On Tuesday last week, the New Zealand Treasury outlined five economic scenarios that aimed to depict how the economy may react to COVID-19. All five included the baseline NZ$20 billion fiscal rescue package announced by the Government. Treasury then modelled the impact of increasing the fiscal rescue package to $40 billion and then $60 billion. Both models showed positive employment and output outcomes from the spending when compared to the original forecasts. Thus the big message is that Government spending in the right places will help improve outcomes for all New Zealanders in the near future. But how can we afford such massive cash injections?  

Where will we get the money to bring our level of public debt back to prudent levels?

New Zealand has prided itself in recent years for maintaining a low Government debt to GDP ratio (our level of public debt vs the total value of what’s produced in our economy each year) compared to other countries. It was a prudent strategy that our leaders took so we would be well placed to deal with a major economic shock. Clearly the Covid-19 crisis is such a shock, and it is right that debt levels should rise. But if there were another big shock in the near future, say a Wellington earthquake or another vicious pandemic, our higher debt levels would mean that we would either have no capacity or a much reduced capacity to cope. So while we’re well placed to borrow now to weather this crisis, to be similarly prepared for what is coming we will need to get debt levels back down again. This leads to the most important question: where will we get the money to bring our level of public debt back to prudent levels?

When it comes to paying off debt there are a number of options to be considered. We can use tax revenue over long periods, effectively getting future New Zealanders to pay for our rescue package. We can also raise taxes in the short term to get the current generation to pay. Or we can try printing money and explicitly aim for increased inflation to play a part in making our debt disappear over time (we hope at least). The reality is that a mix of all these options are probably being considered. The eventual mix, and the measure to which each option is used will have significant impacts on who feels the brunt of the cost for our rescue package. Being honest about these impacts, and the potential winners and losers of each option is an important consideration.

When it comes to paying off debt there are a number of options to be considered.

At the moment we are leaning toward making future generations pay. What this means is that people with savings who can afford to lend the government money now do so, and then in the future the government pays these people back by raising taxes or spending less on government transfers (like the Job Seeker Benefit and Working For Families) and government services. This might mean lowering the welfare safety net, or changing super-annuation so it pay out less than what people receive today. But it can also mean having less money to spend on repairing or upgrading our health facilities (similar to what happened after the GFC) or having limited ability to invest in cutting edge medicine for people who have cancer. These would be stark choices.

There is also the option of paying (or at least part paying) ourselves. The first way this can be achieved is by raising taxes now on those we think can afford to pay more in tax.  While the obvious choice in the minds of many will be higher income earners, income doesn’t tell us the whole story about a person’s capacity to afford a higher tax bill. An individual earning $65,000 a year would likely be better able to afford a tax increase than a single parent of four who earns $97,000 per year. Another choice being talked about is some form of capital or death tax. A less obvious choice that could still be on the table might be to raise GST. All of these options redistribute people’s money back toward those wealthy savers who have lent money to the government and each is fraught with difficult choices.

A substantial and sustained rise in inflation would have untold damage on the financial system and to people’s savings

What of the third strategy? Can we just resolve the situation by the Reserve Bank just printing more money and then the government giving this to people to spend? This strategy—commonly known as “helicopter money”—has the potential to be effective in times when the economy has a lot of unused capacity for growth (in a recession), but it cannot overcome the current restraints on the supply side of our economy that have come as a result of the Covid-19 restrictions so it’s a finely balanced path to tread. If we were to see a continual oversupply of new money pushed into our economy, it is likely we would see high levels of inflation, which devalues people’s savings while increasing consumer prices and potentially pushing up the price of fixed assets like housing.

Given the scale of the expected rise in the government debt we would eventually expect a substantial rise in inflation if we don’t pay for the debt by raising taxes and/or cutting back on spending. A substantial and sustained rise in inflation would have untold damage on the financial system and to people’s savings—leaving many much less prepared to sustain themselves through further shocks or even their retirement years.

Overall, we are making enormous personal sacrifices to deal with Covid-19. To support and mitigate those personal sacrifices the Government is now incurring huge amounts of debt to cover the gap between its current spending and expected revenue. This is the right response to the current circumstances, but this debt poses a major challenge for New Zealanders now and the future. While the temptation to simply print money is strong, the risk of sustained high inflation means it should only be used sparingly, while in deepest recession, alongside more traditional forms of quantitative easing. The heavy lifting of debt repayment will need to be done by some combination of the more difficult options: higher taxes and some form of restrained government spending in the future. Prudence and equity might well mean we should shoulder some of the costs of our rescue package now. This will not only help bring the debt to GDP ratio back down but over a longer period of time will mean we have room to respond with similar speed to the next economic shock that comes our way.