Analyzing the Fiscal and Monetary Policy of New Zealand

New Zealand is a small island country located off Australia. While it has a developed economy, it is subject to volatile fluctuations in GDP growth, due in large part to its dependence on trade and exports for much of its GDP. Additionally, the government takes an active role in the economy with large social programs, state-owned-enterprises, and involvement in healthcare. By evaluating different factors of the economy, we can surmise whether or not this is a good investment location for a new manufacturing plant. We will look at fiscal and monetary policy, GDP figures and components of GDP, trends in these components, New Zealand’s trade and its trading partners, and the exchange rate between USD and NZD as key determinants in our investment decision.

Fiscal and Monetary Policy

Like many economies in the developed world, New Zealand was hit by the recent financial crisis and acted by altering its monetary and fiscal policy. Due to the joint structure of the New Zealand Treasury and Reserve Bank, the Treasury maintains control over the fiscal policy of the Crown, including management of SOEs (state-owned enterprises) while the Reserve Bank controls the OCR (official cash rate) and reserve requirements of banks – the monetary policy.

The Treasury’s role in fiscal policy and its response to the financial crisis of 2008-2009

According to the 2009 Fiscal Strategy Report, the Treasury will focus on bringing down debt to a prudent level; ensure a stable economic environment, and a public sector that produces quality goods. In order to achieve these goals, the Treasury will look at long-term debt as net debt to evaluate the strength of its financial position, review the long-term debt level forecasts to include the effect of the 2008-2009 crisis on the national debt level, reduce the allowances from the planned 2010 budget, and delay tax cuts and investment fund payments until the economy stabilizes.

Due to the nature of New Zealand’s economy, the size of purchases by the government has a large impact on the overall GDP. New Zealand’s government spending is close to 35% of its GDP, consistent with the Treasury’s goal of increasing productivity and improving the lives of New Zealanders. As the chart to the right shows, in a period of recession, such as 1999-2000 or 2008-2009, the government increased spending as a percent of GDP to compensate for decreased consumer spending. This suggests that New Zealand follows a Keynesian view that a recession should be countered by increased government spending as the recession is caused by decreased consumer demand.

Monetary policy and change during the 2008-2009 financial crisis

As part of New Zealand’s monetary policy, the Reserve Bank of New Zealand controls the banking system primarily through the Official Cash Rate (OCR), but also sets reserve requirements for the banks. The chart to the right shows the OCR since 1999. Of particular interest is the large drop in the OCR during the 2008-2009 crises. The OCR changed from 8.25% to 2.5% over nine months. The Reserve Bank has expressed its policy to keep the OCR at a historic low rate until the middle of 2010 based on pressure from CPI inflation, subdued credit growth, and weak business spending.

Potential for more public debt issuances

The Treasury has made clear that it is concerned about the forecasted debt levels moving forward. While the Reserve Bank believes some debt increase is necessary to keep the New Zealand dollar from depreciating too much, both institutions believe the debt needs to be adjusted to be less than 20% of GDP. This would mean the government is pursuing a plan to pay down debt after the crisis abates.

Adam Link is an avid follower of the financial markets and constantly looking for the next arbitrage opportunity. He has written on topics ranging from debt markets to Internet start ups to complex financial transactions. His passions include his company, Liekos Group (found online at [http://www.liekosgroup.com]), and traveling when his schedule allows

Monetary Policy Vs Fiscal Policy

MONETARY POLICY

Monetary Policy is the process undertaking by monetary authority of concerned country to control the supply of money, usually targeting a rate of interest. Generally Monetary Policy exercised to achieve a set of goals towards the growth as well as stability of economy. Normally these objective or goals contains reduction of unemployment and stability of prices. Monetary theory provides way to make best monetary policy.

Monetary policy can be either an expansionary policy, or a contractionary policy. Where an economy increase the total supply of money rapidly is said to be Expansionary Policy and when an economy decrease the total supply of money or increase it unhurriedly it is called contractionary Policy. Expansionary Policy generally used to overcome unemployment in the recession by decreasing the interest rate. Where as the Contractionary Policy is used to meet the inflation by increasing the rate of interest.

Monetary Policy rests on the association of rates of interest in an economy. The money can be borrowed and can supply on this price. Monetary policy is a tool to have power over inflation, exchange rate with foreign currencies, economy growth and unemployment.

The most important thing which policymakers should follow is to make a reliable policy and denounce interest rate targets because they are not much important in respect of monetary policy. If an employee thinks the price to be higher in future then he/she would create a contract with higher wages to meet this high price. So the belief of lesser wages indicates wages-setting behavior among personnel and owners. And while wages and lesser there can not be demand-pull inflation as employees are getting a minor wage and there will no cost-push inflation as employer are playing not much money in wages.

FISCAL POLICY

Fiscal policy is exercised for Govt. expenditure and to collect revenue to control the economy. Fiscal Policy is deferent from other major Policies like macroeconomic Policy and monetary policy which are used to control the economy by the help of interest rate and supply of money. Main tools of fiscal policy are expenditure of government and taxation. Transformation in the level and compiling of taxation and government payments can affect the variables in an economy like cumulative demand and economic activity levels, pattern of resource allocation, income distribution.
There are three view of fiscal policy, neutral, expansionary and contractionary. These all are defined as under;

• A neutral view point of a fiscal policy means a balanced economy. This includes the larger tax revenue, Govt. expenses are totally supported by tax revenue and overall budget result neutrally affects the level of economy.
• An expansionary view point of fiscal policy contains a larger government spending than tax revenues.
• In a situation when Govt. spending is lesser than tax revenues is called Contractionary fiscal policy.

