125220 Topic 12: Fiscal Policy (in NZ & impact on Financial markets)

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125220 Topic 12: Fiscal Policy (in NZ & impact on Financial markets)
2015-10-20 01:25:29
125220 Topic 12

fiscal policy
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  1. Fiscal Policy & instruments of fiscal policy
    Means by which a government adjusts its spending levels and tax rates to monitor and influence a nation's economy

    • Tools used include
    • - taxes
    • - government spending or outlays &
    • - transfer payments
  2. Fiscal policy & NZ
    • NZ tax reform since 1984 generally aimed at broadening, simplifying & flattening tax scales (still progressive for income tax)

    • •New Zealand has a progressive tax system
    • ⇒Individual tax payments ↑ as fraction of income as income ↑
    • ⇒As people earn more, they pay a higher marginal tax rate.
  3. NZ Fiscal Policy
    - Results & current debate
    • Results ⇒ limited success. e.g. end of 2007, 44% of revenue from personal income tax high when compared internationally

    • • Current debate on level of taxes- evidence to suggest high taxes harm economic growth.
    • • Argument that reducing taxes could ⇒ to greater tax take by stimulating economic growth.
  4. Tax bracket creep
    • With successive governments ⇒ income tax bracket creep:
    • Over the years, tax changes ⇒ large bracket creep)
    • In 2004, incomes over 60k, 308,000 people (10%) paid $9,480m = 46% of income tax take
    • In 2015, incomes over 70k, 586,000 people (17%) paid 16,848b = 60% of income tax take. (large bracket creep in recent years)
  5. Effects of Government Borrowing & Budget Surplus/Deficits on Financial System & the Economy
    • Budget Deficits where government spending exceeds income (taxes & other minor sources e.g. interest, fees & fines)
    • So deficit → government must borrow by issuing govt. bonds
    • (1) if a govt wants to use expansionary fiscal policy & stimulate an economy but is running a budget deficit, one option is to
    • borrow so it can increase its expenditure (G)
  6. Effects of Government Borrowing & Budget Surplus/Deficits on Financial System & the Economy
    • Borrowing from the domestic market
    • central bank issues $100m govt bonds to borrow.
    • - If govt spends all funds ⇒ no change in money supply.
    • ⇒ Increase in real gross domestic product (GDP) in short-run. If one-off borrowing, first, upward pressure on ST interest rates
  7. Effects of Government Borrowing & Budget Surplus/Deficits on Financial System & the Economy
    - Borrowing funds from overseas markets
    • - initially, no impact on local borrowing, then either inflationary or growth creating (↑ in govt expenditure ⇒ increase in real gross domestic product (GDP) in S/T, & likely increase in taxes paid)
    • - Long term ⇒ the debt has to be repaid with interest ⇒ contractionary impact on economic growth in L/T.
  8. Fiscal policy
    For contractionary fiscal policy
    • If a government wanted to contract an economy using fiscal tools, it could cut its expenditure (spending) (G) overall.
    • - or raise taxes ⇒ people will consume less as their net disposable income drops.
    • - or reduce transfer payments- targeted groups spend less.
    • However, the size & timing of fiscal tools is crucial

    If a government expenditure increases too late after a recession, it may well cause a boom in GDP & inflation increases.
  9. Budget Surplus
    • • Budget Surplus where income exceeds expenditure
    • • Options: Govt can retire debt or cut taxes or build up assets or increase govt. spending.
    • • Impact of govt debt retirement on the economy & the financial system depends partly on who holds the debt securities
  10. Budget Surplus:
    Retirement of Govt Debt held by domestic market/overseas institutions
    Retirement of Govt Debt held by domestic market - interest rates may fall when govt security holders save the money they receive & govt need for funds drop. Also govt risk drops.

