Treasury Staff Insights: Rangitaki article by Anna Hamer-Adams, Analyst, Forecasting Team
Why do governments raise and spend money? One of many reasons is to influence the economy – to increase growth in times of recession, or to cool an economy down when it’s running too hot.
But how fiscal policy impacts the economy – and specifically by how much – is still an open question amongst economists. There is some generally accepted wisdom: The impact of fiscal policy on growth is likely smaller in open economies, with high levels of trade, floating exchange rates, with a central bank that actively targets inflation, and in times of high growth. This sounds a lot like New Zealand, doesn’t it?
There has been some New Zealand-specific research on the impact of fiscal policy, and the Treasury is currently conducting a wider review of fiscal policy, its impacts, and the tools we have to analyse it. Generally, past NZ research finds fiscal policy has a small impact on the economy (much less than one-for-one).
This blog summarises new research published by the Treasury and the RBNZ, with the latest data, and show the first attempt at using New Zealand data to analyse the effects of government consumption (eg, health) , government investment (eg, roads), transfers (eg, superannuation) and taxes (eg, goods and services tax) in the same model.
The impact of fiscal policy in New Zealand is similar to overseas
We find the impact of fiscal policy on the economy is larger than we previously thought, and is more in line with the impacts found internationally.
A standard way of measuring the impact of fiscal policy on the economy is to find the ‘multiplier’. This number shows how much GDP changes on average due to a fiscal stimulus (eg, a tax cut or increase in transfers) equal to one percent of the GDP.
We find that the multiplier is typically around one. Tax revenue has the largest impact on GDP (1.29% in GDP after a tax cut the size of 1% of GDP), followed by government consumption (0.82%) and transfers (0.76%). We find government investment has a negative multiplier (-0.59%) – a surprising and not particularly believable result.
Figure 1 shows our results (the blue bars) are largely similar to the average multipliers found overseas (yellow dots), and well within the range of multipliers found internationally (red and green bars). The estimated multipliers for public consumption and transfers are close to the overseas average. The multiplier on public investment is different to the mean internationally but lies within the (wide) range of multipliers reported. The estimated tax multiplier appears to be larger in New Zealand (at 1.30) than elsewhere (around 0.44). This could be due to the nature of New Zealand’s taxes, with more tax receipts from personal and corporate income than the OECD average.
Figure 1 - Comparison of GDP multipliers with the literature
Note: The numbers shown here are the impact on average in the first year following a policy change. The model we use is linear, so the impact of a 1% increase in, say, taxes is proportional to a 1% decrease.
How did we find these results?
We use a structural vector auto-regression (SVAR) model. An SVAR explains movements in each variable with past movements of all the variables included in the model. We chose to include seven variables in our SVAR: Government consumption, government investment, transfers, taxes, real expenditure GDP, inflation and 90-day interest rates. The sample is 1990Q3 to 2017Q4.
We wanted to make causal statements as a result of our research. That is, to say x caused y. To do so we had to identify instances where fiscal policy changed in a way that was unrelated (exogenous) to the state of the economy.
Take taxes for example. If we see tax revenue change, it could be that tax rates have changed, but it could also be because the economy has changed (eg, the population is growing).
We identify these the exogenous changes in fiscal policy with some judgements about the short-run behaviour of the economy. We use estimates from the OECD about the elasticity of taxes and transfers to changes in GDP, inflation and interest rates. We also use instructional information to assume that government spending responds to changes in the economy with at least a 3-month delay.
This analysis is one piece of a wider puzzle
These estimates are just one piece of a wider puzzle. The Treasury is conducting a wider review of fiscal policy, its impacts, and the tools we have to analyse it. The numbers here will help inform our economic and tax forecasts and other policy advice.
The data used for this work is available at Quantifying fiscal multipliers in New Zealand: The evidence from SVAR models. The more research in this area, the better!
Batini, N., Eyraud, L., Forni, L., & Weber, A. (2014). ‘Fiscal multipliers: Size, determinants, and use in macroeconomic projections.’ International Monetary Fund, Fiscal Affairs Department: Technical Notes and Manuals (14/04).
Blanchard, O. & Perotti, R. (2002). ‘An empirical characterisation of the dynamic effects of changes in government spending and taxes on output.’ The Quarterly Journal of economics, 117(4), 1329-1368.
Claus, I., Gill, A., Lee, B., & McLellan, N. (2006). ‘An empirical investigation of fiscal policy in New Zealand.’ New Zealand Treasury, Working Paper, (06/08).
Dungey, M., & Fry, R. (2009). ‘The identification of fiscal and monetary policy in a structural VAR.’ Economic Modelling, 26(6), 1147-1160.
Gechert, S., & Rannenberg, A. (2014). Are fiscal multipliers regime-dependent? A meta regression analysis (IMK working paper, No. 139-2014). Dűsseldorf, Germany: Macroeconomic Policy Institute.
Hamer-Adams, A., & Wong, M. (2018). Quantifying fiscal multipliers in New Zealand: The evidence from SVAR models (Reserve Bank of NZ Analytical Note, AN2018/05). Wellington, New Zealand: Reserve Bank of NZ and the Treasury.
Ilzetzki, E., Mendoza, E. G., & Végh, C. A. (2013). ‘How big (small?) are fiscal multipliers?.’ Journal of monetary economics, 60(2), 239-254.
Murray, J. (2013). ‘Parameter Uncertainty and the Fiscal Multiplier.’ New Zealand Treasury, Working Paper (13/19).
Parkyn, O., & Vehbi, T. (2014). ‘The effects of fiscal policy in New Zealand: Evidence from a VAR model with debt constraints.’ Economic Record, 90(290), 345-364.
-  IMF, 2009, Ilzetzki et al, 2011.
-  See previous work from the Treasury and elsewhere: Parkyn and Vehbi (2013), Dungey and Fry (2009), Fielding, Parkyn and Gardiner (2011), Murray (2013), Claus, Gill, Lee and McLellan (2006) .
-  Why do we not believe this number? In short, our model doesn’t capture long-term impacts, the Christchurch earthquake could be impacting our results, data quality for government investment is not great, and government investment is possibly too small to reliably look at (only 4% of GDP, compared to government consumptions which is 17% of GDP). Including government investment in our model doesn’t change the results for other types of fiscal policy. See the Quantifying fiscal multipliers in New Zealand: The evidence from SVAR models for more detail.
-  See OECD revenue statistics (2016): https://www.oecd.org/tax/revenue-statistics-new-zealand.pdf.
-  The min, max and mean of overseas multiplier estimates are sourced from Gechert and Rannenberg (2014).
-  See Blanchard & Perotti (2002).
-  First, information about the economy is usually published with a 3-month lag, and even then the government must decide what to do with this information and then implement their decision.