been unwilling because they were still unwinding from the GFC.)
If we go to a higher debt-to-GDP ratio target, we do face the problem of who holds the debt – whose asset is it? We do not talk about this enough.
At the moment, much of the covid financial injections seem to be running around looking for a speculative home: housing, shares, collectables, bitcoin ... Some appears to be being held in individuals’ bank accounts with the danger they may spill out into consumer inflation. (Some is being used for house extensions – hence the pressure on building supplies and builders.) The government should be trying to sterilise this loose cash by getting people to pay off more of their housing mortgages and putting more aside for retirement in, say, Kiwisaver. (They will need more retirement funds if, as is generally expected, real interest rates remain low.)
Not all serious economists may t exactly agree with what I have written here. That is why we are discussing appropriate debt management policies. There is much of the argument to fill out and I’ve not given any parameters. We have time to discuss such issues. The critical thing is not to be trapped in the past and to recognise that anyone who is certain of the answers has not understood the question.