    • • Retirement of Govt Debt held by overseas institutions more independent policy setting regime.
    • Initially, no demand ↓ for domestic loanable funds ⇒ no impact on interest rates.
    • - But retirement of debt makes govt safer (credit rating) & reduces need to service debt with interest so interest rates should fall
  11. Issues relating to Government Debt
    • Amount of debt usually compared with GDP
    Actual percentage an indication of easily it can be paid back
  12. Issues relating to Government Debt
    • Preserving an efficient capital market
    • Argument for preserving the liquidity of key benchmark maturities - contingency to ensure ready market if needed & to underpin  pricing of other securities.
    • – Example of countries introducing govt bond market
    • – Many countries require their banks to hold govt securities for liquidity purposes or reserve requirements
  13. Issues relating to Government Debt
    • Where is government debt is held?
    • International borrowing creates capital flows (dividends) from the country with capital not being used for productive purposes & impacts on monetary policy.
    • As well, it results in foreign exchange risk for country.
    • • The reason for borrowing the money. If it is borrowed forproductive purposes
  14. • Net Government debt
    • Net debt peaks as a share of GDP in 2014/15...
    • • While the Crown returns to operating surplus in 2014/15, core Crown operating cash flows remain in deficit a further year, not reaching surplus until 2015/16. By 2016/17, the re Crown cash surplus is expected to reach $3.9 billion.
    • • While operating cash flows are positive by 2015/16, net capital spending is expected to exceed these cash flows. As a result, residual cash remains in deficit for each year of the forecast period. These deficits are funded by an increase in net debt. In nominal terms, net debt is expected to peak in 2016/17 at $70.3 billion before beginning to decline. However, net debt peaks as a share of GP in 2014/15 at 28.7% (Figure 2.11) as the growth in the economy is expected to outpace the increase in net debt.
  15. Management Of Government Debt
    • What effect does a Government’s debt have on financial markets?
    • Managing risk - rate
    • → foreign exchange risk
    • → interest rate risk

    • • May have a large effect as it affects money & capital markets through interest rates, exchange rates & the flow of funds especially if government demand fluctuates
    • • New Zealand transferred its debt from overseas debt to internal public debt over the last twenty years.
    • • Net public debt (NZ lends some money offshore as well).
  16. Key fiscal questions & how they relate to NZ are:
    • Size of government
    Research suggests it should be decreasing. Govt is major player in markets- its efficiency is important in terms of the overall good.

    • In 2013 Budget crown expenses $73.7b (33.8% of GDP)
    • In 2014 Budget crown expenses $73.1b (30.3% of GDP)
  17. Key fiscal questions
    Some Points
    • • Advisable to grow GDP. If GDP is falling, hard for govt. to move into surplus as tax take ↓ & so a government must cut expenditure by more than the decrease in GDP.
    • • GDP decline (growth) is mirrored by decline (growth) in employment.
    • • Changes in tax collections & in expenses are called automatic stabilisers- in economic expansion, fiscal deficit moves towards surplus
    • • & in contraction, surplus falls & moves towards deficit
    • • Fiscal policy may reach where monetary policy cannot – Can target specific industries, social groups
  18. Relationship between Monetary policy and Fiscal policy given Monetary policy objective is stable prices
    • Domestic Demand affected by:
    • • Increases or decreases in current disposable income.
    • • Increases or decreases in fiscal deficit/surplus.
    • Interest rates affected by:
    • • Fiscal policy impacts on domestic demand & may alter demand on funds.
    • • Sustainability of fiscal policy/monetary policy mix may → to changes in risk premium for funds.
    • • Capital market effects related to government funding needs.
    • Direct inflation affects:
    • • Changes in indirect tax rates, tariff levels, Govt user charges.
  19. Assessing Fiscal Policy in Practice - Debt
    Sustainability & Debt Stabilisation Ratio (DSR)
    • Use ratio to assess if fiscal policies lead to worsening, or improvement or stabilisation of government’s net debt position
    • Where:
    • D = nominal net govt. debt
    • GDP = nominal GDP
    • r = forecast real interest rate on govt debt
    • g = forecast real GDP growth rate, &
    • DSR = ratio of the primary fiscal balance to nominal GDP
  20. DSR
    • Used to estimate size of financial surpluses to stabilise ratio of net debt to GDP.
    • A high positive DSR needs a high fiscal balance (as a % of GDP) to hold the net govt. debt to GDP at a specified level
  21. If DSR equals 5%, whats does this mean?
    To maintain this level of debt, we need a primary surplus of 5% (of GDP). The primary surplus = govt. budget surplus before interest charges on govt debt are considered.
  22. In 2015, some countries’ net government debt:
    • Since 2009:
    • US 59.3% → 87.9% of GDP
    • UK 64.1% → 101.9% of GDP
    • Japan 186.6% → 255.5% of GDP
  23. Importance of Fiscal Policy:
    • • For countries continually running a budget deficit, risk profile of country higher, so too is interest rates, & money has to be borrowed from mainly off-shore to fund it.
    • • Pertinent issues:
    • – if the size of Government spending in relation to GDP increases? Research suggests inefficiencies can arise.
    • – Have been many sovereign defaults in the past e.g. Spain
    • – Countries with big primary deficits, big debt stocks & big gap between interest rates & growth very vulnerable