Fiscal and Monetary Policy

Imagine you are listening to the radio around the year 1900 and there is news that the economy is going to enter into a recession. Chances are that sooner or later you will not have a job, and there isn’t going to be nearly as many goods available because of lack of production. The only thing of any value will end up being the money in your checking and savings accounts, so the only choice you have it to run to the bank and get hold of that money. The problem: every other person who just heard that announcement is thinking the same thing, and now there’s going to be a run on the bank, or even worse, a bank panic. This was a serious dilemma prior to the year of 1913 – the year the Federal Reserve Bank was established – because there was no way to ensure the economy would remain stable. Although bank panics were not an everyday thing, it was something that citizens had to worry about more than they do today. When the Federal Reserve Act of 1913 was set in place, however, two policies were enabled to monitor and help control the stability of the economy: to this day they remain a very important part of our government and these courses of action are known as monetary policy and fiscal policy.

To fully understand the purpose of monetary and fiscal policy, it is important to look at the structure behind them. The basis of these policies comes from the Federal Reserve. The “Fed” is a fairly simple system to understand: it is the central bank of the United States. This central bank is broken down into districts; the Board of Governors being the most recognized, but also included is the Federal Open Market Committee. Today the head chairman of the Board of Governors is Benjamin Bernanke, and he oversees all the actions that are taken.

The Federal Reserve is the only bank with the power to control a run on the banks or a bank panic. It holds the money available to lend to smaller banks as a last resort in bad economic times. Therefore, the Federal Reserve plays a huge part in controlling the money supply of the US. When the “Fed” was established, so was monetary policy. In the book Macroeconomics by R. Glenn Hubbard and Anthony Patrick O’Brien, monetary policy is defined as “the actions the Federal Reserve takes to manage the money supply and interest rates to pursue economic objectives.” These certain objectives include maintaining a stable economy, increasing economic growth, keeping unemployment at a satisfactory low, and keeping prices of goods and services stable in order to minimize the chances of inflation.

The Federal Reserve uses three separate tools of monetary policy to maintain the money supply. These tools include open market operations – controlled by the Federal Open Market Committee – and the discount rate and reserve requirements, which are controlled by the Board of Governors. Open market operations are a tool used by the FOMC to increase the money supply through the buying and selling of Treasury securities. The trading desk at the Federal Reserve Bank in New York is designated to buy these securities and the sellers deposit them into banks. These deposits increase the reserve of the bank which in turn increases the total money supply because there will also be an increase in loans and checking account deposits (Hubbard/O’Brien). The FOMC also has the power to decrease the money supply by reversing the operations of that same process.

The branch of the “Fed” which controls the other two tools of monetary policy is the Board of Governors. One tool, the discount rate, is defined as “the interest rate the Federal Reserve charges on discount loans (Hubbard/O’Brien). If a bank needs to increase the money available in their vault, otherwise known as their reserve, they turn to the “Fed” for the money and this loan is known as a discount loan. However, unless the Federal Reserve has become the last resort in the case of a recession, discount loans are not typically taken out by banks.

In certain instances, such as the case of Black Tuesday when the worst stock market crash hit the United States, discount loans did not save the economy. It was not until after the Great Depression when the run on the banks caused a severe bank panic that Congress established deposit insurance. In other words, prior to the Federal Deposit Insurance Corporation, a person was neither assured that the money they held in the bank was safe nor that they would be able to retrieve it if the economy were to fall into a recession.

The third tool of monetary policy which is also controlled by the Board of Governors to help manage the money supply is reserve requirements. It is a rare occasion for the Fed to change the reserve requirements though. In essence, changing the reserve requirements entails the banks to make “significant alterations in holdings of loans and securities” (Hubbard/O’Brien). Although it is not a common course of action, it is still purposeful. When the Fed decreases the reserve requirements, it allows the banks to use the excess money to loan out as opposed to holding in the vault. Conversely, if the Fed chooses to increase the reserve requirement, the banks will have less money to lend out. Either way, though, the Fed is makes the change based on the assumption that it will help the economy. All of these tools of monetary policy are followed through with the intention of meeting the objectives stated previously. On the other hand, fiscal policy also plays and important role in helping to maintain a stable economy.

Fiscal policy is defined as “the changes in federal taxes and purchases that are intended to achieve macroeconomic policy objectives” (Hubbard/O’Brien). Fiscal policy is similar to monetary policy in terms of what it attempts to achieve, but varies because of the way it tries to do so. Changes in taxes and spending are controlled solely through the federal government.

A better understanding of fiscal policy can be explained through the ideas of John Maynard Keynes. His theory came about after the Great Depression and said if the governments were to spend more money in times of economic decline, then it would soon stimulate the economy. He argued that through the excessive government spending, incomes would rise and so would purchases of goods and services. Eventually, this would stabilize the economy and take the country out of decline and into a state of economic growth. His theory was proved when President Franklin D. Roosevelt took action during World War II and spent an excessive amount of money which ending up in economic growth, as Keynes had said it would (What is Fiscal Policy?).

More recently, as of the 1980s, the main goal of fiscal policy has focused on reducing the budget deficit that has skyrocketed since World War II. Because of such things as new technology and foreign trade opportunities economic growth has been happening automatically, and the deficit only continues to rise (What is Fiscal Policy?). The War in Iraq has also caused the deficit to steadily increase, and George W. Bush is currently under pressure to find a way to decrease it. Although the overall goal of fiscal policy is to achieve broad goals of the economy, it now focuses on smaller goals as well.