The visible hand in economics

Agreeing with Treasury or the Finance Minister?

Posted on: December 4, 2008

I am surprised to see Bill English slam his former department – of course it is entirely likely that the newspaper is simply exaggerating his reaction to their briefing.

The core of Bill English’s criticism of Treasury appears to be that “they aren’t thinking of ways that fiscal policy could prevent the recession”. But maybe they believe that it is not the role of fiscal policy to stabilise activity while monetary policy still has plenty of bullets left?

If that is the case then their focus on the “medium term” makes sense – doesn’t it. Well not quite.

We still have the issue of distribution – a recession is especially painful because the loss is not spread evenly (or to be closer to correct, it is not spread in a way that appropriately associates the individuals cost of losing a job to the actual lose of a job – there is no “market price” for getting fired which can be used to ensure that those who value work at the highest rate keep their jobs!).

The cost of a “temporary slump in demand” is felt disproportionately by those who lose their jobs. As a result, there may be a role for government to re-distribute, in order to buffer the pain of the recession – even if they can’t prevent the recession.

Is that the type of plan Bill English wanted from them? I don’t know – I suppose things will become clearer as the briefings are made public.

Update: Gareth notices the briefing here.  Sounds like a medium term strategy (given that is what they call it!) with a mention that fiscal stabilisers are sufficient for variability

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14 Responses to "Agreeing with Treasury or the Finance Minister?"

Thanks🙂

A bunch of “productivity” stuff aye – good times

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The NZI/NSX idea of a holiday on provisional tax has some merit. John Key has ruled out a temporary GST cut (such as in the UK). Other than that, best just to keep encouraging the RBNZ to ease monetary policy IMHO. I’d much rather Treasury focused on improving living standards over the next 20 years, especially now that they should have a receptive Govt.

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“The NZI/NSX idea of a holiday on provisional tax has some merit”

Although, this relies on the belief that the issue in the New Zealand economy is one of a “demand deficiency”. If we don’t believe this is the case, then even a temporary fiscal stimulus could be damaging

No Matt, the NZI/NZX idea relies on the idea that firms face temporary cash shortages due to current credit conditions and the problems that this is causing some firms that rely on bridging finance to do the basic things like pay employee salaries over the Xmas break. And it also notes that in the current environment it ios very hard for firms to estimate their tax liability with a degree of accuracy. A holiday (of some form) on provisonal tax would not change the tax liability, just delay it.

“No Matt, the NZI/NZX idea relies on the idea that firms face temporary cash shortages due to current credit conditions and the problems that this is causing some firms that rely on bridging finance to do the basic things like pay employee salaries over the Xmas break”

Fair point. In this case we at least need to believe that firms are currently credit constrained – although I agree that they are the assumption still needs to be made.

I thought that the Treasury briefing was a timely reminder that short-term fluctuations, even big ones, are less important to long-term living standards than the trend level of growth, of which productivity is the main determinant.

If we can life labour productivity from 1.5% to 2.0% and sustain that for a decade, then our GDP will be much higher than if we do some things to return the level of GDP to the level that applied 18 months ago and then leave it there.

I also thought that Treasury were saying, subtly, that some of the short-term “fixes” being proposed might actually do more harm than good.

This is were I part company with the NZI/NZX idea. Not because I don’t think that some firms could do with some extra cash-flow (they always can), but because their idea doesn’t address the root cause of the problem. And because it adds an unnecessary criteria to judging tax administration policy, namely short-term fiscal policy.

If firms are having trouble accessing finance because of a solvable market failure, then we should fix that failure. If we can’t fix that failure, then we just ave to accept the world as it is and acknowledge that there will always be marginal firms who are no longer profitable in the prevailing circumstances.

I thought that the Treasury briefing was a timely reminder that short-term fluctuations, even big ones, are less important to long-term living standards than the trend level of growth, of which productivity is the main determinant.

If we can lift labour productivity from 1.5% to 2.0% and sustain that for a decade, then our GDP will be much higher than if we do some things to return the level of GDP to the level that applied 18 months ago and then leave it there.

I also thought that Treasury were saying, subtly, that some of the short-term “fixes” being proposed might actually do more harm than good.

This is were I part company with the NZI/NZX idea. Not because I don’t think that some firms could do with some extra cash-flow (they always can), but because their idea doesn’t address the root cause of the problem. And because it adds an unnecessary criteria to judging tax administration policy, namely short-term fiscal policy.

If firms are having trouble accessing finance because of a solvable market failure, then we should fix that failure. If we can’t fix that failure, then we just ave to accept the world as it is and acknowledge that there will always be marginal firms who are no longer profitable in the prevailing circumstances.

Sorry for the double post: I was trying to see if I could fix a typo after you have added a comment, and it appears that you can, but only at the expense of a double post.

Any advice on how to be more efficient much appreciated.

“I thought that the Treasury briefing was a timely reminder that short-term fluctuations, even big ones, are less important to long-term living standards than the trend level of growth, of which productivity is the main determinant.”

Indeed – a very apt point.

This is part of the reason why the RBNZ is forecasting 4%+ growth out in 2011 – as long as it is not a supply side shock economic activity will rebound.

“I also thought that Treasury were saying, subtly, that some of the short-term “fixes” being proposed might actually do more harm than good.”

A point where I would agree🙂

“This is were I part company with the NZI/NZX idea. Not because I don’t think that some firms could do with some extra cash-flow (they always can), but because their idea doesn’t address the root cause of the problem. And because it adds an unnecessary criteria to judging tax administration policy, namely short-term fiscal policy. …

… If we can’t fix that failure, then we just ave to accept the world as it is and acknowledge that there will always be marginal firms who are no longer profitable in the prevailing circumstances”

Agreed in part. Ultimately, the root cause of the problem is credit constraints stemming from temporary shocks offshore.

A temporary policy to help alleviate the impact of these credit constraints (which are huge by historical standards) makes some sense – in a second best world methinks. The government in this case is the “borrower of last resort” – they have access to credit markets when some profitable firms have lost it.

There is a degree of hysteresis in the economy – we don’t want firms that would normally be profitable and competitive shutting down and destroying human and entrepreneurial capital just because of a temporary shock.

However, I think there is a risk of doing “too many” of these short term fixes, and causing uncertainty for businesses – which would be damaging.

Should we let firms fail – yes. Should we cushion any temporary blows that aren’t simply the result of individual and firm level maximising behaviour – yes. Observing this sort of thing is difficult – but the existence of a inflamed credit constraint is highly obvious IMO.

I share your concern that the government will do TOO MUCH though – I am not worried that they will do too little😛 . As a result, the discussion on the tax holiday is merely “academic”.

“Sorry for the double post: I was trying to see if I could fix a typo after you have added a comment, and it appears that you can, but only at the expense of a double post.

Any advice on how to be more efficient much appreciated.”

No worries – I have no idea how to be more efficient😛

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