The trade-offs of trying to reach surplus

The following is from Question Time in the New Zealand Parliament on June 4th (emphasis added):

Paul Goldsmith: Why is it important that the Government gets back to surplus and starts repaying debt?
Hon BILL ENGLISH: Although the level of Government debt is well below that of many other Governments that we compare ourselves with, it is important that we keep Government debt low in order to offset very high household debt and to ensure that we can manage through another recession. Net Government debt is still rising today by around $130 million a week and will reach $70 billion in 2016-17, up from around $10 billion just 5 years ago. That is the equivalent of around $15,000 for each and every New Zealander. We simply believe that it would be prudent to return Government debt to lower levels so that we are better able to reduce the pressure on interest rates rising sooner than they otherwise would, and reduce pressure on an exchange rate that is already higher than is comfortable for us.

Economists will always remind you that there are trade-offs to be considered when making choices - in order to get more of something, we have to accept having less of something else. Now in this case, Mr. English "simply believes" it's better to make loads of spending cuts* that are actually depressing economic growth, affecting the lives of our most vulnerable citizens, and increasing unemployment (these are the trade-offs), in order to keep interest and exchange rates down for longer**. 

Is he really considering the trade-offs here? What are the real benefits of keeping interest rates down for longer? And even then, how much influence does government spending actually have on interest rates anyway? Looking at the chart below, there doesn't seem to be any such link between interest rates, inflation, and government spending over the last 15 years. In fact, interest rates came down at the same time as government spending spiked following the global financial crisis in 2008. You make up your own mind...

* For those of you that doubt the size of cuts that the National government has made over the past few years, my next post will show you how extensive they are.
** Incidentally, Mr. English has laughed off intervention in the exchange rate as proposed by opposition parties, but here he is implying that this is part of the reason for targeting surplus!

Thought experiment

Imagine that the Treasury of the New Zealand government had an overdraft facility on its existing account (called the Crown account) with the Reserve Bank of New Zealand (RBNZ). This would mean that when the government wanted to spend, it would debit the Crown account, as it does currently, but would not have to worry about whether or not there was a positive balance in that account. In other words, the government wouldn't have to issue debt (sell government bonds) in order to cover the shortfall between what it receives in taxes and what it wants to spend. In case you didn't know, this shortfall is the deficit. 

And then imagine that the RBNZ takes on the roll of issuing "debt" into the market (instead of the government) - not because it has to, but because it needs to replace the role that the Treasury would usually have as part of the RBNZ's monetary policy. 

The key thing to note here is that as far as the non-government sector is concerned (that's us), nothing has changed. The market can still purchase "risk-free" assets, but those will consist of bonds and bills issued by the RBNZ instead of the Treasury. However, the big change for the government is that it wouldn't have to "borrow" money from the non-government sector; we would no longer have to be concerned with rising government debt.

Anyway, getting back to the overdraft on the Crown account: since the overdraft is provided by the RBNZ, the Treasury never has to worry about repaying it. Why would it? The RBNZ doesn't need the money back - it created the overdraft out of nothing in the first place - it's all just numbers in a computer! And if that's the case then it wouldn't matter if the government spent more than it received from taxes (a deficit) or spent less (a surplus). So any government policy that explicitly targeted "reaching surplus" would be pointless. Therefore, targeting budget outcomes along these lines would be completely arbitrary. 

Now as it turns out, when we take a consolidated view of the way the Treasury and the RBNZ operate, we see that it actually works the same way as the system I've laid out above, with the exception being that the "debt" is recorded on the Treasury's balance sheet under the current system (this is the government debt) as opposed to the RBNZ's balance sheet. But it's really just the same thing. 

The whole point of this post is to show you that trying to reach surplus has no relevance to, well, anything really! So the next time you hear Bill English talking about how the government expects to reach surplus by [insert date here], then remember that it just doesn't matter. And if he tells you that we need to reach surplus in order to build up a "buffer" against the next financial crisis, remember that the government can always spend when it needs to - and so again, it just doesn't matter! 

To be fair, I'm not just picking on National here - the opposition parties also think that it's important to reach surplus. So why do they all think this? It's probably a mixture of 1) not understanding the monetary system properly; and 2) knowing that voters are (mistakenly) worried about government debt. 

But now you know, it's nothing to worry about...