Nicola Willis, the Reserve Bank and a tough road ahead

Thursday, 21 December 2023

OPINION: The Government’s mini-Budget and accompanying budget update made clear the size of the fiscal challenges facing New Zealand.

The mini-Budget itself was modest. A one-page list of well-telegraphed changes that will pare back Government spending a bit over four years and make some fiscal room for a tax cut package to be deliver in the May Budget.

It was more importantly a political statement from Finance Minister Nicola Willis about the Government’s intent and its approach to getting the country back into surplus. That was the key role it had to play - setting expectations for the coming six months. It succeeded in that regard.

There was consistent fiscal slippage under the previous Government, with spending outstripping projections. Former finance minister Grant Robertson defends that on many grounds, but primarily the once-in-a-century disruptive impact of Covid-19 and its subsequent bedfellow of both domestic and global inflation.

It isn’t that there is suddenly some massive fiscal problem that was unknown before the election - although there are certainly some biggies that were not known to the public including the Interislander cost blowout, which the Government has now scotched.

Willis was clear that National will be gripped with delivering a surplus in 2026-27 and stopping the slippage. Delivering surpluses matters for many reasons: getting debt down, which reduces interest payments and gives future Government more choices. For a small, trade-exposed nation such as New Zealand having buffers when required also matters.

And the broader economic trends are clearly going to make for a tough 2024. The Reserve Bank - and its Governor Adrian Orr - has indicated that the bank is determined to drive interest rates back into the target 1% to 3% band. Both the bank and the Treasury predict that the target band will be achieved by late next year.

At the same time, the Government’s fiscal stance will be one that is likely to be contractionary - or at least flat - in real terms.

Meanwhile, last week’s gross domestic product figures showed that the economy has been shrinking That is especially the case on per-capita basis.

And while the per-capita situation is worrying, all of New Zealand’s headline economic growth over the coming two years or so is expected to be generated by much needed inward migration - which in itself is inflationary.

The upside of all of this is that monetary policy will remain tight, trying to drive inflation out of the system. While fiscal policy will also be tightened to get the Government books into order and ensure the Budget surplus is not kicked further on down the road.

The upshot of all of that will mean a constrained economic environment. Discretionary spending is down, interest rates are up and household and business budgets are tight. And the Reserve Bank’s first job will not be to relieve any sputtering economic data through rate reductions, but to stay the course on inflation.

Fiscal and monetary policy will be in lockstep, meaning the only way that the Government will be able to get the dial moving by next May is through supply-side and micro-economic reform

How much of that will be achieved by the May Budget should be keenly watched. But economically, things are going to get worse before they better. The only way to squeeze inflation out is by doing just that.

The mini-Budget was political down-payment on that reality. But also a quiet acknowledgement that the next year the new Government will face the same economic sickliness the old one did.

But there is going to be a significantly different prescription.