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